What are options?
A stock option is a contract that gives the owner the right, but not
the obligation, to buy or sell a particular stock at a fixed price
(the strike price) for a specific period of time (the expiration
date). The contract also obligates the seller or writer to meet the
terms of delivery if the contract right is exercised by the owner.
Listed stock options, commonly known as calls and puts, are contracts
that allow an investor to control 100 shares of stock for a
pre-agreed period of time for much less money than it would take to
buy the 100 shares of stock. Options may be either very risky or
relatively conservative, depending upon the level of expertise of the
investor and the option strategy used.
Why use
Options?
There are two main reasons why an investor would use options: to
speculate and to hedge.
Speculation - You can think of speculation as betting on
the movement of a security. Because of the versatility of
options, you can make money when the market goes down or even
sideways. Speculation is the territory in which the big money
is made and lost. The use of options in this manner is the
reason options have the reputation of being risky. Why? When
you buy an option, you have to be correct in determining not
only the direction of the stock's movement, but also the timing
of this movement.
Hedging - The other
function of options is hedging. Think of this as an insurance
policy. Just as you insure your house or car, options can be
used to insure your investments against a downturn. For
example, you might sell short one stock, expecting its price to
drop. At the same time, you might buy a call option on the same
stock as insurance against a large increase in value.
What is a call option?
A call entitles the option buyer to purchase 100 shares of a
particular stock at a pre-agreed price for a specific amount of
time--as little as a few days or for several months--no matter how
high the stock price may rise. The call buyer is betting that the
stock price will go up. For example, let's say that you believe
Walmart will appreciate in value during the next six months, but you
are unwilling or unable to buy 100 shares at $50 per share, for a
total of $5000. However, for $400 (the option premium), you may have
the right to purchase 100 shares of Walmart for $50 (known as the
strike price), no matter how high the price rises during the next six
months.
Now, let's suppose that you're right and at the end of six months
Walmart is not selling for $70 per share. The call option you
originally purchased for $400 is now worth $2000, because the
underlying 100 shares of Walmart have appreciated $20 per share. You
can either sell the call in the open market for $2000 for a $1600
profit, or exercise the option by purchasing the 100 shares of stock
at $50 per share. Most option buyers would sell the call at a profit
and not exercise it.
Although the call buyer's profit is unlimited on the upside, the most
an option buyer can lose is the amount of the option premium--in this
case, $400. For example, let's say that Walmart stock drops to $30 a
share during that period instead of going up to $70. The call
buyer may have bet wrong, but his loss is limited, unlike that of the
investor who bought 100 shares at $50 and now owns the same 100
shares worth only $30 per share (for a loss of $2000 on paper).
Why would an investor sell calls against
stock that he or she owns?
The most common reason is the goal of receiving option premiums,
which add to the overall return on the stock position and offer at
least a measure of downside protection. By that we mean: By receiving
a $400 call premium on Walmart for a six-month call, the investor is
protecting 100 shares of stock against a 4 point drop. A $400 option
premium divided by 100 equals 4 points of protection. Commissions
charged for options and stock purchased are not included in the
calculation for simplification.
If you write a covered call and a dividend is to be paid, who will
get paid the dividend and when?
The owner of record on the date specified by the company receives the
dividend. So, if the option is not exercised prior to the ex-dividend
date, the dividend would be kept by the writer of the covered call
because he is still short the option contract and owns the stock -
and only owners of a stock have voting privileges and can collect a
dividend. But you may notice that many call options are exercised on
dividend-paying stocks prior to the ex-date.
This book describes just about every
fundamental strategy you could try with options. It covers the total return
concept of covered call writing, the pros and cons of option buying, examines
various types of spreads (vertical, calendar, and diagonal) and the various
delta (price) neutral strategies. If you have to have only one book on options,
this will be it.
Spend less than you earn! People who spend every penny
they make usually end up going broke.......
Take enough risk on the money you save! Playing safe by
putting your money under the mattress or in a savings account
will not make you wealthy..
Remember that.....Fully one-fifth of humanity, some 1.3 billion people,
struggles to survive on less than $1 per day. About 40% of
humanity survives on less than $2 per day. More than a billion
people around the world will go to bed hungry tonight. Life
expectancy in some 32 countries is less than 40 years. If you
have a few extra dollars in your pocket (you don't have to be a
millionaire to make a difference), please share some of your
financial good fortune with others who are in great need.
Think About It... Being in the 'now' brings a freedom, unlike living
in the past or in the future, which is a kind of imprisonment.
This isn't a kind of a denial where you pretend life doesn't have
problems. Life is full of problems, but most of those stresses
and failures are reliving old hurts or worrying about future
concerns. -- Carl Honore
When you 're diagnosed with cancer, you start to
bargain with God: "Let me get through this, and I'll take better
care of myself. I'll get my priorities in order. I'll learn to
live every day to the fullest." Isn't it sad that you have to get
sick before giving yourself permission to live life to the
fullest? -- Robert Schimmel
Look at Life in different & Positive ways
