Finance and capital markets
- 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
Option expiration and price
In this video we explore how aspects of an option's expiration affect the option's price. Created by Sal Khan.
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- i didnt really get why its better to sell the longer dated option than exercising it. How exactly does selling the longer dated option work?(25 votes)
- Ok, I'll try to explain it using a different example. Imagine that you bought a regular old antique box for your house in the flea market for 10$. After a few days you found out that the box is actually made out of gold! ( bear with me here :) ). You know EXACTLY how much you can make if you sell it right now because because gold is a commodity and is traded daily on a public exchange. So you measure the weight and quality, etc... and find out that you can sell it for $1,000.
However, you also overheard people talking about this seemingly regular gold box and actually found out that this box actually belonged to Cleopatra or some famous dude and thus carries even more value. Would you still be selling it for $1,000 now? Or would you wait a bit and sell it for probably $1,000,000!
$1,000,000 = $1,000 (the actual gold) + $999,000 (historical value)
The same here, If you EXERCISE the option at the strike price then you know what you would be getting exactly: Profit = 2.21 = 19.21 (stock price) - 17 (strike price).
But if you SELL the option then you may be getting more than 2.21 since you would be selling @ no less than 2.21 (because that's what you be getting if exercised) + whatever extra you can get from the buyer. Why?
Since he is willing to buy the option from you then he thinks the stock price might increase even more and thus will pay more over $2.21 say $4 cuz he thinks maybe the stock will increase to $25.
Hope that answers your question and sorry for the long answer.(32 votes)
- so... does the fact that all options expire on a fixed day of the month, does that have any effect on the market in the surrounding days?
- Shouldn't the option price be multiplied by 100 since each option contract is really an option to buy or sell 100 shares of the underlying stock?(7 votes)
- I was just wondering if this time/pricing model was relevant to European options also? Since they can only be exercised on the expiration date, would two differently timed options have correlating value?
- In the case of an European Option, you don't know how the time affect -with 100% certainty- the price of the option, because if the underlying asset pay dividends before the option expiration date, you know that the stock price will go down and in consequence the price of the option will go down too (more probability to be out of the money); but if the underlying asset doesn't pay dividends, having more time the option (that it's like a insurance to the volatility of the stock price) will be more valuable. you can also check John Hull, Cap 9 "Options, Futures and others derivatives" if you have any doubt...good luck!(4 votes)
- Hi Sal,
I don't understand your argument at3:02. If one was going to sell the call option it would eventually give him the money of the option ITSELF, but not the money of EXERCISING the option, isn't it? And then how could someone benefit from an option if the option was sold to someone else?(1 vote)
- Sal is saying that you will be able to make similar or greater profit from selling the option because the person who is buying it will include the upside into the price that they buy the option from you. In this instance, the strike price is still $17 and the share is hypothetically at $25. If another person were to buy the option at this point, they would expect to pay the difference between strike price and current price -> $8 plus the price a small amount for the actual cost of the option. An option that is in the money by $8 will cost more than the $8 that it is in the money.(5 votes)
- Around3:20, Sal says that you would be better off selling the contract then exercising it, so what exactly is the difference, and why is the former more advantageous?(2 votes)
- If you exercise it, you have to lay out money to buy all the underlying shares, and then sell those shares. Why bother doing that when you can just sell the option to someone else, and end up with almost exactly the same amount of profit (or loss)?(2 votes)
- So you can sell options without being a broker?(2 votes)
- There are several online trading platforms which offer the ability to trade options online. Each trade will have a transaction cost which will cut into your profit, or add to your loss when you are a retail trader.(2 votes)
- Can a Call option be exercised at any time before the expiration date if it is "out of the money"? Say you sold the call at $25.50 for a strike price of $27.00 to expire in July. Can the buyer of the call exercise to buy the stock, if say, it's at $25.00?(1 vote)
- what will be the value of option on the basis of black scholes model on expiration date. Either it is equal to market price or less or more than the market price(1 vote)
- The value of a call option at expiration is equal to the difference between the market price and the strike price, if that difference is positive. If it's not, the option is out of the money and it is worthless.
A put is similar but in the opposite direction. It has value if market < strike, and otherwise it is worthless.(2 votes)
- Lets say a company XYZ has a stock right now at $30 and there is an option with a
1 month expiration date valued at $9, which lets me buy 100 shares at $20. So I buy the option now for $9 and buy the 100 shares RIGHT NOW for $2000, then I immediately sell it for $3000.
Can I do this and gain the 3000 - 2000 - 9 = $991 in a single day or the next day? Is there any restriction regarding how soon I can exersice my option?(1 vote)
- There are different types of options. One type can be exercised at any time. One type can be exercised only on the exercise date. But regardless of which type you own, you would always be foolish to exercise before the exercise date. Instead of exercising, you should just sell the option, because an in-the-money option will always be worth more than the difference between the strike price and the stock price.
What you are forgetting in your money-making idea here is that you have to buy the option before you can sell it. You didn't make 991 because you had to pay for the option, and the option is not going to cost you $9 it's going to cost you over $1000. The only way the option would be valued at $9 is if the stock is way, way, way out of the money, and the option is very close to expiration.
There's no free lunch. Ever.(2 votes)
Let's explore a bit how the price of an option can vary, or how it can relate to the actual expiration date. So what I'm going to do is compare two similar options with the underlying stock being General Electric. And they're going to be the same in every way, except one is going to have a further out expiration date. So let's compare this call option right here. So this is a call option on GE with a $17 strike price. So it's the option to buy GE stock at $17. And it has an April, 2011 expiration. So it's going to expire, or the last day of trading that you could trade this option, will be the third Friday in April. Let's compare that with an option that has the same strike price, but has a December, 2011 expiration. So we're going to look for $17 strike price right over here. And you can see right when you compare the options that the one that has a further out expiration cost more. This one costs $3.25, while this one only cost $2.36. And the reason why it costs more is because you get to retain the option for longer. So you could imagine, $17. Let's say that $17 is right over here. Let me draw a hypothetical stock chart. So let's say that $17 is right over here. And so you could imagine, let's say, that you have both of those options. Or you have the option to have either one of those options. And let's say that the stock does something like that. Well, it's going to be in the money. You have the right, if you own either one of those options, you have the option to buy the stock at $17 and then sell it at whatever price this is. Maybe this price over here is like $20 something. So you would make money. But if you have the option with a closer expiration, with the April, 2011 expiration, you have to exercise the option right now. You would have to exercise it right now and close out the option. If you had the longer dated option, you could do it. You could do the exact same thing that this owner of an April, 2011 option has. Or you can hold the option and maybe see if the stock continues to go up. Or you could imagine a downside scenario. Maybe the stock does something like this, where it goes out of the money. Someone who holds the closer dated option, the one that expires first, they'll be completely out of the money. The option would be worthless on this date. But if you have the longer expiration, if your option does not expire until December of 2011, then you could hold it. And maybe, maybe the stock will do something nice. There's some probability that it will one day become in the money. I want to make it clear. Even if you have this situation here, and you hold the longer dated option-- you have the option that's going to expire in December-- you still would not want to exercise it. Because there is someone who would still enjoy all of this optionality of the future. So what you're better off doing, instead of exercising the option, you're better off selling the longer dated option right over there. And you should be able to capture at least as much profit as you would from exercising the option, plus capturing whatever value the buyer sees in the future optionality.