Portfolio margin: The value of an option
E*TRADE from Morgan Stanley
The value of an options contract
Options contracts are priced on a per-share basis. So when you read that an option is priced at $3.50, that doesn’t mean you can buy the option with pocket change. Options are contracts that usually represent 100 shares. Therefore, in order to buy one of those option contracts that you see priced at $3.50, you’ll need $3.50 x 100, or $350, plus any applicable commissions.
By extension, if you wanted to purchase 20 such contracts, you would need 20 x 100 x $3.50, or $7,000, plus any applicable commissions.
To arrive at your per-contract requirement, you’d typically multiply the option price by the contract size multiplier (CSM).The general formula for options values can then be reduced to the quantity of the options contracts x CSM (usually 100) x the option price.
For options strategies such as straddles, debit spreads, or calendar spreads, you’d simply substitute the term (option price) from the total strategy price. For example, in creating 10 long straddles with a call option valued at $3.50 and a put option valued at $2.75, your per-contract requirement would be 10 x 100 x ($3.50 + $2.75), or $6,250, plus any applicable commissions.
Options contracts are priced on a per-share basis. So when you read that an option is priced at $3.50, that doesn’t mean you can buy the option with pocket change.
The value of an options position at expiration
While an out-of-the-money option is worthless at expiration, in-the-money options expire with intrinsic value. It’s important to understand how an options position makes or loses value at expiration based on the option type, option strike, and price at which the option was traded.
For example, suppose you sold one 60-strike call option for $2.75 and the stock settled at $71 per share at expiration. In order to calculate the profit or loss of the position, you’d need to know what each of the following four basic options positions would grant you:
- Long call — Right to buy stock at the strike price
- Short call — Obligation to sell stock at the strike price
- Long put — Right to sell stock at the strike price
- Short put — Obligation to buy stock at the strike price
In this example, you sold a 60-strike call, so looking at the definition for the short call, you’d incur the obligation to sell stock at $60 per share. Since you sold one option contract, you’d be incurring the obligation to sell 100 shares of stock at $60.
Since you sold the shares at $60, and the stock settled at $71, you’d incur a loss of $11 per share or $1,100. Remember, however, that when you sold the call option, you collected $2.75 per share, or $275 per option contract. This represents a gain to your overall position. Netting out the two values, you get $1,100–$275, for a net loss of $825.
As an alternative example, if you had bought a 45-strike put for $2, and the stock settled at $39 per share, looking at the definition for a long put, you have the right to sell stock at $45 per share. Since the stock settled at $39 per share, you’d enjoy an initial gain of $6 per share. But because you paid $2 for the put option, your net profit would be $6–$2 = $4 per share, or $400 per contract.
Examples in this article are for hypothetical purposes only and not a recommendation.