Financial Industry Regulatory Authority (FINRA) Practice Exam

What is likely to happen when an investor is long a call option and the underlying security rises above the strike price?

1. The call option will be exercised

2. The option will decline in value

3. The option will have no intrinsic value

4. The investor will let the option expire

The correct answer is: The call option will be exercised

When an investor is long a call option, they have the right to purchase the underlying security at a predetermined strike price. If the underlying security's market price rises above the strike price, the call option becomes more attractive because it allows the investor to buy the security at that lower strike price. This scenario creates intrinsic value for the option, which is the difference between the market price of the security and the strike price of the call option. As the underlying security increases in value beyond the strike price, the likelihood that the investor will exercise the option increases significantly. Exercising the option means the investor can purchase the underlying asset at a price that is lower than the current market value, potentially leading to a profit when they sell the asset at market price. Thus, the best outcome in this situation is that the call option will be exercised, making this the correct response. The other options do not align with this situation. For example, the option cannot decline in value in this context; instead, it generally increases as the underlying security price goes up. Additionally, if the market price exceeds the strike price, the option certainly holds intrinsic value instead of having none. Finally, letting the option expire would be counterintuitive because the investor would want to capitalize