How to Make the Right Call

The Independent (London, England), September 11, 1994 | Go to article overview
Save to active project

How to Make the Right Call


THE FOUR TRADES that follow illustrate the main uses of options:

Example 1

On 5 April 1994, the price of Sears shares was 115p. To buy 1,000 shares would cost pounds 1,150. However, the May 120 call option, securing the purchase price of Sears shares at 120p until 11 May, were trading at 41 2 p per share. With each traded options contract being for 1,000 shares, the total cost of the option would be pounds 45.

By 19 April, the share price had risen to 124p. The holder of the option now had the choice of exercising the option and buying the shares for 120p each, or selling the option back into the market. Having already paid 41 2 p per share for the option, the effective purchase price of the shares, using the option, was 1241 2 p (the exercise price plus the premium). However, the premium of the May 120 call option had risen from 41 2 p to 9p per share, or pounds 90 per contract, giving a profit of pounds 45, or 100 per cent, if the option was sold in the market.

The graph for the above trade shows that if the share price stays below the 120p exercise price of the option at expiry, the investor will lose the whole of the premium paid. This represents the maximum loss the investor can suffer. Once the share price rises above the exercise price, the losses start to erode until the trade breaks even at 1241 2 p (the exercise price plus the premium). If the share price continues to rise, the investor has the possibility of an unlimited profit.

Example 2

On 5 April, after a short rally, the share price of Scottish Power was 420p but was expected to fall back. Not wishing to sell the holding, it was possible to purchase the May 420 put option at 17p per share, or pounds 170 per contract, giving the right to sell Scottish Power shares at 420p at any time until the expiry of the option in May. By 19 April, Scottish Power had fallen to 372p. The value of the May 420 put option had risen to 52.

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
Loading One moment ...
Project items
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

Cited article

How to Make the Right Call
Settings

Settings

Typeface
Text size Smaller Larger
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

While we understand printed pages are helpful to our users, this limitation is necessary to help protect our publishers' copyrighted material and prevent its unlawful distribution. We are sorry for any inconvenience.
Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.

Are you sure you want to delete this highlight?