On July 1, 2014, Stan Getz, Inc., bought call option contracts for 500 shares of Selmer Manufacturing cotton stock. The contracts cost $200, expire on September 15, and have an exercise price of $40 per share. The market price of Selmer’s stock that day was also $40 a share.
On July 31, 2014, Selmer stock was trading at $38 a share, and the option contracts’ fair value was $125—that is, Getz could buy the identical $40 strike price contracts on July 31 for $125.
On August 31, 2014, the market price of Selmer stock was $44 a share, and the fair value of the options contracts was $2,075.
1. Prepare the journal entry to record Getz’s purchase of call option contracts on July 1, 2014.
2. Prepare the journal entry to record the change in fair value of the option contracts on July 31, 2014.
3. Prepare the journal entry to record the change in fair value of the option contracts on August 31, 2014.
4. Why are the option contracts worth so much more on August31 ($2,075) than they were worth on July 31 ($125)?
5. What entry would Getz make to record exercising the options on September 15, 2014, when Selmer’s shares were trading at $46?
6. Suppose instead that Getz allowed the option contracts to expire on September 15, 2014, without exercising them. What entry would Getz then make?