Overview of Security Types 3-9
If Intel is selling for $55 per share, you will profit handsomely. You have the right
to buy 500 shares at a price of $40 per share. Because the stock is worth $55,
your options are worth $15 per share, or $7,500 in all. So you invested $475 and
ended up with more than 15 times that. Not bad.
If the stock ends up at $30 per share, however, the result is not so pretty. You
have the right to buy the stock for $40 when it is selling for $30, so your call
options expire worthless. You lose the entire $475 that was originally invested. In
fact, if the stock price is anything less than $40, then you lose $475 (plus
applicable commissions and exchange fees).
E. Investing in Stocks versus Options
To get a better idea of the potential gains and losses from investing in stocks
compared to investing in options, let’s suppose you have $15,000 to invest.
You’re looking at Monster Beverage, which is currently selling for $150 per share.
You also notice that a call option with a $150 strike price and three months to
maturity is available. The premium is $10. Monster pays no dividends. You’re
considering investing all $15,000 either in the stock or in the call options. What
is your return from these two investments, if, in three months, Monster is selling
for $165 per share? What about $135 per share?
First, if you buy the stock, your $15,000 will purchase one round lot, meaning 100
shares. A call contract costs $1,000 (why?), so you can buy 15 of them. Notice
that your 15 contracts give you the right to buy 1,500 shares at $150 per share.
If, in three months, Monster is selling for $165, your stock will be worth 100
shares × $165 = $16,500.Your dollar gain will be $16,500 less the $15,000 you
invested, or $1,500. Because you invested $15,000, your return for the three-
month period is $1,500 / $15,000 = 10%. If Monster is selling for $135 per share,
then you lose $1,500, and your return is -10 percent.
If Monster is selling for $165, your call options are worth $165 - $150 = $15 each,
but now you control 1,500 shares, so your options are worth 1,500 shares × $15
= $22,500 total. You invested $15,000, so your dollar return is $22,500 - $15,000
= $7,500, and your percentage return is $7,500/$15,000 = 50%, compared to 10
percent on the stock investment. However, if Monster is selling for $135 when
your options mature, then you lose everything, and your return is -100%.
3.6 Summary and Conclusions
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of