Introduction to Corporate Finance

Ross et al.: Fundamentals

of Corporate Finance, Sixth

Edition, Alternate Edition

V. Risk and Return 14. Options and Corporate

Finance

(^484) © The McGraw−Hill
Companies, 2002
complicated than stock tickers, so our nearby Work the Webbox shows you how to get
them along with the associated option price quotes.
Option Payoffs
Looking at Table 14.1, suppose you buy 50 January 30 call contracts. The option is
quoted at $6, so the contracts cost $600 each. You spend a total of 50 $600 
$30,000. You wait awhile, and the expiration date rolls around.
Now what? You have the right to buy AOL stock for $30 per share. If AOL is selling
for less than $30 a share, then this option isn’t worth anything, and you throw it away.
In this case, we say that the option has finished “out of the money” because the stock
price is less than the exercise price. Your $30,000 is, alas, a complete loss.
If AOL is selling for more than $30 per share, then you need to exercise your option.
In this case, the option is “in the money” because the stock price exceeds the exercise
price. Suppose AOL has risen to, say, $50 per share. Because you have the right to buy
AOL at $30, you make a $20 profit on each share upon exercise. Each contract involves
100 shares, so you make $20 per share 100 shares per contract $2,000 per contract.
Finally, you own 50 contracts, so the value of your options is a handsome $100,000. No-
tice that, because you invested $30,000, your net profit is $70,000.
As our example indicates, the gains and losses from buying call options can be quite
large. To illustrate further, suppose you simply purchase the stock with the $30,000 in-
stead of buying call options. In this case, you will have about $30,000/32.28 929.37
shares. We can now compare what you have when the option expires for different stock
prices:
456 PART FIVE Risk and Return

TABLE 14.1

A Sample Wall Street

JournalOption

Quotation

–Call– –Put–

Option/Strike Exp. Vol. Last Vol. Last

AmOnline 25 Oct 6 810 1599 075

3228 30 Sep 432 330 1860 105

3228 30 Oct 197 420 5564 205

3228 30 Jan 298 6 1612 340

3228 30 Apr 9 710 17287 410

3228 3250 Sep 5847 180 7259 2

3228 3250 Oct 434 3 3644 320

3228 35 Sep 6074 085 508 350

3228 35 Oct 10825 185 3625 450

3228 35 Jan 427 360 3168 550

3228 3750 Sep 3276 040 1063 550

3228 3750 Oct 10692 110 318 610

3228 40 Sep 5161 020 3158 790

3228 40 Oct 5260 070 314 820

3228 40 Jan 1287 190 393 820

3228 4250 Jan 1552 140 17 11

3228 50 Oct 2343 010 60 1780

3228 60 Jan 4415 010 30 2760

Source: Reprinted with permission from The Wall Street Journal,September 10, 2001

© Copyright 2001 by Dow Jones & Company. All Rights Reserved Worldwide.