Question

On April 1, 20X1, Peanut Company purchased a call option for 10,000 shares of Sax Company that expires on October 1, 20X1. On the date that Peanut Company purchases the option, the strike price is $25. Additionally, the option is purchased for $10,000. On April 2, 20X1, the price per share of Sax Company stock is $23.75. The price remains at $23.75 through the date of the expiration of the call option. Prepare the journal entries to record the initial acquisition of the option and the expiration of the option 6 months later.

Answer 1

Exercise date of option on 10000 shares = April 1, 20X1

Expiry date of option = October 1, 20X1

Strike price = $25

Option premium paid = $10000

Call option is taken for upside betting and it is exercised only when the price of share on which call option is taken is above exercise price i.e. strike price. If the price of share is below exercise price then call option is lapsed and premium paid to take call option is considered as net loss to the buyer of option.

In our question, Strike price which is also known as exercise price is $25 and price of share on the date of expiration is $23.75 which is below the strike price of $25. It means that call option is lapsed and loss to the buyer is option premium paid i.e. $10000.

Journal entry to record the initial acquisition of the option:

April 1, 20X1​

Call option Dr 10000

Cash Cr 10000

(Option premium paid for purchasing call option)

Journal entry to record the loss on expiration of option

October 1, 20X1​

Loss on expiry of option Dr 10000

Call option Cr 10000

(Loss recognised on expiry of option)