- How to Hedge Option Trade
- When Do Call Options Expire?
- How to Decide Whether to Exercise a Call Option
- How Much Tax Do You Pay on Call Option Gains?
- What Is the Difference Between Buying a Call vs. Selling a Put?
- If Most of the Call Options on a Stock Are in the Money Is It Likely That the Stock Price Has Risen?
Options give you the right but not the obligation to buy or sell a financial asset at a predetermined price and specific date. "Call" options allow you to buy, while "put" options allow you to sell. The underlying asset can be practically anything, but options are most frequently used to lock in a transaction price for stocks. Since the option holder has the privilege to decide whether to execute an option, many options expire without ever being exercised. If you do exercise the option, you can calculate its return in a few simple steps.
Subtract the purchase price from the sales price of the asset, which you bought or sold using the option. Regardless of whether the option was a call or a put, the steps are identical. For example, if you have a call option giving you the right to purchase a particular stock for $30 and you decide to exercise this option because the market price of the stock is $35, subtract $30 from $35. If you were holding a put option allowing you to sell a stock at $20 and you decided to exercise the option because the stock sells for $18, then you would subtract $18 from $20. In the first case, you buy the stock from the person who wrote the option and sell it in the stock market. In the second case, you buy the stock in the stock market and sell it to the option's writer.
Multiply the difference between the purchase and sale price by the quantity of assets. If the call option was for 100 shares, multiply $5 by 100. The result is $500. If the option had been for pounds of corn, you would multiply the difference between the purchase and sales price per pound of corn by the number of pounds.
Subtract the price you paid for the option, also referred to as the option premium, from the result you found in Step 2. Since the option puts you in a privileged position to decide whether you want to exercise it or not, you must always pay money to the option's writer. If you have paid $400 to purchase the call option, subtracting $400 from $500 gives you a net profit of $100. To convert this return to a percentage basis, divide the net profit by the option's purchase price and multiply the result by 100. In this case, $100 divided by $400 times is 0.25. When you multiply the result by 100, you get a return of 25 percent.
- The steps outlined above are only necessary if you have exercised the option. If you elected not to exercise the option, all the money you paid to purchase the option registers as a loss, so your return is zero.
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