by Tatya H.P.
Perhaps among the most complicated and possibly the riskiest type of trading is option trading. Most seasoned traders realize that option trading does not suit all traders. It selects its own type of people, usually the risk takers. And the trade itself requires skills and thinking unique only to people who could handle extreme risks. Most experts recommend this type of trading only to those people who have sufficient risk capital as it carries with it substantial risks.
By nature, it is also speculative. So if you are a person who doesn’t want to speculate too much, you might as well find another type of security which will work best for you. However, rejecting the idea of entering this trade right away is as risky as not knowing anything about it. It carries with it risks, that's true, but it is also a highly profitable venture. You might as well try to learn something on it such that you could decide whether to try you luck on options trading or not.
While it is inherently risky, option trading also offers advantages that may not be had with other types of trades. Among its premium advantages is the flexibility it lends its investors. Each lender has the option to trade at a specific price within a predetermined period.
It is also, by comparison, a more advantageous type of trade because of the high leverage it offers. Depending on the location, each option may cover a number of underlying assets. In the United States, for example, each option may represent for 100 underlying assets. Thus, this principle lends the holder the capacity to profit from several assets within a single option.
So what is an option?
An option is a type of security, perhaps closely comparable to bonds and stocks. It is, in itself, a binding contract, that is monitored by and through strict terms and conditions. In gist, options are contracts that owners could buy or sell at a certain price prior to or on a specific date. An option is typically an added price tag to a certain asset or item because it is a reservation for the purchase or sale of a certain asset.
Options are also sometimes called derivatives. This is due to the fact that the value of an option is derived from the value of the underlying asset.
To give light on this topic, consider the example below:
Say you have considered buying a real estate property which is worth several hundred thousand dollars. However, when you first negotiated with the owner, you did not have sufficient money to purchase the property right there and then. So you made a deal with the owner to pay an extra $5, 000 to reserve the deal for you for the duration of two months. The extra money you put in is called the options. In case you don’t want to pursue with the sale, the owner of the real estate can neither force you to buy the property nor can the law impose the sale on you. However, you would still have to pay the price of the option.
In summary, when considering buying a property with an enclosed option, you will have the right to pursue with the sale or to turn down the sale. You are not obligated to do either of the two. However, you may lose 100% of your total investment in options trading which is the value of the option itself.
Sunday, January 10, 2010
Options Trading: Call and Put Options
by Tatya H.P.
An option contract is an agreement wherein the owner has the right to buy or sell a security or an asset at a particular price on a fixed date in the future. It is called an option because the owner of the contract is not committed to carry out the obligation of the contract if he or she feels that it is disadvantageous.
There are two types of options contracts: call options and put options.
Call Options
In simple terms, call options give the owner the right to buy the underlying asset in the contract. Again, it is not an obligation.
For example, John and Tom agreed on a call options contract wherein John will buy from Tom, 100 shares (equivalent to one option) of Company A at $20 (strike price) what will expire on the third Friday of April. The current price of the share is $20.
At the expiry date (also called maturity date), the share price of Company A remains at $25. John can then exercise his right to buy the share for $20 and thus, yielding $5. Meanwhile, if the share price goes down to $22, John can still earn $2 by simply exercising his rights as stated in the contract. In whichever way, any amount higher than the strike price at the end of the contract will become the profit of the owner. But before it can happen, the owner who decides to pursue his right has to have his money ready to pay for the amount.
However, if the share price goes down below $20, say $18, on the maturity date, it will be too expensive for John so he can just ignore the contract since he is not obliged to carry it out. He will only lose the amount he paid for the contract called the Option Premium. Tom, on the other hand will keep the asset and the premium, which in a sense, is his profit.
Put Options
In put options, the buyer has the right to sell an asset to the writer (the seller). Just like the call asset, it is bounded by a contract which states that the underlying asset will be sold at a particular price and a particular date. But the similarity ends there. In put options, the writer has to buy the underlying asset at the strike price if the buyer exercises this option.
Let us continue with John and Tom. John bought call options from Tom. But he could also buy put options from Tom. If John buys put options, it means that he buys the right to sell Company A's shares at $20 on April 1. If the price of shares goes down below $20 on the expiry date, John can exercise his right and can still sell it at $20, thus making a profit.
