I have a question on options. If the strike price for the call is $12.50 does this mean the options price at the expiration date has to be $12.50 or does this mean the price of stock has to be at $12.50 or greater. And what does delta mean? (January 29, 2003)
Good questions. The strike price determines if you make money or lose money at expiration. If the strike is $12.50 on a call, if the stock price is greater than 12.50 on expiration the option's value will roughly be the difference between the stock price and the strike price. For example, if the stock is at 15, the value of the option at expiration will be 2.50. Why? Because you could exercise the option and buy the stock at $12.50 (the strike price you bought) and then go out and sell the stock for $15 and make roughly $2.50. If the stock price is less than 12.50 (say $10) at expiration, the option will be valueless because you would not exercise the option to buy the stock at $12.50 to go and sell it at $10.
Thus the strike price helps set the value of your option not only at expiration but anytime during the option's life. If the stock is $2.50 above the strike price (known as 'in the money') the options value will include that $2.50 intrinsic value as well as a time element (at expiration there is no time left so it is 0) and a volatility element (stocks that run up and down or make big moves have a higher volatility element in their options).
We typically buy options not to exercise them but to sell them when the stock makes the move we want. The intrinsic value will increase as the stock moves in the direction we want and volatility may increase as well if the move is a sharp one. That volatility element will fade if the stock settles down a bit; once the news is disseminated it is not news and volatility thus drops and so does the option value even if the stock price does not change. Given the volatility and time component, we rarely hold options until expiration unless the stock just continues to move steadily in our favor enough to offset the falling time value as time runs out. Thus when we have a target hit on an option play we usually take the gain as opposed to letting the play run out of gas and come back on us.
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