The variance between the underlying asset price and the option exercise price is categorized as __________?
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Answer: B. intrinsic value of option
Explanation
Intrinsic value is defined as the absolute difference between the underlying asset's market price and the option's exercise price. An option possesses intrinsic value only when the current asset price is favorable relative to the specified strike price. Calculating this variance tells investors the immediate monetary payoff they would receive if the option were exercised immediately. Options are categorized as being in-the-money, at-the-money, or out-of-the-money based entirely on their calculated intrinsic value. Intrinsic value can never be negative; if the price variance is unfavorable, the intrinsic value is simply recorded as zero. This foundational metric separates the hard financial value of an option from its speculative extrinsic time value premium.
Extrinsic value of European option measures time and volatility premiums rather than the direct price variance between asset and strike. Extrinsic value of option refers to time premium and volatility factors instead of the absolute price difference defining intrinsic worth. Intrinsic value of European option adds regional terminology unnecessarily, as intrinsic value calculations apply equally to American styles.
- Subject
- Accounting and Finance
- Category
- Finance
- Topic
- —
- Difficulty
- medium
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