Transferable stock options - TSO

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After you have read basics of stocks trade and got common terms some of terms, its time to peek into real life examples.

Google is trend setter in many areas and its known that Googleplex is best working environment. Even today Google employees receive stock options beside salary in order to longterm bound themselves to company. GOOG index has been in good shape recently, but Google financial wizards went step further in securing employees.
If GOOG is under water they still earn money an have received round $40M of additional value during recent years. How?
By targeting 90th percentile of market price for new comers equity. More info can be found on slide on this page:
http://www.sec.gov/Archives/edgar/data/1288776/000119312508212899/dfwp.htm

Stock options : Put Option

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Example of a put option on a stock
Buy a Put: A Buyer thinks price of a stock will decrease.
Pay a premium which buyer will never get back, unless
it is sold before expiration.
The buyer has the right to sell the stock
at strike price.

Write a put: Writer receives a premium.
If buyer exercises the option,
writer will buy the stock at strike price.
If buyer does not exercise the option,
writer's profit is premium.
'Trader A' (Put Buyer) purchases a put contract to sell 100 shares of XYZ Corp. to 'Trader B' (Put Writer) for $50/share. The current price is $55/share, and 'Trader A' pays a premium of $5/share. If the price of XYZ stock falls to $40/share right before expiration, then 'Trader A' can exercise the put by buying 100 shares for $4,000 from the stock market, then selling them to 'Trader B' for $5,000.
Trader A's total earnings (S) can be calculated at $500.
Sale of the 100 stock at strike price of $50 to 'Trader B' = $5,000 (P)
Purchase of 100 stock at $40 = $4,000 (Q)
Put Option premium paid to Trader B for buying the contract of 100 shares @ $5/share, excluding commissions = $500 (R)

S=P-(Q+R)=$5,000-($4,000+$500)=$500
If, however, the share price never drops below the strike price (in this case, $50), then 'Trader A' would not exercise the option. (Why sell a stock to 'Trader B' at $50, if it would cost 'Trader A' more than that to buy it?). Trader A's option would be worthless and he would have lost the whole investment, the fee (premium) for the option contract, $500 (5/share, 100 shares per contract). Trader A's total loss are limited to the cost of the put premium plus the sales commission to buy it.

There is another related post about call options on this blog.

Stock Options: Call Option

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Example of a call option on a stock

Buy a call: The buyer expects that the price may go up.
The buyer pays a premium that he will never get back.
He has the right to exercise the option at the strike price.

Write a call: The writer receives the premium.
If the buyer decides to exercise the option, then
the writer has to sell the stock at the strike price.
If the buyer does not exercise the option, then
the writer profits the premium.
'Trader A' (Call Buyer) purchases a Call contract to buy 100 shares of XYZ Corp from 'Trader B' (Call Writer) at $50/share. The current price is $45/share, and 'Trader A' pays a premium of $5/share. If the share price of XYZ stock rises to $60/share right before expiration, then 'Trader A' can exercise the call by buying 100 shares for $5,000 from 'Trader B' and sell them at $6,000 in the stock market.
Trader A's total earnings (S) can be calculated at $500.
Sale of 100 stock at $60 = $6,000 (P)
Amount paid to 'Trader B' for the 100 stock bought at strike price of $50 = $5,000 (Q)
Call Option premium paid to Trader B for buying the contract of 100 shares @ $5/share, excluding commissions = $500 (R)

S=P-(Q+R)=$6,000−($5,000+$500)=$500'
If, however, the price of XYZ drops to $40/share below the strike price, then 'Trader A' would not exercise the option. (Why buy a stock from 'Trader B' at 50, the strike price, when it can be bought at $40 in the stock market?) Trader A's option would be worthless and the whole investment, the fee (premium) for the option contract, $500 (5/share, 100 shares per contract). Trader A's total loss is limited to the cost of the call premium plus the sales commission to buy it.

Related blog post: Put Options.