Option Examples

Example One - Basic Call

You did your research on Apple and decided that the stock price will increase dramatically soon. You want to invest approximately $2000, but the stock is very expensive (currently trading at $121.51). Your $2000 will only buy you about 16 shares. You want more leverage. So you look into options for Apple. You find that the May $125 Strike Price Call Option will cost you $470 per option (stated as $4.70). You stretch it a little and buy 5 option contracts costing you $2350. Sure thing the next day, Apple shares jump up to $126.17. You look at your option and its now worth $5.65.

Do some quick math and your profit is $475. That is, 5 contracts * ($565 - $470). Now if you had bought the stock directly, your profit would have been around $88 because remember that $2350 would have only bought you 19 shares. That is the power of options...if you get it right!

AAPL stock
$121.51 * 19 =  $2,308.69
($126.17 * 19) - $2,308.69 = $88.54
AAPL option
$470 * 5 = $2,350  ($565 * 5) - $2,350 = $475 

This example shows a really nice profit. But remember that you could have easily lost $475 if Apple did not perform well. If you had bought the stock, you would have lost only $88.54 and you would have the luxury of holding onto the stock and wait for it to appreciate. With options, you don't have the luxury of time.

By the way, I did not make up these numbers. This is how the it was on April 23rd, 2008.

Example Two - Basic Put

You have a fairly bearish sentiment on VMWare. The ticker is VMW. You know that people are really cutting back on their technology budget these days so you believe VMW will have something bad to report on their earnings. VMW is currently trading around $32 so you go ahead and buy some put options. You scan the option table and decide to pick the May Put where the strike price is $31. It costs you $1.85 per contract (remember that you have to multiply by 100 to find out what you will actually pay from your pocket!). Because it's only $1.85 you purchase 10 contracts. So your cost is $1,850 plus commission.

The next day you find out how lucky you are (or smart you are depending on how you want to look at it). VMWare reports terrible earnings and their stock price dips to $26! You hate to see the company do bad but you love to make money. You option is now worth $5.4. I'm sure you can do the math by now. Your net profit is $3,550. Not bad huh?
VMW Stock
$32 * 60 = $1,920
  $1,920 - ($26 * 60) = $360
VMW option
$185 * 10 = $1,850   ($540 * 10 ) - $1,850 =  $3,550

For comparison purposes, I've assumed you have shorted the stock. So the first row in the table shows what the profit would have been if you closed your short position at $26/share.

Example Three - Call gone wrong

You got a nice tip about a little known company poised for a big bounce. The ticker is VOL. You buy some call options where the strike price is $7.5. You buy it at $0.45 (again multiply by 100 to get $45). So you sit and wait for the thunder to come rolling in.

You soon discover that your tip was bad. VOL is not behaving as expected...in fact it is declining in stock price! you put in your sell order for the options but you can't sell them. Why? Because the volume is zero! Somebody sold you a bum option when the sentiment was high. But now nobody likes it and nobody is willing to take those options off your hands. You're stuck!

But wait; you still have some time before expiration. Maybe the stock will pick up and people will start trading in these options again. Maybe...and maybe not. This is the risk you sometimes take when dealing with options. I suggest you stick to the ones where the volume is high; at least a few thousand a day. So you have a reasonable chance of getting out if you want.