“Out of the Money” Stock Options VERSUS “In the Money” Stock Options IF You Buy 50 January 30 Call Contracts

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. Notice that, because you invested $30,000, your net profit is $70,000.

—Stephen A. Ross, Randolph W. Westerfield, and Bradford D. Jordan, Fundamentals of Corporate Finance, 6th ed. Alternate ed. (New York: McGraw-Hill Irwin, 2003), 456.