Option puts and calls for dummies
Also, the proceeds from selling short are in a margin account so you have to pay interest and meet margin requirements. Buying puts is a more conservative way of betting on a stock declining in price. Selling a Call For every buyer of a call there must be a seller, who assumes that the stock price will remain flat or go down.
The seller collects the purchase price of the option but has the obligation to sell shares of the stock if the buyer decides to exercise the option.
If the seller gets called - he must sell the stock. If the stock continues to appreciate in price after the stock is sold, the seller looses the future price gain. In most cases you must own shares of the stock for each contract you sell - this is called a covered call.
Therefore, if your stock gets called away, you have the shares in your account. You can sell covered calls to generate a stream of income. If the stock price does not rise enough during the period of the contract, you won't get called and won't have to sell the stock so you keep the money you received when you sold the call. If your broker lets you, you may sell "uncovered "or "naked" calls in a margin account. This practice lets you sell calls when you don't own the stock.
If you get called, you must buy the stock at its current market value to cover the call even when the market price is higher than the strike price of the option. Like any margin account transaction, you must execute the transaction immediately.
The seller of a put collects the purchase price of the option from the buyer of the put. The seller has the obligation to buy shares at the strike price regardless of the market value of the underlying stock. So if the put buyer decides to exercise the put contract, the seller of the put has to buy the shares at the strike price no matter the current market value of the stock.
When you sell a put, you want the price of the stock to go up so you don't get the stock put to you - buy the stock for more than it's worth. Selling a put places the money you receive in a margin account so you pay interest on the proceeds until the put contract is closed. If you don't have the financial resources to cover the obligation of buying the stock from the buyer of the put, you sold "naked puts".
It tells about a trader who sold naked puts and experienced financial ruin. It was an unhedged bet, or what was called on Wall Street a "naked put" On October 27, , the market plummeted seven per cent, and Niederhoffer had to produce huge amounts of cash to back up all the options he'd sold at pre-crash strike prices. He ran through a hundred and thirty million dollars - his cash reserves, his savings, his other stocks-and when his broker came and asked for still more he didn't have it.
In a day, one of the most successful hedge funds in America was wiped out. Niederhoffer was forced to shut down his firm. He had to mortgage his house. He had to borrow money from his children. He had to call Sotheby's and sell his prized silver collection Use calls and puts judiciously. If you're right, you can make quick money. If you're wrong, you can lose part or all of your investment very quickly.
Do not sell "naked" options. You may be inviting a financial disaster. Knowledgeable, experienced investors may want to sell covered calls and puts to collect other peoples money. Because the price of options can change very quickly and dramatically, you must continually watch their price movement. If you not prepared to do so, don't buy or sell options. Alternative Actions for the Call Buyer. Alternative Actions for the Put Buyer.
Alternative Actions for the Call Seller. Alternative Actions for the Put Seller. For a Put Option, obviously the Intrinsic Value would be based on how much lower the market price is relative to the strike price. Time Decay An important factor to consider is the decay of time. The Intrinsic Value doesn't decay, just the Time Value. Buying and Selling Options All this discussion was assuming the fact that you would keep the option contract until expiration.
But the fact is you may not want to. In reality many people do not buy and hold the option that long. If they see an increase in the option they bought they will most likely sell the option and take their profit. Now you know that as time proceeds the decay in Time Value will decrease the value of your option.
So the only way to make money is to hope that the underlying stock moves in your favour. But if IBM's market price increases as well, the decay in time value may be offset. You can probably guess by now that the closer the market price is to the strike price, the more the option is worth.
Now you can wait and see what happens on May 15th, but if you just wanted to take advantage of a short term price swing you can take your profits right now and run.
This section about reading options chains has been out dated, but it is still worthwhile to read through because you may still encounter these in various other websites.
Click here to find out the latest method of reading options chains. Now that you know so much about options, lets talk about how to find them and how to interpret what you see. You can look at the diagram below or go directly to Yahoo by opening another browser page and entering the URL http: As you can see there is a table like the one below: The red circle indicates this is for May The first column shows all the available strike prices.
The green circle shows a weird looking symbol. It's certainly not the symbol for IBM, but it looks similar. There is a standard for listing option quotes which you can see by going to the cheat sheet see link on the right hand navigation. You can probably figure out the rest of the circles if you've seen stock quotes. A couple of things to point out is the pricing standard and the highted area. It is divided by and then listed. The volume however, has not been divided by anything!
It really is The final thing to note is the area highlighted in yellow. Remember we talked about Intrinsic Value? The yellow highlighted options are referred to as "In the money" options. Buyer Beware Until now I've just been giving pure facts about options. Now I'm going to give some advice. You have to be very careful when trading options. People often tout the upside to options investing while playing down the risks involved.
If you watch T. While it is true that you can realize tremendous profits, the chances of you realizing tremendous losses are just as great.. Even the best and brightest investment professionals cannot predict price movement especially over the short term. They get it wrong just as often as they get it right. At the end of the day, options are meant to add another dimension to your entire investment strategy, so be careful not to get wiped out as soon as you enter the option world.
It's best to start out playing 5 to 10 options at a time. If you find you've made some money doing it, then you can risk more capital. New Options Chains As mentioned above, there is a new way to read options chains and it is quite easy to understand.
You will see below: You can see it is almost self explanatory. The red circle represents the underlying stock symbol, the blue circle represents the expiration date, the green circle represents the type of option "C" for Call, "P" for Put , and the black circle represents the the strike price. The one small catch is that the expiration date is stated as the day after the actual expiration date.
I know weird, but the option actually expires as of close of market the day before. In the example above, the expiration date of '' reads , March 22nd. That is, the option is already expired as of that morning. But for your trading purposes you have to make sure that whatever trade you want to make has to get in before the close of market on , March 21st.
Summary Okay, we've gone through a lot of material here. And you might still be confused.