35 lines
2.2 KiB
Plaintext
35 lines
2.2 KiB
Plaintext
Option Fundamentals • 13
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4. The arrow at the top of the shaded region in the figure indicates
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that our exposure extends infinitely upward. If, for some reason,
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this stock suddenly jumped not from $50 to $60 per share but
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from $50 to $1,234 per share, we would have profitable exposure
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to all that upside.
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5. Clearly, the diagram showing a purchased call option looks a great deal
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like the top of the diagram for a purchased stock. Look back at the top
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of the stock purchase figure and compare it with the preceding figure:
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the inherent directionality of options should be completely obvious.
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Any time you see a green region on diagrams like this, you should
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take it to mean that an investor has the potential to realize a gain on the
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investment and that the investor has gained exposure. Any time an option
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investor gains exposure, he or she must pay up front for that potential gain.
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The money one pays up front for an option is called premium (just like the
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fee you pay for insurance coverage).
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In the preceding diagram, then, we have gained exposure to a range
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of the stock’s upside potential by buying a call option (also known as a long
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call). If the stock moves into this range before or at option expiration, we
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have the right to buy the stock at our $60 strike price (this is termed exer -
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cising an option) or simply sell the option in the option market. It is almost
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always the wrong thing to exercise an option for reasons we discuss shortly.
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2
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If, instead, the stock is trading below our strike price at expiration, the
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option is obviously worthless—we owned the right to an upside scenario
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that did not materialize, so our ownership right is worth nothing.
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It turns out that there is special jargon that is used to describe the
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relationship between the stock price and the range of option exposure:
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Jargon Situation
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In the money (ITM) Stock price is within the option’s range of exposure
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Out of the money (OTM) Stock price is outside the option’s range of exposure
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At the money (ATM) Stock price is just at the border of the option’s range of
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exposure
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Each of these situations is said to describe the moneyness of the option.
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Graphically, moneyness can be represented by the following diagram: |