In this series, on alternate weeks, I’m going to go through the subject of options in the most basic way. Even if you’re a veteran, these articles may give you a deeper understanding of some aspects of options than you had before.
Last time, in the article you can review here, we introduced an example involving Call options on the stock of Apple Computer. As of that writing (August 29, 2012), Apple’s stock had closed at a price of $673.40. Among the many available call and put options, we looked at call options with a strike price of $650 and an expiration date of September 22. Those calls were selling for $27.60 per share, which was $2760 per contract.
Let’s see how the buyers of these calls could make out:
Let’s say Apple were to make another new all-time high, and end up 23 days out $30 higher at $703.40. The call options at the $650 strike would then provide a discount (that is, has an intrinsic value) of $703.40 – $650, or $53.40 per share. Anybody who owned a $650 Apple call at that time could exercise it – that is, in effect turn it in to their broker, along with $65,000, and receive the hundred shares of stock. They could then immediately sell those hundred shares for $70,340. Let’s see, buy for $65,000 and sell at $70,340. That’s a gross profit of $5,340. From that we have to subtract what we paid for the option, which was $2,760; leaving a net profit of $2,580. Ignoring commissions (which in this case would take a dollar or so out of our $2580), that’s about a 94% profit (2580 on 2760) in 23 days. This on a stock that itself increased only 4.5% (from $673.40 to $703.40). That magnification of the profit (from 4.5% to 94%) is what we call leverage, and it’s one of the main attractions of options.
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