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Understanding calls

Suppose you have a coupon from the Purple Pizza Company that lets you buy a pizza for $ 12, and it ‘s valid for a year. This is basically a call—it gives you an option to buy the pizza for $ 12, and it expires on a certain date. It ‘s up to you whether you use it .
normally, you ‘ll only use the coupon if it has value. Let ‘s say pizza are on sale for $ 10. Are you going to use the $ 12 coupon ? obviously not .
On the other bridge player, if pizzas are selling for $ 20, then the coupon has $ 8 of substantial value, and you ‘ll use it. In the linguistic process of options, you ‘ll exercise your right to buy the pizza at the lower price.

now, let ‘s translate this mind to the stock marketplace by imagining that Purple Pizza Company ‘s lineage is traded on the market. A Purple Pizza Co December 50 call option would give you the right to buy 100 shares of the company ‘s livestock for $ 50 per share on or before the call ‘s December termination.

If the shares are trading at less than $ 50, it ’ s improbable that you would exercise the call, for the lapp reason that you would n’t use a $ 12 coupon to buy a $ 10 pizza. alternatively, you could hang on to the call choice in hopes that the livestock moves above $ 50 before the call option expires.

Let ‘s say the price of the standard does, in fact, go up to $ 55 per share. now, if you were to exercise your option, you could buy shares for $ 50, then re-sell them on the open marketplace for $ 55 each. Or you could hold on to the shares and see if the price goes up even further. Either way, you will have used your choice to buy Purple Pizza shares at a below-market price .
Another hypothesis is to sell the call choice to person else before it expires, giving them the right to buy Purple Pizza shares at the below-market price of $ 50 per share. Since you bought the option when it had less value—i.e., when Purple Pizza neckcloth was selling for less than $ 50 per share—you can potentially sell your choice for a higher price and make a profit ( not counting fees and commissions ). In this scenario, you would make money buying and selling alone the option ; you ’ d never own actual Purple Pizza shares .
This is a good topographic point to re-emphasize one cardinal remainder between a coupon and a address option. Most coupons are free, but as we ‘ve mentioned, you have to buy an option. The price is known as the premium, and it ‘s non-refundable. You do n’t get it back, even if you never use ( i.e., exercise ) the choice. so, remember to factor the premium into your thinking about profits and losses on options .

source : https://www.peterswar.net
Category : Finance

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