SOME EXAMPLE OPTIONS

Consider some call and put options on Sun Microsystems (SUNW). The date is 13 June OF and Sun is selling for $16.25.  The July options expire on 20 July and the October options expire on 18 October. In the parlance of the profession, these are referred to as the July 15 calls, July 17.50 calls, October 15 calls, and October 17.50 calls, with similar terminology for the puts. These particular options are American style.
Consider the July 15 call. This option permits the holder to buy SUNW at a price of $15 a share any time through 20 July. To obtain this option, one would pay a price of $2.35. Therefore, a writer received $2.35 on 13 June and must be ready to sell SUNW to the buyer for $15 during the period through 20 July. Currently, SUNW trades above $15 a share, but as we shall see in more detail later, the option holder has no reason to exercise the option right now.3 To justify purchase of the call, the buyer must be anticipating that SUNW will increase in price before the option expires. The seller of the call must be anticipating that SUNW will not rise sufficiently in price before the option expires.
Note that the option buyer could purchase a call expiring in July but permitting the purchase of SUNW at a price of $17.50. This price is more than the $15.00 exercise price, but as a result, the option, which sells for $1.00, is considerably cheaper. The cheaper price comes from the fact that the July 17.50 call is less likely to be exercised, because the stock has a higher hurdle to clear. A buyer is not willing to pay as much and a seller is more willing to take less for an option that is less likely to be exercised.
Alternatively, the option buyer could choose to purchase an October call instead of a July call. For any exercise price, however, the October calls would be more expensive than the July calls because they allow a longer period for the stock to make the move that the buyer wants. October options are more likely to be exercised than July options; therefore, a buyer would be willing to pay more and the seller would demand more for the October calls. Suppose the buyer expects the stock price to go down. In that case, he might buy a put. Consider the October 17.50 put, which would cost the buyer $3.20. This option would allow the holder to sell SUNW at a price of $17.50 any time up through 18 October.
He has no reason to exercise the option right now, because it would mean he would be buying the option for $3.20 and selling a stock worth $16.25 for $17.50. In effect, the option holder would part with $19.45 (the cost of the option of $3.20 plus the value of the stock of $16.25) and obtain only $17.50.~
The buyer of a put obviously must be anticipating that the stock will fall before the expiration day.
If he wanted a cheaper option than the October 17.50 put, he could buy the October 15 put, which would cost only $1.85 but would allow him to sell the stock for only $15.00 a share. The October 15 put is less likely to be exercised than the October 17.50, because the stock price must fall below a lower hurdle. Thus, the buyer is not willing to pay as much and the seller is willing to take less.
For either exercise price, purchase of a July put instead of an October put would be much cheaper but would allow less time for the stock to make the downward move necessary for the transaction to be worthwhile. The July put is cheaper than the October put; the buyer is not willing to pay as much and the seller is willing to take less because the option is less likely to be exercised.
In observing these option prices, we have obtained our first taste of some principles involved in pricing options.