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AshishKumar36
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Speed
However, an option trader has an additional problem that we might call
the “speed” of the market. If we ignore interest and dividend considerations,
a trader who believes that a stock will rise in price within a specified period can
be reasonably certain of making a profit if he is right. He can simply buy the
stock, wait for it to reach his target price, and then sell the stock at a profit.
The situation is not quite so simple for an option trader. Suppose that a
trader believes that a stock will rise in price from $100, its present price, to $115
within the next five months. Suppose also that a $110 call expiring in three
months is available at a price of $2. If the stock rises to $115 by expiration, the
purchase of the $110 call will result in a profit of $3 ($5 intrinsic value minus
the $2 cost of the option). But is this profit a certainty? What will happen if
the price of the stock remains below $110 for the next three months and only
reaches $115 after the option expires? Then the option will expire worthless,
and the trader will lose his $2 investment.
Perhaps the trader would do better to purchase a $110 call that expires in
six months rather than three months. Now he can be certain that when the stock
reaches $115, the call will be worth at least $5 in intrinsic value. But what if the
price of the six-month option is $6?