October 9, 2008
How to Trade Call Options
The majority of casual investors buy and sell stocks. If they are bearish on a stock, some will even short-sell stock. But relatively few investors fully understand and take advantage of trading options.
With stocks, you own a small piece of a company. However, with options, you purchase the right to buy or sell underlying stock. There are two basic types of options – calls and puts. When you purchase a call option, you buy the right to purchase a stock at a specific price before a specific date. When purchasing put options, you buy the right to sell a stock at a specific price before a specific date. Like stocks, you can both buy and sell options.
Traders consider buying call options when they are bullish on an underlying stock. As the stock rises, call options, in general, also rise. There are, though, some important differences between buying an underlying stock and its call options. First, options are cheaper than buying the underlying stock. If you a share of XYZ is $100, it may cost you the same to control 1000 shares with options.
Options are cheaper because they have a strike price and an expiration date. The strike price of a call option is the price at which you have the right to purchase the stock. If the price of an underlying stock is above the strike price, the call option is considered “in-the-money.” If the price of the stock is below the strike price, the call option is “out-of-the-money” while it is “at-the-money” if the stock is the same price as the strike price. Call options that are in-the-money have inherent value. For example, let’s say the price of stock XYZ increased to $105. You, however, own a call option with a strike price of $100. You thus have the option to buy XYZ at $100 while selling it for $105. This in-the-money call option thus as an inherent value of $5. Call options that are at-the-money do not have any inherent value. For instance, it would not be worth it to exercise a call option with a strike price of $15 because you cannot sell it for a profit. Call options that are out-of-the-money actually have a negative inherent value since the stock would have to rise just to get to the strike price. The farther the stock price is from the strike price, the lower the inherent value.
The expiration date is the time until which you have to exercise your option. Because options expire, they have a time value. As the expiration draws nearer, the time value of call options decrease because there is less time for the underlying stock to increase in value. A call option that expires in a year will therefore have much greater time value than a call option that expires in a week. The price of options are roughly calculated by:
Option price = inherent value + time value
There are several exit strategies with call options. If you do nothing and let an option expire, call options that are at-the-money or out-of-the-money will become worthless – they will have no inherent or time value. However, if a call option is in-the-money at expiration, you can exercise your option for a profit. Many option trading companies will automatically exercise options that are in-the-money at expiration for you.
Most option traders, however, have no intention of ever owning the underlying stock. Traders often sell their options well before expiration. Call options, in general, increase in value with the underlying stock. Thus, if a stock rises, you can usually sell a corresponding call option at a profit.
This can be beneficial because it leverages your capital. Let’s say you have $1000 to invest. If a share of XYZ costs $100, you can buy 10 shares. However, a call option of XYZ, with a strike price of $100, costs only $10. You can thus alternatively purchase 100 call options of XYZ. If shares of XYZ go to $105 at expiration, owning the stock would give you a profit of $50. Owning the options, however, would give you a profit of roughly $500. The risk in call options, however, is that this increase in price needs to occur before the expiration date.
For more information about trading options, visit DayTradingModels.com
By: Greg Chan
About the Author:
With stocks, you own a small piece of a company. However, with options, you purchase the right to buy or sell underlying stock. There are two basic types of options – calls and puts. When you purchase a call option, you buy the right to purchase a stock at a specific price before a specific date. When purchasing put options, you buy the right to sell a stock at a specific price before a specific date. Like stocks, you can both buy and sell options.
Traders consider buying call options when they are bullish on an underlying stock. As the stock rises, call options, in general, also rise. There are, though, some important differences between buying an underlying stock and its call options. First, options are cheaper than buying the underlying stock. If you a share of XYZ is $100, it may cost you the same to control 1000 shares with options.
