Main content
Finance and capital markets
Course: Finance and capital markets > Unit 9
Lesson 1: Put and call options- American call options
- Basic shorting
- American put options
- Call option as leverage
- Put vs. short and leverage
- Call payoff diagram
- Put payoff diagram
- Put as insurance
- Put-call parity
- Long straddle
- Put writer payoff diagrams
- Call writer payoff diagram
- Arbitrage basics
- Put-call parity arbitrage I
- Put-call parity arbitrage II
- Put-call parity clarification
- Actual option quotes
- Option expiration and price
© 2023 Khan AcademyTerms of usePrivacy PolicyCookie Notice
American call options
Unlike European option, an American options can be exercised at any point before it expires. In this video we walk through the process of exercising an American call option. Created by Sal Khan.
Want to join the conversation?
I don't see why there's a difference between American and European call options in a liquid market.
If I had an option allowing me to buy a $50 stock for $60 for 30 days and the price increased to $80 in 15 days, excercising the option on day 15 would give me $20. But the option would have a market value of say $25 because of the probability that the stock will rise further. This means no sane person would excercise an option before expiry rather than sell it on? Am I wrong?(35 votes)
Oli you're actually correct. An American call option on a non-dividend paying stock SHOULD NEVER be exercised prior to expiration (Derivatives Markets, 2nd Ed. pg 294). What is always more profitable is what you said, to instead sell your option with time (T-t) left, where T is expiration date and t is time you would exercise, receiving both the difference in spot and strike value (S(t) - K) and option premium.(20 votes)
- Are options also used for people with limited initial capital who wish to maximise future returns through owning more shares later on when they can exercise them??
Also slightly off topic - Why are options considered derivatives?
Thanks in advance!(4 votes)
Yes, they do provide an excellent way to leverage your capital. More importantly they provide a way to hedge your downside risk which is virtually impossible to do absent options.
The rate of change of the slope of a curve is the first derivative (Calculus). Generally speaking, derivatives is a term of art used by financiers to describe anything that derives it's value from any other underlying (including another derivative). Virtually all of these instruments are expressed mathematically, often with advanced math. I do not know, but reasonably speculate that someone along the way simply recognized that derivative was a good, mathematically descriptive term. You will often hear folks say that they are "stripping" risk off of the underlying assets - essentially that means creating a new derivative and selling it (that is basically how the CDOs (Credit Default Swaps) got created. Remember, there are always two sides to every trade - so while you think you made a smart move, the person (or computer more likely) on the other side thinks you didn't!(15 votes)
- so the call is the right to buy and put is the right to sell. None of them are obligation. Let say the stock price is $50. I buy a call $60 that expires in 90 days. well In 2 months the stock price goes up to $100. If I decide to exercise my call, can the stock owner refuse to sell it to me for $60? Or once the call/put is written, the writer of it is required to comply if the purchaser of the option decides to exercise it?(5 votes)
- The writer must comply with what the purchaser of the option wants. That's why they get paid when they write the option. They are getting paid as compensation for taking on that risk.(4 votes)
How does the stike price set?
For example, the above example shows that the strike price is $60. How did the price, $60 set up in the first place?(5 votes)
Typically there are "market makers" who decide what options they want to make a market in. They try to offer instruments that a lot of people will want to buy and sell. They don't want to have illiquid options markets. If you are a big enough investor, you can probably get a brokerage firm to offer just about any strike price and expiration you want.(7 votes)
So who does the money go to for the option? Does the company that issues the stock offer the option or is there a broker that does this for a fee. It seems like a lot of risk for the broker... well, if that's the case ( I don't think it is).(5 votes)- The option could be written by anyone who has the financial backing to meet their obligation or be bought by anyone who also has the financial backing to meet their obligation. It all depends on who is in the money at the time the option is exercised. For American options this can be before or on the options expiration date and for European options they can only be exercised on the expiration date.(4 votes)
Is there ever any benefit to buying a European stock option vs an American one? I can't seem to think of any reason why someone would give up on the flexibility of buying at any point before expiration.(4 votes)
One reason is that European stock options tend to be more volatile, so that attracts short-term traders. Another reason is that although it is better to own American options, it is still better to sell and short European options. Perhaps the most important reason is that they tend to be cheaper.(6 votes)
- for the example in that vedio i have some quistions
1- at what basis the price of the option determined ( 5 dollars )?and who determine it ??
2- now the price is 50 and i buy an option with strike price 60 >> is the strike price is the price where i need the stock to go higher than it for me to start profiting ?? and who determine it ?? and at what basis he determine it ?? and what happen if the price at the end of the month was (55 or 60 or 65 )
3- the option period is 1 month lets say the stock go to 80 at the first week can i close the contract and collect my profit or i must wait to the end of the month ??
