Let's look at an example. For the right granted by an option, the buyer pays the seller a certain amount, known as the option premium.
Let's say the current price of AAPL stock is $ 194.
An investor decides to purchase an option with a strike price of $ 197.50 for an option premium of $ 3.
The option expiration allows the option holder to exercise the trade before a certain date (the expiration date), in this example until January 12, 2023.
In this case, the investor, by purchasing the option, locks in his right to buy AAPL stocks at a price of $ 197.50 before the option expires.
Let's assume that by the option expires, the price of AAPL stocks has risen to $ 220.
The option holder now has the opportunity to buy back the stocks at $ 197.50 and sell them on the market for their current value, resulting in a potential profit.
The profit calculation is as follows: 220 – 197.50 – 3 = 19.5.
Thus, the profit will be $ 19.5 per stock.
On the other hand, if the stock price remains at $ 194 or falls, the option holder can simply choose not to exercise the option. In this case, he will only lose the option premium – $ 3.
Thus, the use of options provides investors with the opportunity to profit from both the rise and fall of stocks, while limiting potential losses to the amount of the option premium.