Overwriting

Finance allah shmoop what are stock options in ninety seconds

or less Here's a stock ibm not the tech company

This one makes an anti constipation drug It's trading at

one hundred eighty bucks a share Okay so here's an

option of buy a share of ibm anytime in roughly

the next three months For one hundred ninety dollars a

share it's called a call option If you really believe

the ibm will go to say two hundred dollars a

share in the next three months well you'd be what's

called ten dollars in the money then or then have

a stock option or call option with a strike price

of one hundred ninety dollars which would then have intrinsic

value of ten bucks a share On the other end

of the buy sell desk is the gal willing to

sell you that call option for three bucks Three bucks

a premium So gut check time Would you pay three

dollars for the right to buy a share if ibm

for ten dollars higher than where the stock's trading now

today Meaning that to break even in the next three

months the stock has to trade all the way up

from one hundred eighty dollars a share to one hundred

ninety three dollars a share jobs for you to get

your money back but it goes to two hundred two

share Well if you sell that option you'll have invested

three bucks a share for a net return of seven

bucks in just three months or less And yes we're

ignoring commissions and taxes here because well in problems like

this or just a in the book but three dollars

into seven only three months Yeah that's a great score

You'd have more than doubled your money And on an

annualized return basis that's over a nine hundred percent dish

return really good score but with a much more likely

case that you spend three bucks to buy the option

and it expires totally worthless And then you've lost your

entire investment in that option So that's a call option

It's evil twin is a put option So whereas a

call options the rightto by a security to set price

by a certain set date a put option is the

right to sell that option We'd go into more detail

here but we're promised ninety seconds