Question about selling call options (as explained by Robery Kiyosaki)?

Question

A stock option is purchased at $1 per option, 100 shares and $50 per share. When the stock price rises to $60 per share, the sophisticated investor sells his/her option for $10 per share (or 1,000 for the unit of 100 shares and realizes a gain of $900).

I understand how the investor has made the $900 gain, as the stock price has gone up. I do not understand how the investor can sell the option for $10 rather than sell the actual stocks. I see how selling at $10 makes the appropriate gain of $900, but how can the actual option have gone up in value? Would it be correct to assume that there are a lot of options selling for $10 at that point in time?

Answer 1

You must understand that a person who is buying the option doesn't know that it's going to go up to $60 per share. This is all based on speculation. What if the stock price went down? Then you would lose the $1 per option x 100 options, and gain nothing.

Apart from this, once the options are purchased and the person decides to 'exercise' their options because of the increase in stock value, the person has 2 choices:
1) Actually purchase the stock at it's option price and retain ownership of the stock, or
2) Make a cash settlement for the difference of the option and the market value of the stock

In your example, there is a cash settlement of the difference between $60 and $50. Basically, you're purchasing the stocks at the stock option price of $50, and then immediately selling them for $60 a stock, which is a $10 net gain(the price of the option is considered, but not actually in theory). And this way I'm explaining it, doesn't apply to how you do your taxes, but just illustrating how it works.


--Mathematically, an option should only be used to create 'Leverage' for other investments to lower the risk of the other investment(especially when dealing with exchange rates).

Answer 2

Options are contracts. If the stock is at $60 -- then it is $10 in-the-money. As the holder of the option, I have two ways of making money:

1. I can exercise the option -- paying $50 per share and then sell the shares for $60 -- making $10 per share on the deal.

2. I can sell the contract to someone else -- transferring the rights to him. If the option is in-the-money, then the contract is usually worth more than $10 -- because of the potential of going up more. This means that I might be able to sell it for $11 or more per share (the option is always worth more -- but the gap decreases as you get close to the expiration date).

Most people choose option two -- because it doesn't involve having to put up the money to buy the stock before you get paid. Sellers of the option are often making a bet on the stock & don't actually own it. They are usually willing to buy your contract back rather than go out & buy the shares in the market so they can deliver them to you.

Answer 3

When you buy an option, you are not really buying the underlying stocks. An option is a contract that you WILL buy when the option expires. Your scenario is missing a vital piece of information: strike price. Which is the price at which you will pay to ACTUALLY buy the stocks. Let's assume it is $60 in your example.

So say the stock is at $50 right now, and it goes up to $60. Since the strike price is at $60, you can 'exercise' the option, in which case you are ACTUALLY buying the stocks (at $60). And then you can sell it for and make a profit.

In this scenario, the owner of the option does NOT exercise it, but instead sells the option. Because the underlying stocks has gone up, so does the value of the option. Because other people may predict it could go up to $70, and by owning that option, they could buy the stocks at $60 (a cheaper rate). In your example, the option has gone up 10 folds but in reality, it could go up at some random amount.

Hope that helps!

Answer 4

The price of an option as the date it expires will be close to the gap between the market price and the option price.