I option trading

Options Basics: What Are Options?

Options are a type of derivative security. They are a derivative because the price of an option is intrinsically linked to the price of something else. Specifically, options are contracts that grant the right, but not the obligation to buy or sell an underlying asset at a set price on or before a certain date. The right to buy is called a call option and the right to sell is a put option. People somewhat familiar with derivatives may not see an obvious difference between this definition and what a future or forward contract does. The answer is that futures or forwards confer both the right and obligation to buy or sell at some point in the future. For example, somebody short a futures contract for cattle is obliged to deliver physical cows to a buyer unless they close out their positions before expiration. An options contract does not carry the same obligation, which is precisely why it is called an “option.”

Call and Put Options.

A call option might be thought of as a deposit for a future purpose. For example, a land developer may want the right to purchase a vacant lot in the future, but will only want to exercise that right if certain zoning laws are put into place. The developer can buy a call option from the landowner to buy the lot at say $250,000 at any point in the next 3 years. Of course, the landowner will not grant such an option for free, the developer needs to contribute a down payment to lock in that right. With respect to options, this cost is known as the premium, and is the price of the options contract. In this example, the premium might be $6,000 that the developer pays the landowner. Two years have passed, and now the zoning has been approved; the developer exercises his option and buys the land for $250,000 – even though the market value of that plot has doubled. In an alternative scenario, the zoning approval doesn’t come through until year 4, one year past the expiration of this option. Now the developer must pay market price. In either case, the landowner keeps the $6,000.

A put option, on the other hand, might be thought of as an insurance policy. Our land developer owns a large portfolio of blue chip stocks and is worried that there might be a recession within the next two years. He wants to be sure that if a bear market hits, his portfolio won’t lose more than 10% of its value. If the S&P 500 is currently trading at 2500, he can purchase a put option giving him the right to sell the index at 2250 at any point in the next two years. If in six months time the market crashes by 20%, 500 points in his portfolio, he has made 250 points by being able to sell the index at 2250 when it is trading at 2000 – a combined loss of just 10%. In fact, even if the market drops to zero, he will still only lose 10% given his put option. Again, purchasing the option will carry a cost (its premium) and if the market doesn’t drop during that period the premium is lost.

These examples demonstrate a couple of very important points. First, when you buy an option, you have a right but not an obligation to do something with it. You can always let the expiration date go by, at which point the option becomes worthless. If this happens, however, you lose 100% of your investment, which is the money you used to pay for the option premium. Second, an option is merely a contract that deals with an underlying asset. For this reason, options are derivatives. In this tutorial, the underlying asset will typically be a stock or stock index, but options are actively traded on all sorts of financial securities such as bonds, foreign currencies, commodities, and even other derivatives.

Buying and Selling Calls and Puts: Four Cardinal Coordinates.

Owning a call option gives you a long position in the market, and therefore the seller of a call option is a short position. Owning a put option gives you a short position in the market, and selling a put is a long position. Keeping these four straight is crucial as they relate to the four things you can do with options: buy calls; sell calls; buy puts; and sell puts.

People who buy options are called holders and those who sell options are called writers of options. Here is the important distinction between buyers and sellers:

Call holders and put holders (buyers) are not obligated to buy or sell. They have the choice to exercise their rights if they choose. This limits the risk of buyers of options, so that the most they can ever lose is the premium of their options. Call writers and put writers (sellers), however, are obligated to buy or sell. This means that a seller may be required to make good on a promise to buy or sell. It also implies that option sellers have unlimited risk , meaning that they can lose much more than the price of the options premium.

Don't worry if this seems confusing – it is. For this reason we are going to look at options primarily from the point of view of the buyer. At this point, it is sufficient to understand that there are two sides of an options contract.

Options Terminology.

To understand options, you'll also have to first know the terminology associated with the options market.

