Let's explore a bit how the
price of an option can vary, or how it can relate to
the actual expiration date. So what I'm going to do is
compare two similar options with the underlying stock
being General Electric. And they're going to be
the same in every way, except one is going to have a
further out expiration date. So let's compare this
call option right here. So this is a call option on
GE with a $17 strike price. So it's the option to
buy GE stock at $17. And it has an April,
2011 expiration. So it's going to expire,
or the last day of trading that you could
trade this option, will be the third
Friday in April. Let's compare that with an
option that has the same strike price, but has a
December, 2011 expiration. So we're going to look for $17
strike price right over here. And you can see right when
you compare the options that the one that has a further
out expiration cost more. This one costs $3.25, while
this one only cost $2.36. And the reason why
it costs more is because you get to retain
the option for longer. So you could imagine, $17. Let's say that $17
is right over here. Let me draw a
hypothetical stock chart. So let's say that $17
is right over here. And so you could
imagine, let's say, that you have both
of those options. Or you have the option to have
either one of those options. And let's say that the stock
does something like that. Well, it's going
to be in the money. You have the right, if you own
either one of those options, you have the option to
buy the stock at $17 and then sell it at
whatever price this is. Maybe this price over here
is like $20 something. So you would make money. But if you have the option
with a closer expiration, with the April,
2011 expiration, you have to exercise the
option right now. You would have to
exercise it right now and close out the option. If you had the longer dated
option, you could do it. You could do the
exact same thing that this owner of an
April, 2011 option has. Or you can hold the
option and maybe see if the stock continues to go up. Or you could imagine
a downside scenario. Maybe the stock does
something like this, where it goes out of the money. Someone who holds the closer
dated option, the one that expires first, they'll be
completely out of the money. The option would be
worthless on this date. But if you have the
longer expiration, if your option does not
expire until December of 2011, then you could hold it. And maybe, maybe the stock
will do something nice. There's some probability
that it will one day become in the money. I want to make it clear. Even if you have
this situation here, and you hold the
longer dated option-- you have the option that's
going to expire in December-- you still would not
want to exercise it. Because there is
someone who would still enjoy all of this
optionality of the future. So what you're better off
doing, instead of exercising the option, you're better off
selling the longer dated option right over there. And you should be able to
capture at least as much profit as you would from exercising the
option, plus capturing whatever value the buyer sees in
the future optionality.