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IBBC CAPITAL ACADEMY / 2027

Option exercise value, time and sensitivities

Independent IBBC Capital draft content for self-study. Not affiliated with or endorsed by CFA Institute. New lessons await subject-matter review. No CFA designation or official PSM credit is awarded.

Learning goals

  • Explain moneyness and value using mechanisms and limitations.
  • Explain pricing influences using mechanisms and limitations.
  • Explain exercise conventions using mechanisms and limitations.

Draft · approximately 35 minutes, excluding further revision.

Moneyness and value

Intrinsic value is immediate exercise value under the contract; option price also reflects remaining uncertainty and exercise opportunities, so payoff and price differ.

A call is in the money when spot exceeds strike; a put is in the money when strike exceeds spot, irrespective of the premium originally paid.

Pricing influences

For standard options all else equal, a higher underlying price raises call value and lowers put value; a higher strike has the opposite directional effect.

Greater volatility generally benefits a purchased vanilla option because upside exercise opportunity is retained while exercise is optional; this does not guarantee profit after paying a rich premium.

Exercise conventions

Dividends and financing rates affect call and put values through carry; separate a dividend forecast from the already observed spot movement.

American exercise permits action before expiry while European exercise is at expiry; early-exercise value depends on payouts, financing and contract terms.

State replication and no-arbitrage option bounds

A forward payoff is linear in the underlying, so cash plus underlying can replicate delivery at a fixed strike across all final prices. A call has a kink at strike and is not replicated globally by one constant stock/bond mix. A two-state binomial model can replicate it within the two modeled states, while a richer state space requires dynamic hedging or additional instruments.

For a European call on a non-dividend stock with positive financing rates, lower bound is max(S−PV(K),0), upper bound S. With S100,K100 and one-year5%, PV(K)=95.2381, lower bound4.7619. A call offered at3 would violate the frictionless lower bound; the arbitrage comparison must include stock, strike financing and the option. Dividends, early exercise and trading frictions require adjusted bounds.

Formula and assumptions

Call intrinsic=max(S−K,0); put intrinsic=max(K−S,0)

Original applied case: Option exercise value, time and sensitivities

  1. A call price is 9, spot 104 and strike 100; consider immediate exercise value only.
  2. Intrinsic value=4; price minus intrinsic=5 as the quoted time-value component.
  3. The 9 premium is not a guaranteed profit; exercise and investment profit require different calculations.

Errors to catch

  • Do not assume: An option price must always equal current exercise value.
  • Do not assume: Moneyness depends only on the premium paid.
  • Do not assume: A higher underlying price lowers a standard call value.

Original knowledge check

Answer every question before checking. Review explanations after submitting; retry starts a new attempt.

Sources and coverage status

These original lessons are drafts. Public outlines are used to check scope; the official learning-outcome text and proprietary question banks are not reproduced here. Follow the source for exam-year requirements and updates.