Chapter 6: How options work?
So far you have some basic understanding on options. Let's use an example to illustrate how option works in reality.
Buying call option
Suppose an investor has a bullish view on the stock XYZ. On 1st March, the stock price of XYZ is $67. A call option of XYZ expires in May, with strike price of $70 is selling at $3. The contract size of XYZ option is 100 shares per contract. Therefore, ignoring commission and other fees, the investor needs to pay $300 (i.e. $3 x 100) Price of XYZ $70 May Call Option = $3
Contract value on hand = $3 x 100 = $300 to buy one contract of the call option.
As the cost of the option is $3 per share and the strike price is $70, the breakeven price of this trade is $73 (i.e. $3 + $70).
The profit and loss swing is best summarised in the following table: