explain this to me please...

[sjzeno]

hey,

if you purchased one of these contracts at a premium of .05, what would your profit be? Can you trade this and make 100% on the premium or how does it work? this was "paper purchased" yesterday at 3.05

SIRI May 2008 3.0000 call
(OPR: QXOEG.X)
Last Trade: 0.10
Trade Time: 3:28PM ET
Change: Up 0.05 (100.00%)
Prev Close: 0.05
Open: 0.05
Bid: 0.05
Ask: 0.10
Day's Range: 0.05 - 0.10
Contract Range: N/A - N/A
Volume: 242
Open Interest: 37,796
Strike: 3.00
Expire Date: 16-May-08

[aiki14]

hey,

if you purchased one of these contracts at a premium of .05, what would your profit be? Can you trade this and make 100% on the premium or how does it work? this was "paper purchased" yesterday at 3.05

SIRI May 2008 3.0000 call
(OPR: QXOEG.X)
Last Trade: 0.10
Trade Time: 3:28PM ET
Change: Up 0.05 (100.00%)
Prev Close: 0.05
Open: 0.05
Bid: 0.05
Ask: 0.10
Day's Range: 0.05 - 0.10
Contract Range: N/A - N/A
Volume: 242
Open Interest: 37,796
Strike: 3.00
Expire Date: 16-May-08

If you owned the contracts at .05 and sold at .10 you would have made 100%, note however that if every contract traded was yours and went from .05 to .1 it would only have been $1210, and I believe some traded at .05 so it would be less than that. Chances are you as an independent investor would not have gotten your contracts to trade up in real life.

[netwrangler]

Your looking at the typical spread for a low value option.
The bid is .05, which is what you get if you sell.
The ask is .10, which is what you pay if you buy.

You will see transactions at both prices. That's just the market maker making a living.

If you buy, and then sell, you will lose 50% — and that's before commissions and fees. [That's assuming the price doesn't change much.]

Options are a great way to use leverage to take advantage of an anticipated change in the price of the underlying stock.
On the other hand, if you don't have a reason to anticipate a change in price, options are a lousy bet.

Here's the problem:
Assuming market volatility stays the same, you need the price of SIRI to go up from 2.44 to 2.60 just to 'make the spread' and break even. You need to see 2.75 to be able to sell your call at $0.15. Doing the math, you need a 6.6% gain to break even, and a 12.7% gain to make a profit.

The good news is, you made 50% (buy @ .10, sell @ .15) before fees on a 12.7% gain in the stock. That's 4X leverage. Easy to see why people like options.
But note there was no opportunity for you to take a 25% gain. The SIRI options are priced in 5-cent increments. So the possibilities are:

The stock price stays the same and you lose 50%;
The stock price goes up 6.6% and you break even;
The stock price goes up 12.7% and you make 50%.

There are no intermediate steps [and we don't need to think about the price of the stock going down].

But all this is before fees. Commissions on options usually involve a fixed fee for the 'trade' plus a fee for each contract. For simplicity, let's assume a fee of $1.00 per contract. That immediately highlights a major disadvantage of buying a call option with a low price. The commission is 10% of the premium. Moreover, that commission is charged twice — when you buy and when you sell. After commissions, the possibilities are:

The stock price stays the same and you lose 70%;
The stock price goes up 6.6% and you lose 20%;
The stock price goes up 12.7% and you make 30%.

You can't actually break even exactly in a single trade, but if you did a large number of trades like this, you would need the stock price to increase by an average of 9%.

The above assumes that the market maker plays fair with the spread. All too often I have seen the ask price on calls I owned go up, and the bid stay the same. When the stock price is moving, the market maker sees 'volatility', and that's a signal to increase the spread. Works for him. Works against you.

Finally, all option profit analysis is tied to time. The above analysis works for a single trading day. If you wait a week, the average break even percentage goes from ~9% to ~13%. The numbers get worse as expiry approaches — options are [as the mandatory training booklet tells you] a wasting asset.

=====
All of the above numbers were calculated with stock and options data available after market close on 4/17/2008.
I used the 'hypothetical option pricing' tool available to Schwab Street Smart Pro users to estimate option prices.
Within that tool, I used the Cox-Ross-Rubinstein algorithm, which is more appropriate for American options than the more commonly available Black-Scholes algorithm.

=====
The main problem with the trade put forth by the OP is the low premium for the call option.
While buying low premium calls may suggest the opportunity for large percentage gains, I think this is a suckers bet.
You really need to have some reason to believe that the price of the underlying stock will change. You need DD for that. Without DD support, buying low premium calls has a significantly lower payout than going to Vegas and playing the slots.

=====
For the analytical folks reading this, I suggest comparing the SIRI MAY 3 call economics with the CSCO MAY 25 calls. Bumping up the stock price by an order of magnitude and choosing a popular option priced in 1-cent intervals [U]significantly improves your odds of winning. I'd love it if someone would do the math on CSCO by way of comparison.