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Take this call for example:

FIO Jan13 22 Call

Let's say this Thursday the stock goes to $23. Here is my math:

Cost of option: $35
Cost of stock bought at $22: 100x$22 = $2,200
Thursday price of stock at $23: 100x$23 = $2,300
Thursday value less costs: $2,300 - $2,200 - $35 = $65

My questions:

  1. Is this math correct?
  2. When executing the contract, do I need to have money in my account to buy the shares, or I can I just have my brokerage buy and sell it immediately? (I am using OptionsXpress, if that matters).
  3. Is there a difference in price between (a) buying the stock and then immediately selling it vs. (b) selling the options contract to someone else? In other words, is the value of the options contract the same as the profit that could be made by executing it ($65)?
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Get this book. amazon.com/Options-Futures-Other-Derivatives-Edition/dp/… . It is a basic book on options and derivatives. Not that hard to understand, just leave out the advance chapters. –  DumbCoder Jan 17 '13 at 9:20

2 Answers 2

Your math shows that you bought an 'at the money' option for .35 and when the stock is $1 above the strike, your $35 (options trade as a contract for 100 shares) is now worth $100. You knew this, just spelling it out for future readers.

1 - Yes

2 - An execute/sell may not be nesesary, the ooption will have time value right until expiration, and most ofter the bid/ask will favor selling the option. You should ask the broker what the margin requirement is for an execute/sell. Keep in mind this usually cannot be done on line, if I recall, when I wanted to execute, it was a (n expensive) manual order.

3 - I think I answered in (2), but in general they are not identical, the bid/ask on options can get crazy. Just look at some thinly traded strikes and you'll see what I mean.

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Here is the answer for #3 from my brokerage:

Your math is correct. Typically, option traders never take delivery of the stock simply to then turn around and sell it at the higher price that the stock is trading at. You wold always expect the option to have a higher value that simply selling the stock at market price. There are many factors involved in options pricing and the math behind it is quite complicated, but unless it is right at expiration, the option will have a higher price than the stock itself.

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1  
Confirms my number 2, "right at expiration". Strange things happen at expiration. Stocks are often pushed to close at a strike price so the puts and calls at that strike are worthless. Anecdotal evidence only. Thousands I lost to this phenomenon. –  JoeTaxpayer Jan 18 '13 at 3:51

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