Options Trading Tutorial

Strike price and Stock price in option trading?

I'm new to option trading, and I don't want to start trading without understanding everything in option trading. If the stock price of GS(Goldman Sachs) is $144 and I look into options. I'm looking for a call option.The expiration-strike price is July170 and another is July90. The stock price is supposed to be above the strike price, when it expires so it's not worthless. Then why would I purchase a contract of July170?

Public Comments

1. Its gonna be worthless in 8 days by next friday.
2. If you buy the July contract with strike 170, which is 18.7% out of the money, you place a bet that the GS spot price will increase from currently 143.21 (closing price on 9 July) to 170, by the expiry date of the option, which is on 18 July. This would mean an increase of the stock price by 18.7% in just 7 days. This is not very likely, and that's why the option is so cheap: last traded price was 10 cents at a volume of only 475 contracts. However, if you plan to sell the option before expiry, let's say on 13 July, you might break even at a stock price of 150 due to the convexity of the option value. All this without counting the transaction costs, of course.
3. As of today's (7/9/09) the ask prices for the two options you mentioned were $53.65 for the July $90 calls $0.10 for the July $170 calls Let's say (1) Tom buys 10 of the $90 calls for $53,650 (2) Dick buys 10 of the $170 calls for $100 If the stock price goes up $40, to $184, at expiration (1) Tom's 10 calls will be worth $94,000, a profit of $40,350 (2) Dick's 10 calls will be worth $14,000, a profit of $13,900 If the stock price goes up $4, to $148, at expiration (1) Tom's 10 calls will be worth $58,000, a profit of $4,350 (2) Dick's 10 calls will be worth $0, a loss of $100 If the stock price goes down $4, to $140, at expiration (1) Tom's 10 calls will be worth $50,000, a loss of $3,650 (2) Dick's 10 calls will be worth $0, a loss of $100 If the stock price goes down $40, to $104, at expiration (1) Tom's 10 calls will be worth $14,000, a loss of $39,650 (2) Dick's 10 calls will be worth $0, a loss of $100 The obvious advantages of the $170 call are (1) Dick only has $100 at risk while Tom has $53,650 at risk. (2) Assuming Dick would not have bought the $170 strike if he did not believe the stock price could make a big more, if he is correct he will make a huge perentage profit (13,900% in this example) on his investment, while Tom's $90 strike calls would make less than 100%. The obvious disadvantage of the $170 call is that most of the time it will result in a small loss. Remember options pricing is based on percentages, not points. So paying $0.10 for an $170 strike on a $144 stock is equivalent to paying $0.01 for a $17 strike on a $14.40 stock. With so little time before expiration the stock is not likely to be in the money at expiration, but moves of that size can and do happen sometimes. Some people call cheap far out of the money options "lottery tickets." Of course, some people will buy an option for some other reason. For example, someone who wrote the option months ago for $5.00 may be buying to close his position in order to free up margin in his account. Someone else might be selling the stock short because he expects it to go down, but he wants to buy the $170 call as "disaster insurance" in case the stock price skyrockets. A third person my be selling a calendar spread (for example, long the July $170 call, short the January $170 call) trying to benefit from an anticipted collapse in implied volatility. When you understand more about option trading you might buy the $170 call option for any of these reasons.