Buying put option allows investors to earn when price of shares drops at the end of the contract.
Profit potentials are unlimited for the buyers of put options, especially if the market begins to sell off. On the other hand, risks are limited if the market goes against them.
Important note:
In reality, trading of options or transactions does not happen between two persons. Buying or selling can happen without knowing the identity of the other party.
Options are only sold in 100 share lots. So if the share price is $20, you will have to pay $2,000 for each option contract plus the Option Premium.
An option contract is an agreement wherein the owner has the right to buy or sell a security or an asset at a particular price on a fixed date in the future. It is called an option because the owner of the contract is not committed to carry out the obligation of the contract if he or she feels that it is disadvantageous.
There are two types of options contracts: call options and put options.
Call Options
In simple terms, call options give the owner the right to buy the underlying asset in the contract. Again, it is not an obligation.
For example, John and Tom agreed on a call options contract wherein John will buy from Tom, 100 shares (equivalent to one option) of Company A at $20 (strike price) what will expire on the third Friday of April. The current price of the share is $20.
At the expiry date (also called maturity date), the share price of Company A remains at $25. John can then exercise his right to buy the share for $20 and thus, yielding $5. Meanwhile, if the share price goes down to $22, John can still earn $2 by simply exercising his rights as stated in the contract. In whichever way, any amount higher than the strike price at the end of the contract will become the profit of the owner. But before it can happen, the owner who decides to pursue his right has to have his money ready to pay for the amount.
However, if the share price goes down below $20, say $18, on the maturity date, it will be too expensive for John so he can just ignore the contract since he is not obliged to carry it out. He will only lose the amount he paid for the contract called the Option Premium. Tom, on the other hand will keep the asset and the premium, which in a sense, is his profit.
Put Options
In put options, the buyer has the right to sell an asset to the writer (the seller). Just like the call asset, it is bounded by a contract which states that the underlying asset will be sold at a particular price and a particular date. But the similarity ends there. In put options, the writer has to buy the underlying asset at the strike price if the buyer exercises this option.
Let us continue with John and Tom. John bought call options from Tom. But he could also buy put options from Tom. If John buys put options, it means that he buys the right to sell Company A's shares at $20 on April 1. If the price of shares goes down below $20 on the expiry date, John can exercise his right and can still sell it at $20, thus making a profit.
Buying put option allows investors to earn when price of shares drops at the end of the contract.
Profit potentials are unlimited for the buyers of put options, especially if the market begins to sell off. On the other hand, risks are limited if the market goes against them.
Important note:
In reality, trading of options or transactions does not happen between two persons. Buying or selling can happen without knowing the identity of the other party.
Options are only sold in 100 share lots. So if the share price is $20, you will have to pay $2,000 for each option contract plus the Option Premium.
Options Trading Basics: A Review
by Tatya H.P.
1. Options give the investor the right to buy or sell the underlying asset or instrument.
2. If you buy options, you are not obliged to buy or sell the underlying asset, you just have the right. Meaning, you can choose to buy the options, sell the options or do nothing and let it expire, depending on what is most advantageous to your position.
3. Options are either call or put. Call options give the power to the buyer to buy the options. Put options give the buyer the right to sell the options.
4. Options are quoted per share, but are sold in 100 share lots. Meaning, if the investor purchases 1 option, he or she is buying 100 shares.
5. The investor only has to pay the option premium and not the total amount of shares like if you are buying per stock. For example, if the option premium of a $50 stock is $3, the total amount of the contract is $300 per option. So if the investor is buying 3 options at $3 per option, since he or she is buying in 100 share lots, the total payment would be $900 (3 options x 100 shares per option x $3 option premium).
6. Buying shares is different. You have to pay per share. For example, the stock price of Company A is $80. If you want to buy 100 shares, you would have to pay $8,000. Whereas with options, if you wish to invest on 100 shares, you just have to enter into a contract wherein you would buy one option at a certain option premium.
7. If you wish to buy the stock at the end of the contract, that will be the only time where you will pay the total amount of money that is equivalent to the number of option contracts, multiplied by contract multiplier. Refer to #6 for example.
