To illustrate how the Options game
works, we will use the stock of a fictional company called
Cocoa Corp. On January 31st, the stock price of Cocoa
Corp was $52. The Premium or Cost for
a June 60 Call is $2.50. This means that the expiration
date for the Option is the 3rd Friday of the month of
June and the Strike Price is $60. Note
that the total price of the strike is $2.50 x 100 shares
= $250.
We are multiplying the Premium of
$2.50 by 100 shares because a Listed Stock Option
Contract holds 100 shares each. The Strike Price
of $60 means the stock must go above
the $60 mark for the Option to be in a position
of profit and worth something. However, note
that since the Premium is $2.50, the Break Even
Price would be calculated as follows:
Break
Even Price = Premium Cost + Strike Price
Break
Even Price = $2.50 + $60
Break
Even Price = $62.50
|
Now assume that the price of the
stock (on March 15th) goes down to $47
in value. This $47 price is below the Strike Price of
$52 and your Option is therefore worthless. However, remember
that you've already paid $215 for this Option so you would
lose this initial investment.
Imagine that a month later on April
15th, the stock price skyrockets to $68. This
means you are in a position of profit of $68 - $60 = $8
x 100 shares = $800. However, you've already paid $250
for the right to acquire the Options, therefore your Net
Profit is summarized as follows:
Position
of Profit = Selling
Price - Initial Cost - Options Cost (Premium)
Position
of Profit = $68 - $60
= $8 per share
Position of Profit = $8 x 100 shares (listed option)
= $800
Net Position of Profit = $800 - $250
Net Position of Profit = $550 |
Upon the stock skyrocketing to $68
per share, you can "Close the Position" and
sell the stock. With this, you would net a profit of $550.
Consider another scenario where the price of the stock
is $55 on the Expiry Date of the Option. This means your
option has become worthless and you would lose the initial
investment of $250 paid to acquire the Option.
Here is a summary of all the transactions
above:
| Date |
March 15th |
April
15th |
Expiry
Date |
| Stock
Price |
$47 |
$68 |
$55 |
| Option
Price |
$2.5 |
$8 |
Worthless |
| Contract
Value |
$-250 |
$8 |
$-250 |
| Gain
or Loss |
$0 |
$550 |
$-250 |
