Stock Trading and Other Things

What are stock options, and can someone give me an option of how it would work in a certain scenario?

I am new to all this, and I would really appreciate if someone could somehow tell me what stock options are about?

Basically, something to do with 10 options worth $1 each..

it was from this textbook but I didn't understand the example.

I would appreciate it alot if someone could help me, by giving an example of stock options in use, in a investment!

Thankyou!

Public Comments

1. I think it is talking about stock worth $1 each from 10 different companies.

2. say u r working in a co. they give u the option or choice to buy shares of the co at a certain price in the future. lets say the option says u can buy 100 shares of xyz at a set price of 10$. u can excercise this only in future after being emplyed for 5 or 7 yrs. by then ur co share ideally wld have gone up to 50$. so u get to buy at 10 & instantly sell at 50- isnt that wow. its a kind of loyalty incentive

3. Free Birdi's right if you are asking about employee share options, but there are other stock options traded on the open market. Here's a link which will give you a good idea of how they work.

http://www.stocktrader.org.uk/what-are-stock-options.html

For employees the price that they get to buy the shares in the future is based on the current share price, usually discounted by 20%.

4. Although there are other types, most people talking about options are talking about one of two types of options.

The first type is an exchange traded option. An exchange traded option is a contract between two parties, the buyer (also called the holder) of the option and the seller (also called the writer). The contract gives the buyer the right, but not the obligation, to make a specific trade with seller. The terms of a stock option contract specify

o Which stock and how much of it will be traded if the holder chooses to exercise his right to make the trade,
o If the holder has the right to buy the stock or sell the stock,
o The price that will be paid for the stock, and
o When the option may be exercised and when it expires.

A call option gives the holder the right to buy the stock from the writer. A put option gives the holder the right to sell the stock to the writer.

The party buying the option contract pays an amount of money, known as the premium, to the party selling the option contract to obtain the right to make the trade.

The contract is terminated when

o The option holder exercises the option
o The expiration date is reached and the holder has not exercised the option, or
o The writer pays the holder a mutually agreed upon fee to close the contract.

On United States exchanges option contracts (unless adjusted) require 100 shares be traded per contract. Prices are quoted on a per share basis. In your example of 10 options worth $1 each the premium for the contracts would be
10 contracts x 100 shares each x $1 per share = $1,000.

The second kind of option is an employee stock option. These give an employee, as part of his compensation package, the right, but not the obligation, to buy a certain number of shares directly from the company at a fixed price during some specified future time period. These stock options are usually given to senior level employees. They are supposed to give the employee motivation to do his best to raise the stock price since his options will be worth more if the stock is worth more. I do not think these are the type of options being discussed in the textbook, but without seeing the context of the phrase I cannot be sure.

5. A stock option gives you the "option" to buy a stock at a fixed price at a specific date (or dates) in the future

Eg. A company's stock is valued now at say $100
you can buy an option to purchase this stock in say 5 years at $120
So today this option is worth 100-120= - $20 (cos if you buy it today but the stock price is still $100 in the future you will lose $20 if you exercise the option to buy)
BUT if you think the stock will be worth say $150 in 5 years then as far as you are concerned the option will be worth $30 ($150-$120) in 5 years
So if you can buy it today at say $1 (it will be worth very little cos at this time it has -ve value)
but the stock DOES get to $150 in 5 years then you will make $29 profit on the $1 option
= 2900% profit (cos you can exercise the option to buy at £120 (so your total cost =$121) - and sell at $150= $29 profit)

However if you were to buy the "real" stock today at $100 and sell in 5 years you would only make $50 on a $100 stock = 50% compared to the 2900% if you bought the option

This is a simple example cos it dont take into account the time factor, but the textbooks should take this into account

So if you had say $10,000 to invest and bought these options it would be worth
10000x29 in 5 years = 290000 profit
however if you bought " real" stocks then you would make $5000
I.e buying options would make you $1/4mill richer

Its called "gearing"

(Course if the stock is still $100 in 5 years then who is going to buy options to buy at $120 when they can buy the "real" stock at $100)
In this case your $10000 investment in options would be worthless
but an investment of £10000 in "real" stocks would still be worth $10000

Even if the stock is worth say $119 your options are worthless , but the investment in "real" stock would now be worth $11900)