Hi Avemaria,With respect to your post # 9096725 my understanding...

Hi Avemaria,

With respect to your post # 9096725 my understanding of options is that you are correct.

An option does not give its purchaser a share of the ownership of the company. An option only gives the holder the legally enforceable right, if s/he fulfills predetermined obligations, to purchase a share of the company.

When the share price is above the strike price i.e the price to exercise the options, the option price is essentially, as you say, equates only to what a person is willing to pay for the priviledge the right to purchase a share. When the share price is under the strike price it is said that the options are 'out of the money'.

When the share price is over the strike price the options are said to be 'in the money'. When the options are 'in the money' then they are valued not only with the 'priviledge value' or 'time value' but also an 'intrinsic value'.

The intrinsic value is the value encompassed in the option by being 'in the money'. Consider the example of the valuation of an option on the last day that it can be exercised. It will not have any 'time value'. If the share price is over the strike price or 'out of the money', it will expire worthless. On the other hand if the share price is under the strike price or 'in the money', the options 'intrinsic value' should be the difference between the two on the last day to exercise the options and this should be the value of the options on that day.

Therefore, the value of the options should be the 'time value' + 'intrinsic value'.

Now, when hypothetically the options are 'in the money' and there is a long period of time for the expiry of the options this will be taken into account in the 'intrinsic value'. The longer the period to expiry and the volitility of the share price have an impact on the 'intrinsic value' of the option. Therefore, when there is a long period for the options to run an increase in share price of say 1 cent will not directly relate to an increase in the option price of 1 cent.

Going back to the 'time value' of an option, the cost of borrowing money will be taken into account in valuing this component of an options value.

So there are a lot of issues that are taken into account in the price of an option. What I would suggest is that most experienced option purchasers would say is they are getting happier when their options are in the money especially when they have a long time to run.

It should also be noted that option holders, in Australia, generally have the right to exercise their options at any time before expiry.

One reason IMHO with a stock like CTP investors in options are willing to pay well over what they could borrow the money to pay for an equivilent number of heads because there is an inherent safety in options. An options purchaser @ 5 cents can only lose five cents. A purchaser of heads @ 15 cents can lose 15 cents. Unless a stop loss is guaranteed, a share price may fall well ahead of the stop loss trigger in a market colapse.

Further as we have seen in the recent past, the options will not fall as much in real terms as the heads. When CTP was 20 cents CTPO got to 9 cents. Now when CTP has got to 13 cents a fall of 7 cents CTPO fell to about 4 cents a fall of 5 cents.

Buying options is not for all. A purchaser of options needs to understand all the factors that are taken into account in their pricing and the legal rights attached to them.

If a person wishes to trade derivatives, which are slightly different instruments than exchange traded options, with Comsec they need to show Comsec they have an understanding of derivatives. I don't know if this is the same for all brokerages. The point being is if a person wishes to invest in options they should get and complete the requirements for derivative options, even if they never trade derivatives. This I would suggest is the minimum a person should do and further reading on options would also be of assistance.

I hope this helps.

Cheers

Stoops.