Finance: What are stock options in 90 seconds or less?

What are stock options? Stock options are derivative contracts, each representing 100 shares, that give the holder the right to buy (call) or sell (put) a stock at a specified strike price before a designated expiration date, usually the 3rd Friday of each calendar month. Stock options can also be a form of additional compensation to employees and executives of a public company. Stock options usually vet at a strike price but are worthless until the stock price is at or above the strike price in order to avoid income taxes that would be otherwise due.

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Transcript

00:19

the next three months For one hundred ninety dollars a

00:21

share it's called a call option If you really believe

00:24

the ibm will go to say two hundred dollars a

00:26

share in the next three months well you'd be what's

00:28

called ten dollars in the money then or then have

00:31

a stock option or call option with a strike price

00:34

of one hundred ninety dollars which would then have intrinsic

00:37

value of ten bucks a share On the other end

00:39

of the buy sell desk is the gal willing to

00:42

sell you that call option for three bucks Three bucks

00:45

a premium So gut check time Would you pay three

00:49

dollars for the right to buy a share if ibm

00:52

for ten dollars higher than where the stock's trading now

00:55

today Meaning that to break even in the next three

00:58

months the stock has to trade all the way up

01:00

from one hundred eighty dollars a share to one hundred

01:02

ninety three dollars a share jobs for you to get

01:04

your money back but it goes to two hundred two

01:06

share Well if you sell that option you'll have invested

01:09

three bucks a share for a net return of seven

01:11

bucks in just three months or less And yes we're

01:14

ignoring commissions and taxes here because well in problems like

01:17

this or just a in the book but three dollars

01:19

into seven only three months Yeah that's a great score

01:21

You'd have more than doubled your money And on an

01:24

annualized return basis that's over a nine hundred percent dish

01:27

return really good score but with a much more likely

01:30

case that you spend three bucks to buy the option

01:32

and it expires totally worthless And then you've lost your

01:35

entire investment in that option So that's a call option

01:38

It's evil twin is a put option So whereas a

01:41

call options the rightto by a security to set price

01:45

by a certain set date a put option is the

01:47

right to sell that option We'd go into more detail

01:49

here but we're promised ninety seconds