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Finance and capital markets
Course: Finance and capital markets > Unit 9
Lesson 1: Put and call options- American call options
- Basic shorting
- American put options
- Call option as leverage
- Put vs. short and leverage
- Call payoff diagram
- Put payoff diagram
- Put as insurance
- Put-call parity
- Long straddle
- Put writer payoff diagrams
- Call writer payoff diagram
- Arbitrage basics
- Put-call parity arbitrage I
- Put-call parity arbitrage II
- Put-call parity clarification
- Actual option quotes
- Option expiration and price
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American put options
Unlike European option, an American options can be exercised at any point before it expires. In this video we walk through the process of exercising an American put option. Created by Sal Khan.
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When you exercise a put option and make profit on it, who is buying this stock that you are selling at a higher price than it's now worth?(29 votes)
The writer of the option HAS to buy the stock from you at this price. While it's an OPTION for the buyer, it's an OBLIGATION for the writer of that option. So you can choose to exercise or not but when you do the writer has to abide by it. What does the writer gain from all this? Well, the premium (price) you paid for that option.(50 votes)
So isnt this just two people making a bet on what a stock does, up or down? The one issuing the option wants it to go up, the one buying wants it to go down. So its just two people making a bet?(10 votes)
What's the economic value of this? this just seems like an instrument for gambling..haha. Please do correct me if I've misunderstood this.(2 votes)
Well it could be seen like gambling, but this contracts are made about 400 years or more to insurance crops. It began with agriculture. Imagine this: A farmer have a crop and in September have usually 200 ton of cereals, and the market price usually is between 100 to 125$ per ton along the years. Now is June (3 months to the harvest), the weather is fine and the perspective is 200 tons in September. A miller goes to the farmer and say: "I would like to offer you a deal, I would like to have the right to buy 50 ton in September at 100$. For that I pay you now 5$ per ton, that is 250$ for that right". The farmer says: "Ok, I accept that, and writes a call option to September at 100$ per ton". It's good to the miller because have a guarantee that will have a good price in September, and is good to the farmer because have 25% of the crop sold in June. I hope it helps to see the origin of options and futures, that was not gambling. Now we gamble, but we should remember that are real people behind companies. Any doubt just ask.(9 votes)
- I am assuming that Put or Call option prices vary according to the stock prices (for example, berkshire hathaway options would probably be much more expensive than options for stock trading at 10$). So my question is, is there a specific formula for calculating those option prices? And if so, what is that formula?(7 votes)
Option prices on higher priced stocks are more "expensive" (not really the correct term, explained later) than that on lower priced ones. Reason being, if a stock was trading at $10 the strike prices would most likely be in $0.50 increments (i.e. $10, $10.50, $11, etc...). Therefore the intrinsic value between them (if they're ITM) would be $50/contract. A higher priced stock, say at $900, would have strike prices in $5 increments (i.e. $900, $905, $910, etc...). Those would have an intrinsic values (again, if ITM) of $500/contract between strikes.
It also has to do with the movement of the stock. A 5% move in a $10 stock is $0.50 or about $50 if you have a deep ITM option. The same 5% move in a $900 stock is $45 or about $4500 if you have a deep ITM option.
The better way to see if an option is truly "expensive" is to look at its implied volatility and see how it relates to its past volatility and current volatility, but that's a different discussion altogether.(1 vote)
What if I buy a call and put option at the same time? Have I secured a risk-free profit in volatile stock market?(2 votes)
How do know you will have a profit? You just spent money to buy the call and the put. If the stock stays where it is, they will both expire worthless. If the stock moves either direction, one of them will expire worthless. Whether you profit depends on the prices you paid and the movement of the stock. So was there a risk free profit? Definitely not.(4 votes)
- I'm curious about the people who are "renting" out their shares (the people putting their shares up for the puts and calls). Is there a video on who can do this and how it is done? I think it sounds like a great way minimize risk for a stock holder if I'm understanding it correctly.(3 votes)
actually there isnt any renting at all, those selling options merely make an agreement with the purchaser of the option and go and buy the shares at going market prices at the exercise date, or just pay out the profit from option price and current market prices. hope that was helpful.(3 votes)
- How can you buy and sell put options? I am having trouble grasping that.(3 votes)
Owning an option means that you have a right to buy (call) or sell (put) a stock for a specified price for a specified amount of time. Selling an option means you exchange that right for cash. That is, someone wants to buy your option, and they pay you for the put or call contract. You would sign some agreement that transfers the call or put right and contract to them, and they then pay you. They could go to the market and buy a new call or put contract, but instead they buy your contract from you. The details of your call or put agreement probably can't be purchased on the open market any more because time has passed, and confidence in the company has changed for better or worse.(2 votes)
- So, what happens step by step if the stock goes down (like I want it to)?
1. I buy a put option for $5 with a strike of $40
2. Stock goes down to $20 by the expiration date
3. I can sell the option or the stock back the issuer for $40.
Whose stock am I selling? Is it the person who issued the stock's stock? So, I'm selling the stock to the owner of the stock?(2 votes) - Isnt this the same thing as limits and stops market orders when you set a price to sell or a price to buy a stock? The only difference i see is that there is a price for a contract which is the $5 dollars for the option and that you have the option to allow it to expire. Are there any other things im missing?(1 vote)
What would happen if I buy a put option for a company that, before the expiration date, goes bankrupt? Would I have lost my money, since I can no longer buy the stock in order to sell it to the writer of the option?(2 votes)- You don't have to buy the stock, you can just sell the put
Also just because a company goes bankrupt doesn't mean you can't buy the stock. There's a long process before the stock gets canceled.(3 votes)
Video transcript
Let's say that you don't
like company ABCD that's right now trading
for $50 a share. But you don't have the
stomach to short the stock because there's a
possibility that you could lose an infinite amount
of money if you short it. You still have an option. Quite literally, you
still have an option. You can buy a put option. Once again, we're dealing
with the American variation. And just like an
American call option, an American put option
gives you the right to exercise the option any time
before the expiration date. A European call
or put option, you can only exercise on
the expiration date. And the situation with a
put option, a call option gave you the right to buy the
stock at a specified price. A put option is the opposite. It gives you the right to sell
the stock at a specified price. So this little
made up put option I've constructed right here. It's maybe being sold on an
exchange for $5 per option. And it gives you the
right to sell company ABCD at $40 a share any
time over the next month. And let's see how, if you were
to buy this, how this really is a bet that the
company would go down. So let's imagine the scenario
where the company does what you expect, it goes down. And one month later, it
just keeps going down. You're like, well, I
better use it today because it's going to expire
if I don't use it today. So you exercise the
option right over there. And so what this allows you to
do is sell the stock at $40. And if you don't
own it, that's OK because you could go and buy the
stock right now on the market. You knew it was
going to get cheaper. So you can buy it for $20,
and then exercise your option and sell it for $40. So you're buying at $20 and
immediately selling for $40. So you're going
to be making $20. And then if you
subtract out the price that you had to
pay for the option, you're going to
have a $15 profit. You're going to have a
$15 profit over here. Let me scroll over to the
right so you have some space. And this is, of course, the
situation with the put option. This is the put option. And if your bet goes against you
and the stock actually goes up, it's not going to be
like a short position where you can lose an
unlimited amount of money. In that situation,
let's say the stock just keeps going up and
up and up and up. Well at any point
above $40, you're like, there's no point in me
exercising the option. So you just let it expire. So in that situation, you
just wasted your money buying the actual option. So you just lose the actual $5. Even if that stock were to
go up to a gazillion dollars, you're not required to
buy it back like you would if you were shorting it. You can just let
the option expire.