40 lines
1.6 KiB
Plaintext
40 lines
1.6 KiB
Plaintext
12 • The Intelligent Option Investor
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Visual Representation of Call Options
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In a similar way that we created a diagram of the risk-reward profile of owner-
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ship in a common stock, a nice way of understanding how options work is to
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look at a visual representation. The following diagram represents a call option.
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There are a few things to note about this representation:
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5/18/2012
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-
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20
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40
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60
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80
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100
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120
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140
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160
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180
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200
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5/20/2013 249 499
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Date/Day Count
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Stock Price
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749 999
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GREEN
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1. The shaded area (green) represents the price and time range over
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which the investor has economic exposure—I term this the range
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of exposure. Because we are talking about call options, and because
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call options deal with the upside potential of a stock, you see that
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the range of exposure lies higher than the present stock price
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(remember, “Call up”).
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2. True to one of the defining characteristics of an option mentioned
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earlier, our range of exposure is limited by time; the option pictured
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in the preceding figure expires 500 days in the future, after which
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we have no economic exposure to the stock’s upside potential.
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3. The present stock price is $50 per share, but our upside exposure only
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begins at $60 per share. The price at which economic exposure begins
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is called the strike price of an option. In this case, the strike price is
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$60 per share, but we could have picked a strike price at the market price
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of the stock, further above the market price of the stock (e.g., a strike
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price of $75), or even below the market price of the stock. We will inves-
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tigate optimal strike prices for certain option strategies later in this book. |