Going back to NFLX example, I have one more question. You said that NFLX was trading at $100 yesterday, so where does $7.00 a share come into play? Are the shares not $100 a piece?
Okay, so I thought I knew enough to work the NFLX example, but I still came up with some mistakes. Unexpected values shown in blue here:
http://oi61.tinypic.com/2h71ndh.jpg
I've probably made a fundamental error, what am I missing?
So just so I understand, what flexibility do you have as the purchaser of the put option when it comes to selling. From what I understand the purchaser can choose to sell between the put option maturity date and the put option expiry date, is that correct? Are these typically the same date? Would you pay a premium to have a wider gap between the maturity date and expiration date?
You can take a look at CBOE's product web page to get an idea about the different kinds of options products they offer.
If you bought 100 shares with 100 covered, then you are purely betting the stock is going up by more than the option price. You would break even at $107, but lose on anything lower.
Implied volatility is the amount the stock is expected to move as implied by the price the market is charging. Sometimes it is easier to think of an option price in terms of volatility rather than raw dollars, especially when you are making trades of the type you proposed.
In the Netflix case, the current price of the option "implies" that the stock will move plus or minus 3% per trading day; if it moves more, say 5% a day, you are likely to make money.
Of course, thinking of options in this way also means you are on board with a ton of assumptions in modern options pricing theory, and lots of smart people point out flaws and objections.