The current price of a stock is $60. I can buy a call at the strike price of $40. The bid for the option $20.10. Would it make any sense to buy this contract?
What if you had limited funds at the moment and are fairly certain the price will be moving up? Expiration being 23 days away.
2007-02-21 18:45:42 · 6 answers · asked by Paper M 1 in Business & Finance ➔ Investing
First, if you want to buy an option the bid quote does not matter nearly as much as the ask quote. Remember the bid quote is the highest price someone else is willing to pay for the option; the ask quote is the lowest price some else is willing to sell it for. The spread between the bid and the ask is also significant since, if you do not have the funds to buy the stock, you will have to sell the options sometime in the future to close your position. If the difference between the bid an the ask is $1.00, that means you may lose nearly 5% of your investment simply due to the spread.
You also want to make sure the next ex-dividend date (if any) will not occur until after expiration.
Ignore those issues, buying the call instead of the stock essentially increase the leverage of the investment. Your percent gain, if the stock goes up, will be roughly three times as much as would be if you simply bought the stock. Of course, if the stock goes down your loss will also be three times as much.
If increased leverage is what you want, buying the option instead of the stock makes sense. Just remember that the expiration date is fixed, so not only does the stock have to go up for you to make a profit, it has to go up enough to cover the bid-ask spread in three weeks. That means you are less likely to make a profit than you would be if you simply bought the stock but, if you are right, you can make a larger profit.
2007-02-21 23:58:20 · answer #1 · answered by zman492 7 · 0⤊ 0⤋
It will be a nonsensical situation assuming it to be a one month expiry and it has picked up 20 for the past 7 days is nothing but awsome and illussion only movies can create. If it is a 3 months expiry it is all the more nonsensical since in the next 23 days the price need to move up more than what it had done in the last 67 days for you to breakeven let alone making any profits.
In 23 days you have to make what you invested making it 20.10 move + any profit that you will make out of it if luck permits. This happens rarely may be in some take over targets in which case other adjustments takes place. Also, it cannot be bid it should be ask which is the quote to sell bid is ones offer to buy.
2007-02-22 04:21:53 · answer #2 · answered by Mathew C 5 · 0⤊ 0⤋
This is an "in the money" option, and whether that is a reasonable price depends on how much the stock price varies. Fisher and Sholes came up with a mathematical model for pricing options, and won a Nobel Prize for it. The premium for this option is only ten cents, but 23 days is a very short fuse, so the premium should be small. Most speculators go for "out of the money: options, preferably with a fairly long fuse; if the stock price increases, the option price increases substantially. But that is not the case here; an increase in the stock price from $60 to $63 would increase the worth of the option at expiration from $20.10 to $23.00 -- a nice gain, but not spectacular, and if the price of the stock goes down (to $57, say) then the option value declines to $17.00. Which is not the best way to pay the rent. An option of this kind is not my cup of tea; a fair amount of money is being put at risk for not much likely gain.
2007-02-21 18:58:53 · answer #3 · answered by Anonymous · 0⤊ 0⤋
Not enough info to give you a good answer. Essentially, you are getting almost dollar for dollar move at 1/3 the capital outlay compared to buying the stock. Depending on your expectations regarding the time frame and the size of the move this could be a good option or not.
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2016-11-24 23:25:13 · answer #5 · answered by Anonymous · 0⤊ 0⤋
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2007-02-21 18:51:13 · answer #6 · answered by boxer 3 · 0⤊ 1⤋