34 lines
2.5 KiB
Plaintext
34 lines
2.5 KiB
Plaintext
O,apter 1: Definitions 7
|
||
the last trading day; the holder does not have to wait until the expiration date
|
||
itself before exercising. (Note: Some options, called "European" exercise
|
||
options, can be exercised only on their expiration date and not before - but they
|
||
are generally not stock options.) These exercise notices are irrevocable; once
|
||
generated, they cannot be recalled. In practical terms, they are processed only
|
||
once a day, after the market closes. Whenever a holder exercises an option,
|
||
somewhere a writer is assigned the obligation to fulfill the terms of the option
|
||
contract: Thus, if a call holder exercises the right to buy, a call writer is assigned
|
||
the obligation to sell; conversely, if a put holder exercises the right to sell, a put
|
||
writer is assigned the obligation to buy. A more detailed description of the exer
|
||
cise and assignment of call options follows later in this chapter; put option exer
|
||
cise and assignment are discussed later in the book.
|
||
RELATIONSHIP OF THE OPTION PRICE AND STOCK PRICE
|
||
In- and Out-of-the-Money. Certain terms describe the relationship between
|
||
the stock price and the option's striking price. A call option is said to be out-of-the
|
||
money if the stock is selling below the striking price of the option. A call option is in
|
||
the-money if the stock price is above the striking price of the option. (Put options
|
||
work in a converse manner, which is described later.)
|
||
Example: XYZ stock is trading at $47 per share. The XYZ July 50 call option is out
|
||
of-the-money, just like the XYZ October 50 call and the XYZ July 60 call. However,
|
||
the XYZ July 45 call, XYZ October 40, and XYZ January 35 are in-the-money.
|
||
The intrinsic value of an in-the-money call is the amount by which the stock
|
||
price exceeds the striking price. If the call is out-of-the-money, its intrinsic value is
|
||
zero. The price that an option sells for is commonly referred to as the premium. The
|
||
premium is distinctly different from the time value premium ( called time premium,
|
||
for short), which is the amount by which the option premium itself exceeds its intrin
|
||
sic value. The time value premium is quickly computed by the following formula for
|
||
an in-the-money call option:
|
||
Call time value premium = Call option price + Striking price - Stock price
|
||
Example: XYZ is trading at 48, and XYZ July 45 call is at 4. The premium - the total
|
||
price - of the option is 4. With XYZ at 48 and the striking price of the option at 45,
|
||
the in-the-money amount (or intrinsic value) is 3 points (48-45), and the time value
|
||
isl(4-3). |