8. If the buyer exercises his rights to buy the option (call), the seller (or the writer) is obliged to deliver the underlying asset.
9. If the buyer exercises his rights to sell the option (put), the seller is obliged to purchase the underlying asset.
10. If the buyer wishes to exercise his rights to either buy or sell the underlying asset, the seller must either sell it or buy it at the strike price, regardless of the its current price.
11. In case the buyer of the option decides to do nothing at the end of the contract for whatever reason, the seller keeps the option premium as profit.
12. In computing your profit, you have to consider 2 things: the option premium and the strike price. If the option premium is $2 and the strike price is $50, your break-even point is at $52. So in order for you to make a profit, the stock must be more than $52. If the stock falls below $52, say $49, and there is no time left, you won't lose $3 per stock. What you will lose, however, is the option premium you have paid for the contract.
Note: The numbers were just picked out of the air to illustrate how options trading work. In real world, numbers vary widely so you have to carefully study each of them.
1. Options give the investor the right to buy or sell the underlying asset or instrument.
2. If you buy options, you are not obliged to buy or sell the underlying asset, you just have the right. Meaning, you can choose to buy the options, sell the options or do nothing and let it expire, depending on what is most advantageous to your position.
3. Options are either call or put. Call options give the power to the buyer to buy the options. Put options give the buyer the right to sell the options.
4. Options are quoted per share, but are sold in 100 share lots. Meaning, if the investor purchases 1 option, he or she is buying 100 shares.
5. The investor only has to pay the option premium and not the total amount of shares like if you are buying per stock. For example, if the option premium of a $50 stock is $3, the total amount of the contract is $300 per option. So if the investor is buying 3 options at $3 per option, since he or she is buying in 100 share lots, the total payment would be $900 (3 options x 100 shares per option x $3 option premium).
6. Buying shares is different. You have to pay per share. For example, the stock price of Company A is $80. If you want to buy 100 shares, you would have to pay $8,000. Whereas with options, if you wish to invest on 100 shares, you just have to enter into a contract wherein you would buy one option at a certain option premium.
7. If you wish to buy the stock at the end of the contract, that will be the only time where you will pay the total amount of money that is equivalent to the number of option contracts, multiplied by contract multiplier. Refer to #6 for example.
8. If the buyer exercises his rights to buy the option (call), the seller (or the writer) is obliged to deliver the underlying asset.
9. If the buyer exercises his rights to sell the option (put), the seller is obliged to purchase the underlying asset.
10. If the buyer wishes to exercise his rights to either buy or sell the underlying asset, the seller must either sell it or buy it at the strike price, regardless of the its current price.
11. In case the buyer of the option decides to do nothing at the end of the contract for whatever reason, the seller keeps the option premium as profit.
12. In computing your profit, you have to consider 2 things: the option premium and the strike price. If the option premium is $2 and the strike price is $50, your break-even point is at $52. So in order for you to make a profit, the stock must be more than $52. If the stock falls below $52, say $49, and there is no time left, you won't lose $3 per stock. What you will lose, however, is the option premium you have paid for the contract.
Note: The numbers were just picked out of the air to illustrate how options trading work. In real world, numbers vary widely so you have to carefully study each of them.
Option Trading: Tips for Beginners
by Tatya H.P.
Trading, in general, is a highly technical field that does not only require would-be participants to have some understanding on what a particular trade is or how it works but also in-depth knowledge of what goes within a particular trade. In short, basic knowledge is not as helpful as most think it is. Specialized trading types, such as that of options trading, may force its participants to gain more knowledge.
Here are some tips that could help power you up when starting with options trading:
Know the lingo. Option trading has its own jargon that may seem gibberish to people who do not know a thing about the trade. To them, the terminologies commonly used in trading, regardless of the form, seem so complicated that they would lose interest on the trade even before they get started. Well the lingo of options trading is downright complicated, probably contributing to why too few people involve themselves to it. However, once a trader manages to pick up some basic terms and has learned quite a bit about the trade, it would be much easier to understand how the whole thing works. Probably not all the ins and outs of the trade but the general idea would be well-understood. So do yourself a favor, study the terminologies commonly used in options trading and maybe after that, read a few stuffs about it.
