Options

A call option gives its holder the right to purchase an asset for a specified price, called the exercise or strike price, on or before a specified expiration date. For example, a February call option on EMC stock with an exercise price of $70 entitles its owner to purchase EMC stock for a price of $70 at any time up to and including the expiration date in February. Each option contract is for the purchase of 100 shares. However, quotations are made on a per-share basis. The holder of the call need not exercise the option; it will be profitable to exercise only if the market value of the asset that may be purchased exceeds the exercise price.

When the market price exceeds the exercise price, the optionholder may "call away" the asset for the exercise price and reap a payoff equal to the difference between the stock price and the exercise price. Otherwise, the option will be left unexercised. If not exercised before the expiration date of the contract, the option simply expires and no longer has value. Calls therefore provide greater profits when stock prices increase and thus represent bullish investment vehicles.

In contrast, a put option gives its holder the right to sell an asset for a specified exercise price on or before a specified expiration date. A February put on EMC with an exercise price of $70 thus entitles its owner to sell EMC stock to the put writer at a price of $70 at

Figure 2.13 Options market listings.

LISTED OPTIONS QUOTATIONS

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Source: The Wall Street Journal, February 7, 2001. Reprinted by permission of The Wall Street Journal, © 2000 Dow Jones & Company, Inc. All Rights Reserved Worldwide.

Source: The Wall Street Journal, February 7, 2001. Reprinted by permission of The Wall Street Journal, © 2000 Dow Jones & Company, Inc. All Rights Reserved Worldwide.

any time before expiration in February, even if the market price of EMC is lower than $70. Whereas profits on call options increase when the asset increases in value, profits on put options increase when the asset value falls. The put is exercised only if its holder can deliver an asset worth less than the exercise price in return for the exercise price.

Figure 2.13 presents stock option quotations from The Wall Street Journal. The highlighted options are for EMC. The repeated number under the name of the firm is the current price of EMC shares, $70. The two columns to the right of EMC give the exercise price and expiration month of each option. Thus we see that the paper reports data on call and put options on EMC with exercise prices ranging from $60 to $80 per share and with expiration dates in February and April. These exercise prices bracket the current price of EMC shares.

The next four columns provided trading volume and closing prices of each option. For example, 1,440 contracts traded on the February expiration call with an exercise price of $70. The last trade price was $3.50, meaning that an option to purchase one share of EMC at an exercise price of $70 sold for $3.50. Each option contract, therefore, cost $350.

Notice that the prices of call options decrease as the exercise price increases. For example, the February maturity call with exercise price $75 costs only $1.50. This makes sense, because the right to purchase a share at a higher exercise price is less valuable. Conversely, put prices increase with the exercise price. The right to sell a share of EMC at a price of $70 in February cost $3.40 while the right to sell at $75 cost $6.70.

CONCEPT CHECK ^ QUESTION 7

What would be the profit or loss per share of stock to an investor who bought the February maturity EMC call option with exercise price 70 if the stock price at the expiration of the option is 74? What about a purchaser of the put option with the same exercise price and maturity?

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