Call Options?

[ActionDavidK]

In a Random Walk Down Wall Street they give an example of a call option which was:
Buying $100 of X and paying $20 for the premium. Then it goes to $200 and you profit $80, which is referred to as a fourfold increase on his investment.
From what I can understand IF the person just bought $100 of X and just held it until it reach $200 then they would profit $100. They referred to this as doubling the investment but I see the two as being different. In the first scenario they used the premium price as the investment, $20, so that’s how they got fourfold.

Other than the premium paid on the call option how is a call option different from just buying and selling the stock?

[CruNKinTILT]

when you buy a call option, you have the "option" of exercising the contracts at the strike date to purchase the stock of the security, or you can sell the option for whatever premium the market currently values it at.

you are not a shareholder when you buy options - so you get no dividends or shareholder benefits

[ActionDavidK]

I still don't understand how it is more profitable in the example I used.

[DcifrThs]

[ QUOTE ]
when you buy a call option, you have the "option" of exercising the contracts at the strike date to purchase the stock of the security, or you can sell the option for whatever premium the market currently values it at.

you are not a shareholder when you buy options - so you get no dividends or shareholder benefits

[/ QUOTE ]

more directly, continuing w/ OP's analogy, in the option scenario, the most you can lose is $20.

in the stock scenario, the most you can lose is $100.

you pay a premium for the right, BUT NOT OBLIGATION, to purchase some amount of the underlying security between now and the date of expiry.

in actuality, it doesn't make sense in most instances to ever exercise the option though (barring dividend payments) since arbitrage makes sure that the prices of all things concerned are close enough that selling the option is a dominating strategy (better than exercising).

Barron

[ActionDavidK]

[ QUOTE ]
in actuality, it doesn't make sense in most instances to ever exercise the option though (barring dividend payments) since arbitrage makes sure that the prices of all things concerned are close enough that selling the option is a dominating strategy (better than exercising).

Barron

[/ QUOTE ]

Does this mean that the premium isn't a stardard 15- 20%? It's a variable based on how the investment is expected to do? Is there anything like shorting but with options?

[DcifrThs]

[ QUOTE ]
[ QUOTE ]
in actuality, it doesn't make sense in most instances to ever exercise the option though (barring dividend payments) since arbitrage makes sure that the prices of all things concerned are close enough that selling the option is a dominating strategy (better than exercising).

Barron

[/ QUOTE ]

Does this mean that the premium isn't a stardard 15- 20%? It's a variable based on how the investment is expected to do? Is there anything like shorting but with options?

[/ QUOTE ]

traditional option pricing formulas show the premium depends on:

1) interest rate

2) current security price

3) volatility (when going from assumptions --> premium prices typically historical volatility is used. when going from premium price ---> back out the assumptions on volatility it is called "implied volatility") of the security price

4) time to maturity

i don't know how premiums are distributed since i don't have extensive experience looking into the universe of options prices. but yes, it is a variable based on the above assumptions.

there is shorting of options.

when you purchase an option, you are long volatility. you make money when volatility increases or investors become fearful and are willing to purchase options at any price to protect their downside. you have an unlimited gain and a known capped loss.

when you sell ("write") a naked option (naked=without purchasing the underlying to hedge the loss), you make money if nothing happnes. i.e. you simply earn the premium fromt he sale. your maximum gain is known and your losses are virtually limitless (though limited in reality in terms of selling naked puts since the security price can only fall to $0...writing naked calls has a literaly unlimited downside with a limited known capped gain).

being short options is similar to betting volatility is overprices and should calm down. In many circles it is called being "short gamma." "don't get caught being short gamma" as the saying goes [img]/images/graemlins/wink.gif[/img]

gamma relates to the change in premium price resulting from a small change in the implied volatility. if you are "short gamma" you are exposed significantly and can result in a "win small, win small, win small ...., win small, BOOM LOSE BIG" type payoff profile.

Barron

[pig4bill]

OP, read the educational material at www.cboe.com.

[ifckladyluck]

as scotty ngugyen would say:

its all about the leverage, baby.