Call options and Put Options (Example Followed by Questions)

Call options and Put options Options are similar to forward and futures contracts. However, if you hold an option, you have the right to exercise it but no obligation to exercise. On the other hand, if you write an option to another investor, you have only obligation but no right of any kind. Also, option contracts involve the non-zero cash-flow today, unlike forward and futures. Example) Suppose you (option holder) buy a call option on Apple stock with the strike price K-$500 from me (option writer) at a price of Co-S12 per share and it expires on October 2013 If the stock price becomes $ST-S600 on the expiration date, you can exercise your call option to buy Apple stock from me at S500 per share (which is cheaper than the current market price S600) and I have to sell it to you. You will make profits of S100 per share from this transaction and lose the price of call option you paid in the beginning. If the stock price becomes S400 on the expiration date, you don 't have to exercise the option. In fact, you should do nothing with the option. In this case, you will lose only the price of call option you paid in the beginning. In both cases, my net loss is the same as your net profit. Again,option contracts are zero-sum games April 2013 October 2013 Spot price: S-$430 (current market price of Apple share) You buy a call option on Apple stock with the strike price K $500 at price C$12 If spot price is $600, exercise the option. If spot price is $400, do nothing. 3. Suppose you (option holder) buy a call option on Apple stock with the strike price K-$450 from me (option writer) at price of Co-$16 per share today and it expires on October this year If the stock price becomes $ST S500 on the expiration date, what will be your payoff per share on the expiration day? Note the call option price is the cashflow today, not on the expiration day 1) S0 2) +S50 3) -S50 4) +S34 5) -S66 4. Suppose you (option holder) buy a call option on Apple stock with the strike price K-$450 from me (option writer) at price of Co-S8 per share today and it expires on October this year. If the stock price becomes SST-$400 on the expiration date, what will be my payoff (net cash-flow) per share on the expiration day? Note the call option price is the cashflow today, not on the expiration day. 1) S0 2) +S50 3) -S50 4) +S34 5) -S66