Option expiration and price

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Option expiration and price발음듣기

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Let's explore a bit how the price of an option can vary, or how it can relate to the actual expiration date.발음듣기

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So what I'm going to do is compare two similar options with the underlying stock being General Electric.발음듣기

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And they're going to be the same in every way, except one is going to have a further out expiration date.발음듣기

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So let's compare this call option right here.발음듣기

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So this is a call option on GE with a $17 strike price.발음듣기

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So it's the option to buy GE stock at $17.발음듣기

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And it has an April, 2011 expiration.발음듣기

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So it's going to expire, or the last day of trading that you could trade this option, will be the third Friday in April.발음듣기

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Let's compare that with an option that has the same strike price, but has a December, 2011 expiration.발음듣기

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So we're going to look for $17 strike price right over here.발음듣기

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And you can see right when you compare the options that the one that has a further out expiration cost more.발음듣기

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This one costs $3.25, while this one only cost $2.36.발음듣기

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And the reason why it costs more is because you get to retain the option for longer.발음듣기

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So you could imagine, $17.발음듣기

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Let's say that $17 is right over here.발음듣기

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Let me draw a hypothetical stock chart.발음듣기

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So let's say that $17 is right over here.발음듣기

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And so you could imagine, let's say, that you have both of those options.발음듣기

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Or you have the option to have either one of those options.발음듣기

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And let's say that the stock does something like that.발음듣기

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Well, it's going to be in the money.발음듣기

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You have the right, if you own either one of those options, you have the option to buy the stock at $17 and then sell it at whatever price this is.발음듣기

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Maybe this price over here is like $20 something.발음듣기

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So you would make money.발음듣기

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But if you have the option with a closer expiration, with the April, 2011 expiration, you have to exercise the option right now.발음듣기

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You would have to exercise it right now and close out the option.발음듣기

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If you had the longer dated option, you could do it.발음듣기

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You could do the exact same thing that this owner of an April, 2011 option has.발음듣기

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Or you can hold the option and maybe see if the stock continues to go up.발음듣기

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Or you could imagine a downside scenario.발음듣기

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Maybe the stock does something like this, where it goes out of the money.발음듣기

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Someone who holds the closer dated option, the one that expires first, they'll be completely out of the money.발음듣기

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The option would be worthless on this date.발음듣기

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But if you have the longer expiration, if your option does not expire until December of 2011, then you could hold it.발음듣기

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And maybe, maybe the stock will do something nice.발음듣기

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There's some probability that it will one day become in the money.발음듣기

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I want to make it clear.발음듣기

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Even if you have this situation here, and you hold the longer dated option - you have the option that's going to expire in December - you still would not want to exercise it.발음듣기

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Because there is someone who would still enjoy all of this optionality of the future.발음듣기

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So what you're better off doing, instead of exercising the option, you're better off selling the longer dated option right over there.발음듣기

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And you should be able to capture at least as much profit as you would from exercising the option, plus capturing whatever value the buyer sees in the future optionality.발음듣기

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