Suppose I have $500 and I spent all of that into buying call option of a stock that is currently trading at $22.68 at a price of $0.16 per contract and I will break even at $27.16. I predict that the stock will be $40 in the future. So if i am right, and the stock goes up to $40. Does that mean I will get a profit of (40-27.16) x ((500/0.16) x 100) = around $401,000(???!!!!). (price difference x amount of shares that i can get for 500$) even without exercising the option?
2 Answers
Two things to clear up - the "price" of an option is quoted per share. So you'd have to spend $16 to buy an option contract on 100 shares for $0.16 per share.
Second, your profit per contract would be the difference in the strike and the spot times the number of shares, or
(40-27.16) x (100) = $1,284
If you spent $500 on this option, you could buy 31 contracts, for a total payoff of $39,804 ($39,304 net profit after you deduct the premium paid)
You have two ways to realize profit from a call option:
- exercise it and immediately sell the shares for the market (spot) price (hence the profit of strike - spot)
- Sell the option on the open market before expiry
Before expiry, it's almost always more profitable to sell the option since there is always some time value (even if minuscule). You could also sell it right before expiry for its intrinsic value if you don't want to mess with assignment and selling the shares.
But you have to do one of those to realize the profit.
-
1
-
-
If i sell the option, is it guaranteed that someone is going to buy it? Commented Oct 31 at 15:57
-
IF the option is exchange-traded, then yes. There are "market makers" that ensure that options can be sold at any time. You may not be able to set the price, but you can look at current prices and determine if you want to sell at that price or not. Commented Oct 31 at 16:07
Couple unknowns here:
- How did you compute breakeven? To breakeven at expiration, you need the underlying stock price to be above the strike price plus the premium you paid for the option.
- To be specific, what option do you have in mind, that cost 0.16. Underlying, expiry and strike.
- Do you intend to buy an option that has an expiry date that matches your price prediction? - If the option is not expired, you will need to sell it (early exercise is seldom beneficial) to profit. Otherwise it's just the right to buy at the strike, and no realized profit at all.
- If you sell it, there will be time value left, and you need to look at the price of the option when you sell, versus when you bought it, and not breakeven vs spot like you intend to do. A crucial assumption will be what IV you expect for the option.
Do you know there are lots of online tools that compute this for you? For example, https://optionstrat.com/build/long-call, where you can also play around with IV expectations etc.
In the example, breakeven is at 245.57 because the option costs 10.75 and the strike is at 235.
Generally, if you let your option expire ITM, you will get auto exercised and get the difference of spot minus strike. If you subtract the costs, you have your PnL, as shown in the screenshot above. While this may sound like a lot of money, there is a reason why your option will be so cheap. The probability of the underlying reaching your strike must be very low, let alone 40. More details on your exact numbers would require you to provide details about the option and dates you have in mind.
Most likely, you just throw the 500 out of he window.
