Seth Harris is an avid investor who likes to speculate on stock price changes. Lately, he’s become bored with the slow movement of most stock prices and thinks options might be more exciting. He has been following the stock of Chelsea Club Inc., a women’s apparel manufacturer. Chelsea’s stock price has been stable for more than a year, but Seth is convinced it will increase in the near future but probably not rapidly.
Amanda Johnson owns 1,000 shares of Chelsea Club purchased a year ago at $37. She thinks the stock’s price will continue in the upper $30s indefinitely and may even fall a little. Her broker has recommended writing options as a source of income on stagnant stocks.
Chelsea is selling for $38, and six-month call options at a $36 strike price sell for $4.
This morning Amanda wrote call options on her 1,000 shares, which Seth bought through an options exchange. At the time of that transaction:
a. What was the intrinsic value of an option? b. What was the option’s time premium?
c. Was the call in or out of the money?
d. How much has Amanda invested?
e. What is the most Seth can make or lose?