Call Options

 If you buy a call option on IBM with an

expiration date in October and an exercise
price of $100, you have the right to buy
shares of IBM at a price of $100 any time
until October.
 You need not exercise a call option:
It will be profitable to do so only if the
share price exceeds the exercise price.
 If the share does not exceed the exercise
price, the option will be left unexercised
and will prove to be valueless.
 Suppose IBM shares are selling above the
$100 exercise price, say at $120, just
before the call option expires. You will
choose to exercise your option to pay $100
to buy shares worth $120.
 Your net proceeds upon exercise equal the
difference between the $100 paid and the
$120 you can realize for the shares.
 However remember the call option
premium which has to be deducted to
arrive at the net gain from the transaction.
 Call Option :
 On July 23, 1999, a call option on Compaq
with a January, 2000, expiration and an
exercise price of $30 per share sold for $2.
If you had purchased the call on this date,
you would have had the right to purchase
shares of Compaq for $30 anytime until
the option expired in January.
 On July 23, Compaq shares sold for $24.75.
Immediate exercise of the call would have
resulted in net proceeds of $24.75 - $30 = -$5.25.
 If Compaq sold in January, for $35, the proceeds
from exercising the call would have been:
 Proceeds: $35 - $30 = $5, and the net profit on
the call would have been:
$5 - $2 = $3 I.e. in 6 months you would have
earned a return of $3\$2 = 150 percent.
 Put Option
 A put option gives the right to sell a share
of stock for the exercise price. If you hold
a put on a share of stock and the stock
price turns out to be greater than the
exercise price, you will not want to
exercise your option to sell the shares for
the exercise price. The put will be left
unexercised and will expire valueless.
 If the stock price turns out to be less than
the exercise price, it will pay to buy the
shares at the low price and then exercise
your option to sell it for the exercise price.
The put would then be worth the difference
between the exercise price and the stock
price.
 Put Option :
 On July 23, 1999, it cost $6 7/8 to buy a
put option on Compaq stock with a
January, 2000, expiration and an exercise
price of $30. Suppose Compaq is selling
for $20 just before the put option expires.
Then if you hold a put, you can buy a share
of stock for $20 and exercise your right to
sell it for $30.
 The put will be worth $30 - $20 = $10.
Because you paid $6 7/8 for the put
originally, your net profit is $3 1/8. If the
stock price is above $30 on the maturity
date, you will let the put option expire
worthless. Your loss equals the $6 7/8 you
originally spent to purchase the put.
 Compaq $20 $25 $30 $35 $40 $45
 Call value 0 0 0 $5 $10 $15
 Put value $10 $5 0 0 0 0
 In some cases, the option can be exercised
only on one particular day, and it is then
conventionally known as “European Call”.
 In other cases, it can be exercised on or
before the expiration date, and it is then
known as an “American Call.”
 Selling Calls and Puts
 Options are not sold by the companies
themselves but by other investors.