Attend options trading seminars, online or off line. If you want the shortcut to learning the trade, you might want to consider attending seminars or subscribing to online seminars and tutorials. In most cases, seminars cover all levels of knowledge regarding the trade. So for beginners, it would be best to start with the basics of the trade and continuously improve your knowledge by completing a series of seminars.
Subscribe to online tutorials. There are several websites and companies that offer online tutorials which may consist of interactive modules, probably among the best learning tool there is. Interactive modules allow you to learn by practice.
Indulge yourself to some options trading books. Internet could provide the basic things you need to get started with options trading but you must realize that internet can only give you so much. If you have started researching online about this trade, you will find out that the websites dedicated on options trading and other kinds of trades only cover the same things- basics of the trade, common terminologies, some risks involved and others. If you want thorough discussions on the trade, you have to rely on books written by well-recognized authors. Remember the operating word- well recognized. There may be a number of books written on this subject but you must try to pick the best book available so you don’t have to waste your time on repetitive information that you could commonly find online and rubbish talk that may not help you at all.
Once you have read a comprehensive book that discusses on various areas of options trading, it would be much easier to understand technical analysis. At this point, you will have to analyze what the charts suggest, know the types of options that you may want to trade (there are lots of them so be sure to pick out the one that suits you best), use the options strategies that work well with you, and demonstrate knowledge on various market analysis tools.
Trading, in general, is a highly technical field that does not only require would-be participants to have some understanding on what a particular trade is or how it works but also in-depth knowledge of what goes within a particular trade. In short, basic knowledge is not as helpful as most think it is. Specialized trading types, such as that of options trading, may force its participants to gain more knowledge.
Here are some tips that could help power you up when starting with options trading:
Know the lingo. Option trading has its own jargon that may seem gibberish to people who do not know a thing about the trade. To them, the terminologies commonly used in trading, regardless of the form, seem so complicated that they would lose interest on the trade even before they get started. Well the lingo of options trading is downright complicated, probably contributing to why too few people involve themselves to it. However, once a trader manages to pick up some basic terms and has learned quite a bit about the trade, it would be much easier to understand how the whole thing works. Probably not all the ins and outs of the trade but the general idea would be well-understood. So do yourself a favor, study the terminologies commonly used in options trading and maybe after that, read a few stuffs about it.
Attend options trading seminars, online or off line. If you want the shortcut to learning the trade, you might want to consider attending seminars or subscribing to online seminars and tutorials. In most cases, seminars cover all levels of knowledge regarding the trade. So for beginners, it would be best to start with the basics of the trade and continuously improve your knowledge by completing a series of seminars.
Subscribe to online tutorials. There are several websites and companies that offer online tutorials which may consist of interactive modules, probably among the best learning tool there is. Interactive modules allow you to learn by practice.
Indulge yourself to some options trading books. Internet could provide the basic things you need to get started with options trading but you must realize that internet can only give you so much. If you have started researching online about this trade, you will find out that the websites dedicated on options trading and other kinds of trades only cover the same things- basics of the trade, common terminologies, some risks involved and others. If you want thorough discussions on the trade, you have to rely on books written by well-recognized authors. Remember the operating word- well recognized. There may be a number of books written on this subject but you must try to pick the best book available so you don’t have to waste your time on repetitive information that you could commonly find online and rubbish talk that may not help you at all.
Once you have read a comprehensive book that discusses on various areas of options trading, it would be much easier to understand technical analysis. At this point, you will have to analyze what the charts suggest, know the types of options that you may want to trade (there are lots of them so be sure to pick out the one that suits you best), use the options strategies that work well with you, and demonstrate knowledge on various market analysis tools.
Saturday, January 9, 2010
Option Trading Important Terminologies
by Tatya H.P.
Although there are hundreds of terms that are used in the financial language, beginners have to understand first the most important and commonly used words.
Option – is the right of the buyer to either buy or sell the underlying asset at a fixed price and a fixed date. At the end of the contract, the owner can exercise to either buy or sell the option at the strike price. The owner has the right to pursue the contract but he or she is not obligated to do so.
Call option – gives the owner the right to buy the underlying asset.
Put Option – gives the owner the right to sell the underlying asset.
