Options are a means to leverage your position and increase the potential returns, but they also magnify the potential for loss. Select any two stocks and locate prices for the stocks and for call options on those stocks. Select the following three call options on each stock (many websites have option prices, for example, www.cboe.com):
- A call whose strike price exceeds the price of the stock (out-of-the-money call).
- A call whose strike price approximates the price of the stock (at-the-money call).
- A call whose strike price is less than the price of the stock (in-the-money call).
Select options that will expire within 3 to 6 weeks, and answer the following questions:
- What is the intrinsic value of each option?
- What is the time premium paid for each option?
- What is the maximum you could lose if you bought each option?
- What is the maximum you could lose if you bought the underlying stock?
- What is the probability of that occurring within 3 to 6 weeks?
Additionally, discuss your in-the-money option and out-of-the-money option. What are the underlying securities? What is the intrinsic value of each of the options, and how is the intrinsic value related to the premium you paid to buy the options? What is the potential for losses and gains in all three scenarios?