4- a good idea have come to my mind after i watch this video (( i am very beginner at option ))
let's say i am a stock trader and i buy a stock at 50 dollar hoping it to go to 90 and at this case i will earn 40 but as we all know there is nothing 100% sure in trading and if the price go to 10 i well be losing 40 dollar
so why i don't protect my self >> you will ask how
i will till you the idea : i will buy the stock at 50 and at the same time sell an option
if the price go up to 90 i will earn 40 -5 ( cost of the option )=35 instead of 40 ( not bad )
but if the stock go to 10 i will not lose 40 because the the lose in from the stock will be combinsated from the profit of the option
is this idea is good or silly ?or is there is things that i don't understand or know(3 votes)- Option strike prices are offered across a wide range, for most optionable stocks. There are brokers and others who make a market in the options and will try to offer the "flavors" that buyers want.
The strike price of a call optiion is what you would have to pay to buy the stock if you decide to exercise the option. If you have a strike price of 60, then if you want to exercise your option, you pay $60 and hand over your option, and you get the stock. Obviously you would not want to do that if the stock is selling for $50. If you have bought a call with a strike price of $60, you need the stock to be above $60 at the time of expiration, or the option is worthless. Of course you can also sell the option any time before expiration.(5 votes)
So if I buy an option, even though the shares' price is $80each, in that moment I can buy the "real" stock for only $60each? Or would I have to pay $80?(2 votes)- You could buy the stock for $60, but you would be better off selling the option. You will get more than $20 for it.(3 votes)
I have never heard about different kinds of options before (0:49-1:04). European options sound like they don't give you as much flexibility since you have to wait until a set time to exercise the right.(2 votes)- It doesn't matter that much because options are almost never exercised. They are traded right up until the time of expiration and the last trade is generally one that is around break-even relative to exercise.(3 votes)
Is there typically a minimum number of shares for an option contract? I am assuming probably 100 shares so in this case you would pay $500 total (100 shares at $5/share)?(3 votes)
0:49Video transcript
Let's say you think very
highly of Company ABCD, and you're convinced that
the stock price will go up from its current trading
price of $50 per share. You could do two things. You could either just
buy the stock for $50, and hope that the price goes up. Or-- and I made this price
up-- you could go to an options exchange and for
the price of $5, you could buy the option to buy
this stock over the next month. It expires in one month. Usually it will be
a specific date, but I'm just saying
one month from the date that you buy the option. And it gives you the option to
buy the stock for $60 a share. The type of option that
I've just described is called an American option. And it can be compared
to a European option. An American option allows
you to exercise the option-- to actually buy the
stock-- any time from the time you have the
option until the expiration. On a European option, you
only have the option-- you could only exercise
it-- on the expiration. But we'll just focus
on the American. Now let's think about
the different outcomes depending on what
the stock does. So let's say the stock actually
does do what you think it does. Let's say it goes up,
and then it goes down. Let's say that you're really
good at calling stock price tops. And then right over here--
let's take the two scenarios. Let's take the scenario
where you bought the stock, and then you sell the stock. So you bought at $50
and then over here right at the top-- you're just a
perfect market caller-- you were able to sell
the stock at $80. So let's just think about the
different profit scenarios. So here we have an end
price of $80 per share. If you had bought the stock for
$50, and now sold it at $80, you will have a profit of $30. Now let's think about if
instead of buying the stock, you bought the option today. So if you bought the
option, same thing. When the stock goes
up to here, you'll say, oh, I think that's
the top for the stock. Let me exercise my option. So I'm going to exercise
my option, which gives me the right to buy the
stock at $60 a share. So you're going to buy it at
$60 a share, right over here. And then you can immediately
sell it for $80 a share. So you can make $20
on that transaction. But of course, you paid
$5 for the option itself. So you make $20 on the
difference between 80 and 60, but you had to pay 5. So you have a $15 profit. So there it says, hey, look. Maybe I was better
off buying the stock. And even there I would say,
look, to buy the stock, you had to put $50
of capital at risk. To buy the option, you only had
to put $5 of capital at risk. And to see that, imagine
the negative scenario, where instead of the stock doing
that, let's say the stock just completely plummets
after you buy it. And it goes all the
way down to $20. Now in the situation
with the stock-- let's say right over
there you just had enough. You just say, I want
to sell the stock. So this is an end price of $20. In that situation, you
bought for $50, sell for $20. You will lose $30. But in the option
scenario, this entire time that it was
plummeting, you'll say, I just won't
exercise the option. The option is out of the money. It makes no sense for
me to exercise it. So you just won't
exercise the option. So you'll only lose the price
that you paid for the option. You'll only lose your $5.