If these traders are buying call options do their

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Unformatted text preview: 6 11/18/05 9:34 AM Page 454 Options An option is a contract that gives the owner of the option the right, but not the obligation, to buy or sell shares of a stock at a specified price on or before a specified date. The two types of options are calls and puts. Call Options option Contract that gives the owner the right, but not the obligation, to buy or sell shares of a good at a specified price on or before a specified date. If these traders are buying call options, do their clients already own the stock in question? Why do you think someone would buy an option on a stock rather than the stock itself? Call options give the owner of the option the right to buy shares of a stock at a specified price within the time limits of the contract. The specified price at which the buyer can buy shares of a stock is called the strike price. For example, suppose Brown buys a call option for $20. The call option specifies that she can buy 100 shares of IBM stock at a strike price of $150 within the next month. If the price of IBM stocks falls below $150, Brown doesn’t exercise her call option. She simply tears it up and accepts the fact that she has lost $20. If she still wants to buy IBM stock, she can do so through her stockbroker as she normally does and pay the going price, which is lower than $150. If the price rises above $150, she exercises her call option. She buys the stock at $150 a share and then turns around and sells it for the higher market price. She has made a profit. If Brown buys a call option, then someone must sell it to her. Who would sell her a call option? Any person who thought the option wouldn’t be exercised by the buyer. For example, if Jackson believed that the price of IBM was going to fall below $150, then he would gladly sell a call option to Brown for $20, thinking that the option would never be exercised. That’s $20 in his pocket. Put Options Put options give the owner the right, but not the obligation, to sell (rather than buy, as in a call option) s...
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