OPTIONS !

Although options can be written on any underlying,let's use options on common stock as an example. A call (put) option on a stock gives its holder the right to buy (sell) a fixed number of shares at a given price at some future date.The specified price is called the exercise price.Whoever sells an option at inception of the contract is called the option writer. When the holder of an option takes advantage of her right,She is said to "exercise it" An option holder who cannot gain from exercising an option before expiration dose not exercise it.The purchase price of an option is called the option premium.

Options enable their holders to lever their resources while at the same time limiting their risk.Suppose an investor, Smith,believes that the current price of $50for Upside Inc.common stock is too low. Let's assume that the premium on a call option that gives the right to buy 100 shares at $ 50 per share is $ 10 per share. By investing $ 1000 smith van buy call options to purchase 100 shares. If she does so, she will gain from stock price increases as if she had invested in 100 shares,even though he invests only an amount equal to the value of 20 shares.With only # 1000 to invest,smith could borrow $4000 to buy 100 shares.At maturity,she would then have to repay the loan.The gain made upon exercising the option is therefore similar to the gain from a levered position in the stock-a position consisting of purchasing shares with one's own money and some borrowed money.However,if Smith borrows, she could lose up to $5000 plus interest due on the loan if the stock price falls to zero. With the call option, she can lose at most $ 1000, which she does if the stock price does not rise above $ 50.