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Let's say you buy stock XYZ, current price $20, you buy 10 call contracts with for the June 17, 2016 expiration date and strike price of $25.
Let's say this order cost you $500.
Now, on June 17, if the price of XYZ is $27, you would exercise the contracts (1000 shares) and you would make $1500 on this trade (1000 x $2=2000-$500)
Options are tricky. You lose the premium over time. But technically your post is correct. Except your premium would be a lot higher, I would say more than $500.
Let's say you buy stock XYZ, current price $20, you buy 10 call contracts with for the June 17, 2016 expiration date and strike price of $25.
Let's say this order cost you $500.
Now, on June 17, if the price of XYZ is $27, you would exercise the contracts (1000 shares) and you would make $1500 on this trade (1000 x $2=2000-$500)
Is this correct?
That's all fine, but say the price went to 27 in the first week you owned it. Then the premium would go up before the expiration and you could sell the options, likely for more than you originally paid. It's not impossible for the value of an option to go up 2x, 3x, or more if the price of the underlying security moves favorably.
It's also possible that the price of the option will move toward zero if the price of the underlying security starts looking like it's never going to reach the strike price.
As Newbie pointed out, the premium always goes to zero as the expiration date approaches. If you paid $500 today, about 40 days out, then 20 days out ( about May 28 ) then your option might only be worth half of what it is today.
-o- If the price of XYZ was up around $24, it might still be worth $500.
-o- If XYZ was still around $20, the option might be worth only $150.
-o- If XYZ dropped to $15 it might essentially be worthless.
The aim of buying the option isn't really to exercise it, but to sell it for more than you paid.
BTW, for your original post, exercising the options doesn't make you any money. It just gives you a lower basis in your 1,000 shares of XYZ.
That's not correct. You are missing a lot of things that go into pricing options. You should google the Greeks of options and read up.
Explain how the greeks would make this hypothetical trade "Not correct".
QUOTE..... "you buy 10 call contracts with for the June 17, 2016 expiration date and strike price of $25.
Let's say this order cost you $500.
Now, on June 17, if the price of XYZ is $27, you would exercise the contracts (1000 shares) and you would make $1500 on this trade (1000 x $2=2000-$500)" Unquote
The only thing incorrect is he left out transaction costs. If he has 10 call contracts with a strike of 25 and he can exercise them at 27 what "Greek" would make this incorrect? He is exercising them on the settlement date. There is no theta left.
That's all fine, but say the price went to 27 in the first week you owned it. Then the premium would go up before the expiration and you could sell the options, likely for more than you originally paid. It's not impossible for the value of an option to go up 2x, 3x, or more if the price of the underlying security moves favorably.
It's also possible that the price of the option will move toward zero if the price of the underlying security starts looking like it's never going to reach the strike price.
As Newbie pointed out, the premium always goes to zero as the expiration date approaches. If you paid $500 today, about 40 days out, then 20 days out ( about May 28 ) then your option might only be worth half of what it is today.
-o- If the price of XYZ was up around $24, it might still be worth $500.
-o- If XYZ was still around $20, the option might be worth only $150.
-o- If XYZ dropped to $15 it might essentially be worthless.
The aim of buying the option isn't really to exercise it, but to sell it for more than you paid.
BTW, for your original post, exercising the options doesn't make you any money. It just gives you a lower basis in your 1,000 shares of XYZ.
He isn't asking about what happens between the purchase and exercising. He paid 500 for the 25 calls and on settlement the underlying is trading at 27. That is 200 dollars per contract. There is no "could have", "Might" or "if" in the question.
Explain how the greeks would make this hypothetical trade "Not correct".
QUOTE..... "you buy 10 call contracts with for the June 17, 2016 expiration date and strike price of $25.
Let's say this order cost you $500.
Now, on June 17, if the price of XYZ is $27, you would exercise the contracts (1000 shares) and you would make $1500 on this trade (1000 x $2=2000-$500)" Unquote
The only thing incorrect is he left out transaction costs. If he has 10 call contracts with a strike of 25 and he can exercise them at 27 what "Greek" would make this incorrect? He is exercising them on the settlement date. There is no theta left.
I totally missed it was being done on expiration date
He isn't asking about what happens between the purchase and exercising. He paid 500 for the 25 calls and on settlement the underlying is trading at 27. That is 200 dollars per contract. There is no "could have", "Might" or "if" in the question.
How do you know that the OP knows that they can sell between purchase and exercising?
I apologize if I read too much into it, but from questions I've previously gotten, many people don't understand that the options are also a security and can be bought and sold. It would be entirely possible for the OP to make their $2,000 without the price going above $26 in this case.
I thought that some explanation of what "could have" or "might have" or "if" was entirely appropriate given the fact that an assumption was being made about making money when no money was made in the scenario proposed.
The original question seemed to indicate that on exercise, money was made, but no. The OP would simply own 1,000 shares of XYZ at a price of $25. There would be no money made until the shares were sold at a price North of $25.50. ( ignoring commissions )
How do you know that the OP knows that they can sell between purchase and exercising?
I apologize if I read too much into it, but from questions I've previously gotten, many people don't understand that the options are also a security and can be bought and sold. It would be entirely possible for the OP to make their $2,000 without the price going above $26 in this case.
I thought that some explanation of what "could have" or "might have" or "if" was entirely appropriate given the fact that an assumption was being made about making money when no money was made in the scenario proposed.
The original question seemed to indicate that on exercise, money was made, but no. The OP would simply own 1,000 shares of XYZ at a price of $25. There would be no money made until the shares were sold at a price North of $25.50. ( ignoring commissions )
Sorry for the reply. Yes it is important that people understand options thoroughly if they intend to trade them.
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