Main content

## 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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# Call option as leverage

An option, like a call option, can provide leverage because it allows a bet on a stock to be multiplied many times. Learn how call options provide leverage in this video. Created by Sal Khan.

## Want to join the conversation?

- At 1min29sec, Khan says making $15 off a $5 investment (Call Option) is a 300% gain. Should it be a 200% gain? A 100% gain on $5 would be $10 (doubling your money); hence, tripling your money should be a 200% gain. Am I correct?(5 votes)
- look like youre confuse.

$15 is net gain ($20-$5).

$15 is 300% from $5.

So 300% gain($15) plus your $5 = $20 gross profit.(19 votes)

- If you want to completely secure your position, isn't it possible to both buy a call option and a put option? Then, regardless of the rise/fall of the stock, you can sell it with a profit (assuming it rises/falls more than what you paid for the options in total)?(5 votes)
- The option market functions in a way that over half of all options must expire worthless (some stats say it's actually over 75%). If this wasn't the case, no one would be willing to sell options. So, more often then not, you're options are going to expire worthless. If you buy both a put and a call option, one of those options must double in value just to break even. That's a pretty big move. The bigger the move required to make a profit, the more likely the option will expire worthless.(4 votes)

- My question relates to evaluating percent gain. In a bullish scenario, the stock goes up from $50 to $80. At1:04, Sal states the call option costs only five dollars--thus a profit of $15 and 300% return. However, I am confused why this move is considered leveraged. Once the investor decides to exercise the option, they have to come up with the $60 to pay for the security. So isn't total capital deployed $65 ($5 for option and $60 for security) and the percent gain only 23% ($80/$65) considerably less than the $50 deployed and the 60% gain of purchasing the security?(4 votes)
- The reason that you do not say that the $60 is not up front is because there is no need to put the money aside for the writer when you buy the option. You can invest the money however you want. In fact, you don't even need to own the $60. You can use a credit card, which is basically borrowing $60 and paying the bank back later, and there would be virtually no interest on it, because you would be able to pay the money back within the day.(3 votes)

- At1:50, Sal mentioned that the option gave us leverage, how does it happen here? I was reading through how some derivatives like contracts for difference (CFDs) do give leverage, like having to invest just 5% and borrow the other 95%, but how does leverage come about in option?(1 vote)
- Options allow you to control more of the underlying at a fraction of the cost.

You buy stock options in groups of 100. 100 options will cost you far less than buying 100 shares, but your profit and loss will move as if you had 100 shares.(7 votes)

- How is the % gain 3oo when a call option is exercised? What about the additional strike money which needs to be paid? Shouldn't the upfront capital then be $65 (60 + 5)?(3 votes)
- You don't have to pay the strike price, you just sell the call option.(2 votes)

- What if I have $100 and used all of my money buying 20 call options at $5 a piece that allow me to buy each stock at $60. Could I still execute the options to sell the stocks at $80 and make $20 on each one even though I do not have the $60 to buy the stock up front?(2 votes)
- You will not be able to buy 20 contracts with $100. The $5 option premium is per share not per contract. Each option controls 100 shares, so you would need $500 per contract. For 20 contracts you would need $10000. For the scenario to work with $100 it would require the option premium to be .05 cents instead of $5 dollars. This is possible for options that are expiring soon or deep out of the money(OTM). OTM meaning the strike price is much higher than the current spot price of the underlying stock.(1 vote)

- At .59 we didn't loose 100%--we only lost the price of the option which was $5.00. Is that correct?(2 votes)
- What if once the stock reaches $60 and we exercise our call option and then the stock plummets? In such a scenario, the maximum loss that we could suffer is $65. So, isn't a call option associated with its share of risks as well. Wouldn't a long-buy be preferable?(1 vote)
- Why did you exercise your option instead of just selling it?

When you exercised the option, that WAS a buy. Now you own the stock, it doesn't matter how you got it. You are exposed to whatever happens to it.(2 votes)

- Hi,

lets say i buy a call option for $5. @ the stike price of $25. and the stock price rises to $50.

am i restricted to howmany shares i can excercise my call option ?

or when i purchase the option i would indicate the number of shares i can use, if i decide to use the option. how does this part work.. Thanks in advance.(2 votes)- An option is 100 shares. In your question if you purchased a call option for $5 your total purchase would be $500 ($5 * 100 shares).(2 votes)

- If I used a call option @ a price of 50$ and I then I used the option @ a higher price of 80$. The option will cost me 5 $ but the strike price is 60$ . My total earnings or gains is 80-5-50 which is equals to 15 $ . My Question is who will take the 10 $ which is the strike price minus the original price of the stock ?(1 vote)
- According to these videos the call option that u bought at $5 has a strike price of $60 which means when u'll use it, u'll be able to buy the stock at $60 and not $50 . so when the stock moved up to $80 (let's say u thought that the price won't go higher so u'll seize the opportunity to maximize ur profit), you decided to excercise the option so u bought the stock at $60 and immediately sold it at the current stock price $80: your gross gain would be 80 - 60 = 20 but as u already spent $5 on the option that would make ur net gain 20 - 5 =$15.(2 votes)

## Video transcript

If we were to buy the stock for $50, so, this is the situation
where we're buying the stock, we're clearly
putting $50 up front. If the stock moved up
to $80, and we able to perfectly call the top
and sell it for that $80, we would make a $30 profit
off of a $50 initial investment. That's a 60%
gain. That's a 60% gain on our upfront capital. On the other side, if the stock were to go
down to $20, we would loose $30 of our $50
upfront investment. It would be a 60% loss. So in the
buying the stock based on the scenario that I
painted we could gain 60% or we could lose 60%. In
terms of the potential upside you can gain an unlimited amount. The stock can just really
go to any possible value. In terms of loss when
you buy a stock the most you can lose is 100%. Let's think about the
scenario with the call option. With the call option.
To buy the call option it only cost us $5. We only
have to put $5 upfront. The scenario where the
stock went up to $80, we figured out that we
were able to profit $15 net of the price of the
options. This was our pure profit. On a base
of $5 investment we were able to get $15 of profit.
We were able to get a 300% gain. We were
able to get a 300% gain. On the other side though
if the stock went down we had no reason to actually
exercise our option. We essentially just
lost all of the money of the option. We lost 100%. What I want to show here
is that when an option did is it gave us leverage.
It gave us leverage. The term comes from
physics, because a lever will give you kind of mechanical leverage. It can allow you to
exert more force than you otherwise could by using that simple tool. A call option is giving
you financial leverage. You're essentially making
this same bet here, but you're multiplying
potential gain or your potential loss. If the
stock you ... based on the scenario we painted
in the good scenario you made 60%. But in the
call option in the good scenario you made 300%. We multiplied. We multiplied our gain.
On the downside with the stock we lost 60%.
With the call option we lost 100%. Once again,
we multiplied our loss. Right here it looks the
numbers are still favorable, because our loss
multiplication wasn't as much as our gain multiplication. This is really based
on some of the numbers I chose. The important
thing to realize is if you're dealing with
option to essentially make the same bet, that the
bet that the company will go up, you're just
putting leverage on your bet. You're multiplying
your potential gains or losses.