Glossary

  • Holding the shares would entitle the investor to any dividends that the company may pay. Holding the option would not entitle the investor to any dividends.

  • If the option is exercised at maturity then the holder will buy the shares and so needs to be able to finance this i.e. in the example, to buy 4,000 shares at 800p each would require £32,000. If the holder cannot finance this then there may be three possible choices:

  • It may be possible to sell the option instead of exercising and so realise the gain in this way, or

  • It may be that the option can be "cash settled" meaning that instead of physically delivering the shares, the option seller simply delivers the cash value of the option to the buyer i.e. in this example, the seller would pay £4,000 as cash settlement to the option buyer, or

  • The option holder could borrow the £32,000 and repay it when the shares were sold.

    It is often useful to look at the return from the option, sometimes called it's "payoff", graphically.

    The graph below shows the payoff from the above call option from the buyer's perspective.