You have a call option. You have the right to buy Pepsi for $80 a share for another 12 weeks. You paid $3 for that option, with PEP trading at about $72 at the time you bought it a month ago. But you also now want to sell that right to someone.
A put on a call represents a compound option. Literally, it's a put on a call...a put being the option to sell an underlying asset at a pre-set price at a pre-set time. A call, meanwhile, describes an option that provides the right, but not the obligation, to buy an underlying asset at a pre-set price and at a pre-set time. So a put on a call represents the option to sell an option to buy some other underlying asset.
Let's flesh it out a bit. In this particular structure, a call exists for some underlying asset, like shares of MSFT. It has a strike price of $140. The call starts to become profitable as the price of MSFT rises above $140. However, a put option exists on this call. It's a contract that gives the holder the right to sell the call at some pre-arranged strike price.
Why not just have a put on the MSFT stock? Why make things so complicated?
At expiration, the holder of the put can choose to sell that call, meaning they have to have a call in hand in order to sell it. The call is relatively cheap compared to the price of the MSFT stock. It allows the holder of the put contract to participate in the trade without having to pay the full amount to buy the MSFT stock come expiration time.
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Finance: What Is a Call Option?25 Views
finance a la shmoop. what is a call option? option? option, where are you? okay
yeah yeah. not phone options, call options. and a close but no cigar. a call option [man smokes in a tub of cash]
is the right to call or buy a security. the concept is easy the math is hard.
you think Coca Cola's poised for a breakout as they go into the new low
calorie beverage business. their stock is at 50 bucks a share and you can buy a [man stands on a stage as crowd cheers]
call option for $1. well that call option buys you the right
to then buy coke stock at 55 bucks a share anytime you want in the next
hundred and 20 days. so let's say Coke announces its new sugarless drink flavor
zero it's two weeks later and the stock skyrockets to fifty eight dollars a
share. you've already paid the dollar for the option now you have to exercise it. [man lifts weights]
so you buy the stock and you're all in now for fifty five dollars plus one or
fifty six bucks a share and your total value is now fifty eight bucks. well you
could turn around today and sell the bundle that moment, and you'll have
turned your dollar into two dollars of profit really fast. and obviously had the [equation on screen]
stock not skyrocketed so quickly well you would have lost everything. still you
lucked out and now you're sitting on some serious cash, courtesy of your call [two men in a tub of cash]
options. as for Coke flavor zero turned out to be nothing more than canned water.
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