Terminology and valuation relating to a call option. A Milwaukee manufacturer us
admin / July 3, 2018
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Terminology and valuation relating to a call option. A Milwaukee manufacturer uses copper in its manufacturing operations and anticipates that copper prices will increase over the next several months. On February 1 the company purchased an at-the-money May call (buy) option for $800. The option has a notional amount of 25000 pounds and a strike price of $0.80 per pound. Copper spot rates and option values at selected dates are as follows:Spot Rate per PoundOption Value28-Feb$79$70031-Mar8180030-Apr85140015-May8717501. For each of the above dates calculate the intrinsic value and the time value of the option.2. If the call option were designated as a hedge of a forecasted purchase of copper explain how the changing value of the option would be recognized in the income statement over time.3. If the price of copper remained below $0.80 per pound subsequent to February 1 calculate the effect on earnings traceable to the hedge.4. Explain why the pure time value of the option would be expected to decrease over time.
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