Ask TheStreet: Limits and Losses

 

A call option gives the buyer of the call the right, but not the obligation, to buy the underlying stock at the option's strike price, which in this case is $22.50. The seller of the call is obligated to deliver (sell) the underlying stock at the option's strike price when the buyer exercises his right.

Since you are only allowing yourself a single day for the stock to move from its price of $20 past its strike price of $22.50, the price of the option is dirt cheap at 5 cents a share. One option contract represents a hundred shares, so therefore the price of the contract is $5. That's where the leverage comes in for the big score.

You buy the ABCD call option for $5 on March 16 when the stock is at $20. Then you wake up the next morning to see that, praise the lord, the fantasy deal came through. The stock jumps to $23 a share and closes at that price.

Since the stock closed at $23 a share, the value of your option will jump to 50 cents from 5 cents, because the call is expiring 50 cents "in-the-money." Or, in other words, the positive difference between the price of the stock, $23, and the strike price of your option, $22.50.

There you have it. In the end, your lottery ticket paid off 10 times over. Your $5 dollar contract is now worth $50 in just a day!

Now, wake up! Because all the shamrocks in Ireland won't give you enough luck to make this trade more than a dream.

Of course, there are ways to increase the chances of a so-called lottery ticket paying off, either by increasing the amount of time before expiration or by lowering the strike price.

But if you want to wish upon a star, that's how you can do it. Just don't do it with my money.

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