Options are cheaper because they have a strike price and an expiration date. The strike price of a call option is the price at which you have the right to purchase the stock. If the price of an underlying stock is above the strike price, the call option is considered “in-the-money.” If the price of the stock is below the strike price, the call option is “out-of-the-money” while it is “at-the-money” if the stock is the same price as the strike price. Call options that are in-the-money have inherent value. For example, let’s say the price of stock XYZ increased to $105. You, however, own a call option with a strike price of $100. You thus have the option to buy XYZ at $100 while selling it for $105. This in-the-money call option thus as an inherent value of $5. Call options that are at-the-money do not have any inherent value. For instance, it would not be worth it to exercise a call option with a strike price of $15 because you cannot sell it for a profit. Call options that are out-of-the-money actually have a negative inherent value since the stock would have to rise just to get to the strike price. The farther the stock price is from the strike price, the lower the inherent value.
The expiration date is the time until which you have to exercise your option. Because options expire, they have a time value. As the expiration draws nearer, the time value of call options decrease because there is less time for the underlying stock to increase in value. A call option that expires in a year will therefore have much greater time value than a call option that expires in a week. The price of options are roughly calculated by:
Option price = inherent value + time value
There are several exit strategies with call options. If you do nothing and let an option expire, call options that are at-the-money or out-of-the-money will become worthless – they will have no inherent or time value. However, if a call option is in-the-money at expiration, you can exercise your option for a profit. Many option trading companies will automatically exercise options that are in-the-money at expiration for you.
Most option traders, however, have no intention of ever owning the underlying stock. Traders often sell their options well before expiration. Call options, in general, increase in value with the underlying stock. Thus, if a stock rises, you can usually sell a corresponding call option at a profit.
This can be beneficial because it leverages your capital. Let’s say you have $1000 to invest. If a share of XYZ costs $100, you can buy 10 shares. However, a call option of XYZ, with a strike price of $100, costs only $10. You can thus alternatively purchase 100 call options of XYZ. If shares of XYZ go to $105 at expiration, owning the stock would give you a profit of $50. Owning the options, however, would give you a profit of roughly $500. The risk in call options, however, is that this increase in price needs to occur before the expiration date.
For more information about trading options, visit DayTradingModels.com
By: Greg Chan
About the Author:
Greg Chan is a business and finance expert. He is an active day trader and the author of several trading articles. For more information, visit DayTradingModels.com
Filed under Investing by Administrator
October 6, 2008
Stock Option Trading Guide for Beginner
There are four different types of players in the stock option trading game. They are buyers of calls, sellers of calls, buyers of puts, and seller of puts. The buyers are called holders, and the sellers are called writers. Buyers of calls are said to have a long position, while buyers of puts are said to have a short position.
Calls are useful in speculation, and puts are useful in hedging. It is all going to depend on the strike price of the underlying asset on the expiration date. If all of this makes perfect sense to you, there is not much need to read on, but if it sounds a bit hazy, a little review might be in order.
The Stock Option market has its own unique language. Like many other activities, an understanding of the terminology used is essential. In many cases, it is a rather simple concept hidden behind an unknown term that leads to confusion, and makes the activity appear a lot more complex than it actually is. The following are a few definitions that might help take away some of the mystery. – Calls: A call is basically a contract giving you an option, but not an obligation to purchase a block of stocks at a set price on or before a certain date. In understanding a call, it is important to remember that you are not obligated to make the purchase. You can exercise your option or not. – Puts: A put is the opposite of a call in that it is a contract to sell a block of stock at a set price on or before a certain date. Again, this is a choice. You can make the choice not to sell. – Holders: This is the name given to the buyers of the contracts. It is the holders that give the option trading market its name since they are the ones who actually are in a position to make the decision to exercise their options. – Writers: Since it is a “trading” market, two parties are necessary. If someone is buying, than someone else must be selling. The writers are the sellers of the contracts. It is important to remember that the writers are not the ones with the options. They do have an obligation to honor the contract if the holder decides to exercise his option. – Long Position: In stock trading, long position means that you are holding the stock in anticipation of it increasing in value. – Short Position: In stock trading, short position means that you are holding the stock in anticipation of it decreasing in value. – Underlying Asset: The underlying asset, or as it is sometimes called, the underlying, is the actual stock or security that is the object of the option contract. The contract is said to derive its value from the intrinsic value of the underlying asset. – Strike price: This is the price at which the option contract will be purchased or sold. If you purchase an option to buy, or make a call, at $10 , but the value of the underlying asset is only $8, you are $2 under the strike price, and most likely would not wish to exercise your option. – Speculation: This is the risk taking side of option trading. It is generally associated with calls and long positions. It essentially means that you are expecting a stock price to rise higher than the strike price. – Hedging: This is the cautious side of option trading. It is generally associated with puts and short positions. You are anticipating that the value of the underlying asset will drop below the strike price. It is called hedging because it is often used to protect an investment, or hedge your bet, by maintaining an option to sell at a certain strike price should the underlying asset take a serious drop in value. In other words, you are able to bail out before your loss becomes too large. – Expiration date: This is the date on which your option must be exercised or it will be lost. It is the deadline. In the stock option market it is usually the third Friday of a month.