Exercise – is the action where the owner can choose to buy (if call option) or sell (if put option) the underlying asset or, to ignore the contract. If the owner chooses to pursue the contract, he must send an exercise notice to the seller.
Expiration – is the date where the contract ends. After the expiration and the owner does not exercise his or her rights, the contract is terminated.
In-the-money – is an option with an intrinsic value. The call option is in-the-money if the underlying asset is higher than the strike price. The put option is in-the-money if the underlying asset is lower than the strike price.
Out-of-the-money – is an option with no intrinsic value. The call option is out-of-the-money if the trading price is lower than the strike price. The put option is out-of-the-money if the trading price is higher than the strike price.
Offsetting – is an act by which the owner of the option exercises his right to buy or sell the underlying asset before the end of the contract. This is done if the owner feels that the profitability of the stock has reached its peak within the date of the contract.
(Option seller) Writer – is the seller of the underlying asset or the option.
Option buyer – is the person who acquires the rights to convey the option.
Strike Price – is the price at which the underlying stock must be sold or purchased if the contract is exercised. The strike price is clearly stated in the contract. For the buyer of the option to make a profit, the strike price must be lower than the current trading price of the stock. For example, if the contract states that the strike price of a certain stock is $20 and the current trading price at the end of the contract is $25, the buyer can exercise his or her rights to pursue the contract, thus earning $5 per stock.
Option Premium – is the amount of the contract which must be paid by the buyer to the writer (the seller). The amount of the option premium is determined by several factors such as the type of the option (call or put), the strike price of the current option, the volatility of the stock, the time remaining until expiration and the price of the underlying asset to date. Taking into account these factors, the total amount of the option premium is number of option contracts, multiplied by contract multiplier. So if you are buying 1 option contract (equivalent to 100 share lots) at $2.5 per share, you must pay a total amount of $250 as the option premium (1 option contract x 100 shares x $2.5 per share = $250).
Although there are hundreds of terms that are used in the financial language, beginners have to understand first the most important and commonly used words.
Option – is the right of the buyer to either buy or sell the underlying asset at a fixed price and a fixed date. At the end of the contract, the owner can exercise to either buy or sell the option at the strike price. The owner has the right to pursue the contract but he or she is not obligated to do so.
Call option – gives the owner the right to buy the underlying asset.
Put Option – gives the owner the right to sell the underlying asset.
Exercise – is the action where the owner can choose to buy (if call option) or sell (if put option) the underlying asset or, to ignore the contract. If the owner chooses to pursue the contract, he must send an exercise notice to the seller.
Expiration – is the date where the contract ends. After the expiration and the owner does not exercise his or her rights, the contract is terminated.
In-the-money – is an option with an intrinsic value. The call option is in-the-money if the underlying asset is higher than the strike price. The put option is in-the-money if the underlying asset is lower than the strike price.
Out-of-the-money – is an option with no intrinsic value. The call option is out-of-the-money if the trading price is lower than the strike price. The put option is out-of-the-money if the trading price is higher than the strike price.
Offsetting – is an act by which the owner of the option exercises his right to buy or sell the underlying asset before the end of the contract. This is done if the owner feels that the profitability of the stock has reached its peak within the date of the contract.
(Option seller) Writer – is the seller of the underlying asset or the option.
Option buyer – is the person who acquires the rights to convey the option.
Strike Price – is the price at which the underlying stock must be sold or purchased if the contract is exercised. The strike price is clearly stated in the contract. For the buyer of the option to make a profit, the strike price must be lower than the current trading price of the stock. For example, if the contract states that the strike price of a certain stock is $20 and the current trading price at the end of the contract is $25, the buyer can exercise his or her rights to pursue the contract, thus earning $5 per stock.
Option Premium – is the amount of the contract which must be paid by the buyer to the writer (the seller). The amount of the option premium is determined by several factors such as the type of the option (call or put), the strike price of the current option, the volatility of the stock, the time remaining until expiration and the price of the underlying asset to date. Taking into account these factors, the total amount of the option premium is number of option contracts, multiplied by contract multiplier. So if you are buying 1 option contract (equivalent to 100 share lots) at $2.5 per share, you must pay a total amount of $250 as the option premium (1 option contract x 100 shares x $2.5 per share = $250).
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