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 288

happens to have a $5 advantage over the FAL's strike price and therefore it is more expensive.

As a stock price moves in a favorable direction, the chances of making a profit with the corresponding options increases and therefore their prices move higher. In our example, as Ford's stock price rises from $50 to $55, all of its call options also rise in price, although some that have remote strike prices (e.g., $70) with short time to expiration (e.g., 20 days) may not budge until the stock gets into the $60s. Also many times expensive stocks may have higher option prices than cheaper stocks given the same strike price distance and expiration date. For example, an option with a $20 strike price on a $10 stock is usually cheaper than an option with a $220 strike price on a $200 stock given the same expiration date. Why? Expensive stocks tend to gain or lose more points than cheap stocks. It's a percentage factor. In our example, the $10 stock has to gain 100% in order to reach the $20 strike price of its option while the $200 stock needs to gain only 10% to reach the $220 strike price. Clearly there is less chance for the first stock to pass the strike price than the second one, the first stock option would be riskier and therefore cheaper.

Underlying Stock Volatility - A stock with violent price swings would have higher option premiums than those of a mild stock. That is because there is a much better chance for a volatile stock to catch up and surpass distant strike prices than for a low-volatility stock to do the same. Back in the heydays of the Internet stocks, you might have expected to pay $1/8 for Ford call options that were $10 out of the money but expected to pay $5 or more for Yahoo call options that were $10 out of the money (with the same expiration date as Ford's) as the Yahoo stock was a lot more volatile than Ford's. Yahoo had a much better chance of having 10 or 20% gains in one day than Ford did, which on good days might have gained 5 or 6%.


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