Options traded both on the exchange and in the over-the-counter market. Call option and put option. Now we will discuss the call option.
Call option gives holder to right buy the underlying the price of an option to purchase one share is $5.The initial investment is $500.The option is European.
The investor can exercise only on the expiration date. If the stock price on this date is less than $60. The investor will clearly choose not to exercise. In these circumstances. The investor loses the whole of the initial investment of $500.If the stock price is above $60 on the expiration date the option exercised.
Suppose that the stock price is $75.By exercising the option, the investor is able to buy 100 shares for 60 per share. If the share sold immediately investor gain of $15 per share or $1500 ignoring transaction costs. When the initial cost of the option taken into account, the net profit to the investor is $1000.
Profit from buying a call option
A put option gives the holder the right to sell the underlying asset by a certain date for certain price. The purchase of a put option is hoping that stock price will decrease.
An investor who buys a European put option to sell 100 shares with strike price of $90.Suppose that the current stock price is $85.Expiration date of the option is in three months and the price of option to sell one share is $7.
The initial investment is $700 Because the option is European.it will be exercised only if the stock price is below$90 at the expiration date. Suppose that the stock price is $75 on this date.
The investor can buy 100 share for $75 per share and under the term of the put option sell the same share for $90 to realize a gain of $15 per share or $1500.
When the $700 initial cost of the option is taken into account. The investor’s net profit is $800.There is no guarantee that the investor will make a gain. If the final stock price is above $90, the put option expires worthless, and the investor loses $700.
Profit from buying a put option