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Basics of options, here is an example of how they work. We'll use a fictional firm called Cory's Tequila Company. Let's say that on May 1, the stock price of Cory's Tequila Co. is $67 and the premium (cost) is $3.15 for a July 70 Call, which indicates that the expiration is the third Friday of July and the strike price is $70. The total price of the contract is $3.15 x 100 = $315. In reality, you'd also have to take commissions into account, but we'll ignore them for this example. Remember, a stock option contract is the option to buy 100 shares; that's why you must multiply the contract by 100 to get the total price. The strike price of $70 means that the stock price must rise above $70 before the call option is worth anything; furthermore, because the contract is $3.15 per share, the break-even price would be $73.15. When the stock price is $67, it's less than the $70 strike price, so the option is worthless. But don't forget that you've paid $315 for the option, so you are currently down by this amount. Three weeks later the stock price is $78. The options contract has increased along with the stock price and is now worth $8.25 x 100 = $825. Subtract what you paid for the contract, and your profit is ($8.25 - $3.15) x 100 = $510. You almost doubled our money in just three weeks! You could sell your options, which is called "closing your position," and take your profits - unless, of course, you think the stock price will continue to rise. For the sake of this example, let's say we let it ride. By the expiration date, the price drops to $62. Because this is less than our $70 strike price and there is no time left, the option contract is worthless. We are now down to the original investment of $315. An option is a contract giving the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date. • Options are derivatives because they derive their value from an underlying asset. • A call gives the holder the right to buy an asset at a certain price within a specific period of time. • A put gives the holder the right to sell an asset at a certain price within a specific period of time. • There are four types of participants in options markets: buyers of calls, sellers of calls, buyers of puts, and sellers of puts. • Buyers are often referred to as holders and sellers are also referred to as writers. • The price at which an underlying stock can be purchased or sold is called the strike price. • The total cost of an option is called the premium, which is determined by factors including the stock price, strike price and time remaining until expiration. • A stock option contract represents 100 shares of the underlying stock. • Investors use options both to speculate and hedge risk. • Employee stock options are different from listed options because they are a contract between the company and the holder. (Employee stock options do not involve any third parties.) • The two main classifications of options are American and European. • Long term options are known as LEAPS. Stock and Option Trading Help
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