WHAT IS A STOCK OPTION? – Lesson 5

Copy of canstockphoto49786261

OPTION:

The right (not the obligation) to buy or sell a

SPECIFIC STOCK at a certain PRICE for a limited TIME.

****ONE Option Contract = ONE HUNDRED Shares of Stock****

Question:

An Option:
1.___ Obligates you to buy the underlying stock
2.___Has an expiration date.
3.___ Can only be bought.

Answer: 2

 

 

When you Think the Underlying Stock will go Up.

1. Every underlying stock has an OPTION CHAIN,
(Future section on how to read an Option Chain)

2. Every Option Chain has a list of EXPIRATION DATES.

 

3. Every Expiration Date has a list of STRIKE PRICES.

 

4. Every Strike Price has a daily BID and ASK –
high/low Option Premium Price.

 

 

EXAMPLE OF AN ORDER FOR A CALL OPTION

 

Let’s place an order for some snow shovels in hot June.

 First, lets take a look at Snow
Shovels Inc.’s OPTION CHAIN:

Handout 1

 

canstockphoto8448499Hardware Store Co. forecasts that in
NOVEMBER they will need a lot of snow shovels.
In JUNE, Hardware Store Co. buys one Option
with Shovels Inc. to provide 100 snow
shovels for $10 each (resale value $40)
until 3rd Friday in NOVEMBER for $157.

 

Sample of an option listing: “Buy 1 SHOV November Call 10.00 @ 1.57”
Can you find “10.00” and “1.57” on SHOV Option Chain above?

 

Snows in NOVEMBER. Hardware Store Co. pays Shovels Inc.
$1,000 for 100 snow shovels (plus the $157 option, which they already
paid upfront) = $1,157 total cost.

Hardware Store Co. sells the shovels for $40 each = $4,000
Minus $1,157 cost = $2,843 profit.

 

Questions:

1.How much profit did Hardware Co. make when it snowed?
A.___Zero, he needed more shovels.
B.___He lost customers and $157.
C.___He made $2,843 profit.

2. How much did Hardware Co. pay Shovels Inc. for 100 shovels?
A.___$1,157
B.___$1,000
C.___$157.00

3. One Option equals how many snow shovels (shares of stock)?
A.___10
B.___157
C.___100

Answers: 1: C — 2: A — 3: C

 

Let’s look at another CALL option:

canstockphoto10328587General Motors stock share price is $88.16
GM is coming out with a self driving car

You think the stock price will go up and buy a
DECEMBER $87.50 CALL @ $2.81.
To make a profit, GM will have to pass $87.50

Buy 1 GM December Call 87.50 @ 2.81
(1 contract = 100 shares X 2.81 = $281.00

GM stock price goes up to $90.50
Sell 1 GM December Call 87.50 @ 4.41
You have profited by $160.00
(4.41 minus 2.81=1.60 X 100 = $160.00

 

Questions:

1. How much did one GM Call contract
for 100 shares
cost to buy?
A.__$2.81
B.___$87,50
C.___$281.00

2. How much did you sell one GM contract for?
A.___$4.41
B.___$441.00 for 100 shares
C.___$90.50

3. Did you make a profit or loss?
A.___I’m in a hole on this one
B.___Only a measly $1.60
C.___$160.00 (1.60 X 100)
ANSWERS:
1–C
2–B
3–C

 

After BUYING A CALL you have three choices:

1. Sell the Call for a profit

2. Exercise and buy the stock

3. Sell for a loss, or allow the option to expire worthless

Question:

You have three choices after buying a call:
A.___Exchange it for another company’s stock
B.___Trade it in for a new one
C. ___Sell the call
D.___Exchange it for a Put

Answer: C

 

PUTS

canstockphoto2188921

When you think the UNDERLYING STOCK will go DOWN.

General Electric stock price is s$81.20
GE is exiting the appliance business and you think the stock will go down.
Buy 1 GE Jan Put $80 @ 70¢
1 contract = 100 shares X 70 cents = $70.00

GE stock price goes down to $78.20

Sell 1 GE January PUT $80 @ 90¢
To open the order, you paid 70¢ X 100 shares=$70.00
To close this order, you received 90¢ X 100 shares = $90.00

Question:

How much profit did you make?
A.___$80.00
B.___$78.20
C.___$20.00
How did you calculate that profit?

A.___$80 minus $78.20
B.___70¢ plus 90 ¢
C.__90¢ minus 70¢ X 100
Answers: 1. — C, 2.– C

Let’s have a cup of coffee

 

Starbucks stock share price is $40.00. Coffee beans have skyrocketed in price and Starbucks is losing money.
You think the stock price will go down, so you buy a put.

canstockphoto21251154You buy a December $38 PUT @ $2.00
To make a profit, the faster and further the stock declines,
the more valuable your PUT option becomes
Buy 1 SBUX December Put 38 @ 2.00
(1 contract = 100 shares X 2.00 = $200.00)

SBUX stock price goes down to $36.00
Sell 1 SBUX December Put 38 @ 3.50
You have profited by $150.00

 

QUESTIONS

1.Why did you buy a 38.00 Put?
A.___I think the stock will go to $38 or lower
B.___I want to make $38.00 profit
C.___I like coffee

2.How much is the PREMIUM @ the stock price of $36.00?
A.___$1.50
B.___$3.60
C.___$3.50

3.How did you calculate a $150 profit?
A.___$3.50 minus $2.00 X 100
B.___$2.00 plus $3.50
C.___$40.00 minus $38.00
ANSWERS
1.– A, 2.– C, 3.– A

After BUYING A PUT, you have three choices:

1. Sell the put

2.Do nothing and it will expire

3.Exercise and convert your option into a Short Position and then sell.
(“Short a stock” = You borrow stock and immediately
sell it – hoping you can buy it at a lower price and return
it to the lender and pocket the profit.)

 

SO WHAT’S SO GREAT ABOUT AN OPTION??

ANSWER: 10% vs 181.5% return !

STOCKS vs OPTIONS
Disney (DIS) Stock @ $111.75

Disney STOCK:

Buy per share @ $111.75 X 100 shares = $11,175.00 INVESTED

Sell @ 10% increase: $122.93 X 100 = $112,203.00
($122.93 minus $111.75 = $11.18)

Increase per share = $11.l8 X 100 shares = $1,118.00 Profit

Stock % Gain = 10%

Disney OPTION:

Buy $110 Call option: $2.60 premium X 100 shares = $260.00 INVESTED

Sell Call @ 10% stock increase: $7.32 premium X 100 = $732.00

($7.32 minus $2.60 = $4.72)

(Option increased 20 – 30% on 10% stock increase)

Increase per option = $4.72 X 100 = Profit: $472.00

Option % Gain = 181.5%

Stock Investment: $11,175.00 – 10%

Option Investment: $260.00 – 181.5%

 

 

Please scroll way down to: “How a Stock and Option are Linked”

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