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 285

sell them at $52. A $2 profit per share. But hold on.You already had paid $2 per share to buy the contracts to begin with and this leaves you with a flat position: you spend $52 per share and you sell at $52 per share for a net difference of zero (not counting commissions, which would put you at a net loss). Not exactly a good use of your efforts.

So in this case $52 is the break-even point. If the stock goes above that you are looking at a profit, and if the stock remains below that you are looking at a loss. Again remember that these potential profits and losses from exercising the options would also be reflected in the option's price. You never have to exercise the options, just sell them directly.

Now let's look at the same scenario with regards to the FAH options with the strike price of $40. Again Ford is trading at $50. You should be able to see that these options already have a $10 profit built into them. No one in their right mind is going to sell you these options for less than $10. But suppose you could buy them at $8. You would then simply buy the options, exercise them by buying the shares at $40 (FAH strike price) and immediately selling them at $50, making $10 per shares minus the $8 per share you paid for the contracts for a profit of $2 per share. Trust me, you won't find them at that price, otherwise this is the easiest money that ever was. Instead the FAH price is $11. This includes the built-in $10 per share plus the fee which happens to be $1. If you buy these contracts, $51 would be your break-even point. Finally let's look at FAL with the strike price of $60 going for $1/8 per share. Now that's cheap, or is it? You probably know that if you buy these contracts, you are already at a $10 disadvantage (i.e., if you exercise these contracts at $60 and sell the shares at $50, you would lose $10 per share). And that is why these options are so cheap: Ford stock must rise $10 1/8 to $60 1/8 in order for you to reach the break-even price. But it has to rise even more in order for you to profit. And a low-volatility stock like Ford has a good chance of not making it to $60 1/8 in 20 days.

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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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