The above are a few of the terms that are used in the stock option trading market, and by understanding them completely you should be better armed to take a closer look at this interesting investment opportunity.
By: Casey Yew
About the Author:
Calls are useful in speculation, and puts are useful in hedging. It is all going to depend on the strike price of the underlying asset on the expiration date. If all of this makes perfect sense to you, there is not much need to read on, but if it sounds a bit hazy, a little review might be in order.
The Stock Option market has its own unique language. Like many other activities, an understanding of the terminology used is essential. In many cases, it is a rather simple concept hidden behind an unknown term that leads to confusion, and makes the activity appear a lot more complex than it actually is. The following are a few definitions that might help take away some of the mystery. – Calls: A call is basically a contract giving you an option, but not an obligation to purchase a block of stocks at a set price on or before a certain date. In understanding a call, it is important to remember that you are not obligated to make the purchase. You can exercise your option or not. – Puts: A put is the opposite of a call in that it is a contract to sell a block of stock at a set price on or before a certain date. Again, this is a choice. You can make the choice not to sell. – Holders: This is the name given to the buyers of the contracts. It is the holders that give the option trading market its name since they are the ones who actually are in a position to make the decision to exercise their options. – Writers: Since it is a “trading” market, two parties are necessary. If someone is buying, than someone else must be selling. The writers are the sellers of the contracts. It is important to remember that the writers are not the ones with the options. They do have an obligation to honor the contract if the holder decides to exercise his option. – Long Position: In stock trading, long position means that you are holding the stock in anticipation of it increasing in value. – Short Position: In stock trading, short position means that you are holding the stock in anticipation of it decreasing in value. – Underlying Asset: The underlying asset, or as it is sometimes called, the underlying, is the actual stock or security that is the object of the option contract. The contract is said to derive its value from the intrinsic value of the underlying asset. – Strike price: This is the price at which the option contract will be purchased or sold. If you purchase an option to buy, or make a call, at $10 , but the value of the underlying asset is only $8, you are $2 under the strike price, and most likely would not wish to exercise your option. – Speculation: This is the risk taking side of option trading. It is generally associated with calls and long positions. It essentially means that you are expecting a stock price to rise higher than the strike price. – Hedging: This is the cautious side of option trading. It is generally associated with puts and short positions. You are anticipating that the value of the underlying asset will drop below the strike price. It is called hedging because it is often used to protect an investment, or hedge your bet, by maintaining an option to sell at a certain strike price should the underlying asset take a serious drop in value. In other words, you are able to bail out before your loss becomes too large. – Expiration date: This is the date on which your option must be exercised or it will be lost. It is the deadline. In the stock option market it is usually the third Friday of a month.
The above are a few of the terms that are used in the stock option trading market, and by understanding them completely you should be better armed to take a closer look at this interesting investment opportunity.
By: Casey Yew
About the Author:
Among the Many Investment Opportunities that Exist, Option Trading Stands as Both One of the Most Exciting and Risky as well as One that Offers Some of the Best Chances for a Substantial Return. Learn Options Trading Basics, Strategies and Pricing here at http://www.option-trading-fortune.com
Filed under Finance by Administrator