Financial Markets Book Financial Markets For The Rest Of Us
An Easy Guide To Money, Bonds, Futures, Stocks, Options, And Mutual Funds
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by Robert Hashemian

Page 284

Now let's spice things up. Suppose you had instead decided to buy FAK priced at $1/2 with the strike price of $55. With $400 you could have bought 8 FAK contracts. When Ford stock hits $60, these options would probably be worth around $5 (maybe a little higher than $5 but indulge me). Selling your 8 contracts you would get

8 contracts x 100 shares per contract x $5 = $4,000

Your profit would now be

$4,000-$400 = $3,600

for a 900% return on investment. Congratulations. You have 10 times your original investment in a few short days. Before we go any further let's look at how a move in the underlying stock affected the value of its options. Let's get back to our example. When Ford stock was trading at $50 we noticed that FAJ with the strike price of $50 was going for $2 with 20 days to go. This means that you are paying a fee (so to speak) of $2 per share for the privilege of buying this stock at $50 per share within the next 20 days. Why pay this fee when you can own the stock at $50 today? Because you may not want to lock yourself into this stock or you may not have enough money to buy the 200 shares. But what you do want to do is to lock in the price and when your prediction of the stock rising to $60 happens, you want to take advantage of it. And $2 per share ($200 per contract) is the price you pay for this privilege. No free lunches here.

Now simplistically, in order for your investment to become profitable, the stock must rise above $52 a share during the 20 day period. Why? Well, let's do the math. If the stock rises to $52 even and you decide to exercise your 2 contracts, you would buy 200 shares of the stock at $50 (the locked in strike price). You can then turn around and

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Copyright and Disclaimer
Book Chapters
Table of Contents Copyright and Disclaimer Foreword Money
Bonds Futures Stocks Options
Mutual Funds Retirement Final Words Appendix A

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