Economics_Ch16

# Who buys put options people who think the price of

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Unformatted text preview: hares of a stock at a strike price during some period of time. For example, suppose Martin buys a put option to sell 100 shares of IBM stock at \$130 during the next month. If the share price rises above \$130, Martin will not exercise his put option. He will simply tear it up and sell the stock for more than \$130. On the other hand, if the price drops below \$130, then he will exercise his option to sell the stock for \$130 a share. Who buys put options? People who think the price of the stock is going to decline. Who sells put options? Obviously, the people who think the price of the stock is going to rise. Why not sell a put option for, say, \$20, if you believe that the price of the stock is going to rise and the buyer of the put option is not going to exercise the option? QUESTION: I’ve heard some people talk about getting part of their pay or a bonus in the form of stock options. I’ve heard that some people make a lot of money through stock options. What are these options? ANSWER: A stock option gives an employee the right to buy a specific number of shares of stock at a price specified by the employer. The “price” specified by the employer is often the current market price of the stock when the stock option is issued. The hope for the employee is that the market price will rise over time. For example, if the stock option specifies the price of \$10 a share, the employee has the right to buy the stock at \$10. Now suppose time passes and the market price of the stock rises to \$40. What can the employee do now? He or she can buy the stock for \$10 a share and then turn around and sell it for \$40 a share. 454 Chapter 16 Stocks and Bonds 16 (428-459) EMC Chap 16 11/18/05 9:34 AM Page 455 How You Can Use Call and Put Options Suppose you think a certain stock is going to rise in price during the next few months. Currently, the stock sells for \$250 a share. You don’t have enough money to buy many shares of stock, but you would like to benefit from what you expect will be a rise in the price of the stock. What can...
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