Some exercises

Now that the basics of puts and calls are explained, it is time to get into exercises.

Value of a call option

You buy a call on stock ABC, strike 50€ and expiration on March 18. You pay 1€ for this.

Look at the graph below

ABCGoingUP

How much is the option worth at March 18? 

As the stock trades at 60€ on March 18,  the option is now worth 10€. The strike of the option is 50€, so you can buy at this price. 60€-50€=10€

What is you profit or loss on March18?

You initially paid a premium for 1€. The net gain is thus 9€. How so?

The call option is worth 10€ on March 18 and you paid 1€. 10 – 1€ = 9€

It is important to note that you need to take an action to realize this gain

1- sell you option on the market for 10€ and realize the gain of 9€ on the option

2- exercise your right to buy that stock at 50€. You now have a paper gain of 10€ on the stock and a real cost of 1€ (the option premium) (keep in mind the stock trading fee). To realize your gain, you need to sell the stock on the market

When you fail to do one of the above before the expiration day, you end up empty handed! After March 18, you loose you right to buy the stock!! Expiration date matters

As from when is the call option in-the-money?

Remember, a call option is in the money when the the stock trades above the strik price. In the example above, this means that the stock needs to trade above 50€. This happens Somewhere between 18 Jan and 18 Feb. After that date, the option stays ITM.

Value of a put option

You buy a put on stock ABC, strike 55€ and expiration on March 18. You pay 1,5€ for this.

Look at the graph below

ABCGoingUP

What is the option worth at March 18?

As you own a put at strike 55€ and the option trades above the strike, the option is worth 0€. As the stock trades 60€ on March 18, it does not make sense to sell the stock at 55€ You can sell it on the market at 60€.

What is you profit or loss on March 18?

As the option is worth 0€ on March 18, you have a los of 1,5€. This is the premium you paid for the option.

When is the put option at the money?

An option – both put and call- are ATM when the stock trades around the strike price. In the given example, this happens twice: One around Feb 1st (the first peak) and one around Feb 18.

 

Value of a put option

You buy the March 18 put strike 50€ for 2€.

ABCgoingdown

What is the value of the option at expiration?

At expiration ,t he option is worth 5€. You can sell for 50€ something that is worth 45€ in the market: 50€ – 45€ = 5€

What is you profit or loss on March 18?

As the option is worth 5€ and you paid a premium of 2€, the profit is now 5€ – 2€ = 3€

Till when is the put option out-of-the-money?

A put option is OTM as long as the market price of the stock is above the strike. this means that the put option is OTM till March 1st (the time when the stock prices drops below the strike of 50€)

Options lingo

Learn about puts.

Learn about calls

 

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