Maybe a tiny addendum is in order why in Jim's example the price of the option is higher than $5? Because normally nobody would sell an option which gives you the right to buy shares currently traded for $105 for only $100 from him for less than the $5 you could pocket if you'd exercise and immediately sell them.

That right is only sold to you if you are willing to pay more than those $5 you'd get if you'd immediately exercise them for $100 and sell the shares for the current $105 market price. No free lunch.

That means the price of the option will always be higher than those $5 (as closer to expiry as less so). And that in turns means if you are the one who bought it you'd rather sell the option for those >$5 proceeds than exercise them for only $5 difference.

Berkshire Hathaway FAQ

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