Canadian Securities Course (CSC) Practice Exam

What is the significance of the intrinsic value of an option?

1. Always negative

2. Cannot be calculated

3. Determines the premium

4. Represents the "in-the-money" value

The correct answer is: Represents the "in-the-money" value

The intrinsic value of an option refers to the difference between the current market price of the underlying asset and the exercise price of the option. This value is important because it represents the "in-the-money" value of the option, meaning the amount of profit that can be realized by exercising the option at its current price. In contrast, options with no intrinsic value (options that are "out-of-the-money") have a value of zero and can only be profitable if the price of the underlying asset changes in the desired direction. Option premiums are influenced by the intrinsic value, as well as other factors such as time to expiration and market volatility. Options with a high intrinsic value generally have a higher premium, while those with no intrinsic value may have lower premiums. Options with a negative intrinsic value (also known as "out-of-the-money" options) have no real value and are not profitable to exercise. Therefore, the significance of the intrinsic value is that it represents the real value and potential profitability of an option, making it a key factor to consider when trading options.