![]() ![]() It’s the right to purchase shares at a price (strike price) before a certain amount of time (typically 10 years). To put it in context a lot of HN readers will understand more intuitively: a call option is what you often receive when you get equity in a startup. Very few reasons you’d buy a bunch of call options that only pay off if something causes a stock to move dramatically in 24 hours.įinally, while short-dated, out-of-the-money call options are not something many if anyone should be playing with, they’re just a different flavor of something very familiar. And strategy 2 seems especially suspicious because the risk is so high and the non-illegal reasons for doing it are so few and far between. In both cases you’re likely to at least be investigated. But with strategy 2 you spend $10,000 to buy something that’s worth $900,000,000 after the news breaks. With strategy 1 you spend $10,000 to buy something that, after the news breaks, is worth $1,000,000. Buy 1,000,000 options to buy the stock for $100/share tomorrow with each option costing $0.01. ![]() Buy 1,000 shares of the stock for $10/share.Ģ. If you know in advance the news is going to break you can do two things to (probably illegally) try and profit from it.ġ. So what was worth $0.01 yesterday is worth $900 today. Now how much is the right to buy the stock at $100 per share worth? The answer is going to be something really close to, but maybe a small discount from, $1,000 (current value of the stock) - $100 (how much you pay based on the option) = $900. News breaks and now it’s trading at $1,000 per share. Now imagine it’s the next day and the company with the $10 stock discovers the cure for cancer or invents time travel or perfects cold fusion. So, again to make the numbers simple, let’s say it’s worth $0.01/option to buy a stock at $100 in the next day when it’s trading at $10 today. It could happen, so it’s worth something. A stock trading at $10 is unlikely to jump to $100 in a day so the option to by it for $100 is not worth much. If it’s the right to buy the stock for $100/share at any point over the next 10 years then that’s worth more than to buy the stock at $100/share in the next day. ![]() If someone came to you and said: how much would you be willing to pay to have an option to buy the stock for $100/share? The correct answer is: it depends. To make the numbers simple, imagine a stock trades at $10/share. The one bit you’re missing is that a call option is the right to buy a stock at a certain price typically on or before a certain date. ![]()
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