Question

1. What is a call option? Pick a specific call option on IBM from the link above and detail how you could make money if the value of IBM stock increased. Use specific numbers. What would happen to your investment if the price of IBM fell?

Answer 1

A call option gives the owner a right but not the obligation to buy an asset at an agreed price, called the strike price on or before a specified date.

For IBM, current stock price: $134.10

a call option expiring on 13/12/2019 has a strike price of $136 and a ask price of $0.19.

This means an investor pays $0.19 as option premium to get the right to buy the share at $136.

If share price increases to $136.10, then the investor can exercise the call option to buy the share at the price of $136. He/She can then sell the share in the market at $136.10, thereby netting $0.10 on the transaction. However $0.19 was also spent on paying the premium for the option. Thus the transaction results in a net loss of $0.09 for the investor.

If however, the price rises to $140, then the investor buys at $136 exercising the option and sells it in the market at $140. Netting the premium paid, it results in a profit of $3.81 to the investor.

If the price of the stock fell below the strike price, the option would not be exercised. In that case the loss to the investor equals the premium paid for the buying the option.