The price at which an underlying stock can be purchased or sold is called the strike price. This is the price a stock price must go above (for calls) or go below (for puts) before a position can be exercised for a profit. All of this must occur before the expiration date. In our example above, the strike price for the S&P 500 put option was 2250.

The expiration date, or expiry of an option is the exact date that the contract terminates.

An option that is traded on a national options exchange such as the Chicago Board Options Exchange (CBOE) is known as a listed option. These have fixed strike prices and expiration dates. Each listed option represents 100 shares of company stock (known as a contract).

For call options, the option is said to be in-the-money if the share price is above the strike price. A put option is in-the-money when the share price is below the strike price. The amount by which an option is in-the-money is referred to as intrinsic value. An option is out-of-the-money if the price of the underlying remains below the strike price (for a call), or above the strike price (for a put). An option is at-the-money when the price of the underlying is on or very close to the strike price.

As mentioned above, the total cost (the price) of an option is called the premium. This price is determined by factors including the stock price, strike price, time remaining until expiration (time value) and volatility. Because of all these factors, determining the premium of an option is complicated and largely beyond the scope of this tutorial, although we will discuss it briefly.

Although employee stock options aren't available for just anyone to trade, this type of option could, in a way, be classified as a type of call option. Many companies use stock options as a way to attract and to keep talented employees, especially management. They are similar to regular stock options in that the holder has the right but not the obligation to purchase company stock. The contract, however, exists only between the holder and the company and cannot typically be exchanged with anybody else, whereas a normal option is a contract between two parties that are completely unrelated to the company and can be traded freely.

Options Basics Tutorial.

Nowadays, many investors' portfolios include investments such as mutual funds, stocks and bonds. But the variety of securities you have at your disposal does not end there. Another type of security, known as options, presents a world of opportunity to sophisticated investors who understand both the practical uses and inherent risks associated with this asset class.

The power of options lies in their versatility, and their ability to interact with traditional assets such as individual stocks. They enable you to adapt or adjust your position according to many market situations that may arise. For example, options can be used as an effective hedge against a declining stock market to limit downside losses. Options can be put to use for speculative purposes or to be exceedingly conservative, as you want. Using options is therefore best described as part of a larger strategy of investing.

This functional versatility, however, does not come without its costs. Options are complex securities and can be extremely risky if used improperly. This is why, when trading options with a broker, you'll often come across a disclaimer like the following:

Options involve risks and are not suitable for everyone. Option trading can be speculative in nature and carry substantial risk of loss. Only invest with risk capital.

Options belong to the larger group of securities known as derivatives. This word has come to be associated with excessive risk taking and having the ability crash economies. That perception, however, is broadly overblown. All “derivative” means is that its price is dependent on, or derived from the price of something else. Put this way, wine is a derivative of grapes; ketchup is a derivative of tomatoes. Options are derivatives of financial securities – their value depends on the price of some other asset. That is all derivative means, and there are many different types of securities that fall under the name derivatives, including futures, forwards, swaps (of which there are many types), and mortgage backed securities. In the 2008 crisis, it was mortgage backed securities and a particular type of swap that caused trouble. Options were largely blameless. (See also: 10 Options Strategies To Know .)

Properly knowing how options work, and how to use them appropriately can give you a real advantage in the market. If the speculative nature of options doesn't fit your style, no problem – you can use options without speculating. Even if you decide never to use options, however, it is important to understand how companies that you are investing in use them. Whether it is to hedge the risk of foreign-exchange transactions or to give employees ownership in the form of stock options, most multi-nationals today use options in some form or another.

This tutorial will introduce you to the fundamentals of options. Keep in mind that most options traders have many years of experience, so don't expect to be an expert immediately after reading this tutorial. If you aren't familiar with how the stock market works, you might want to check out the Stock Basics tutorial first.

The NASDAQ Options Trading Guide.

Equity options today are hailed as one of the most successful financial products to be introduced in modern times. Options have proven to be superior and prudent investment tools offering you, the investor, flexibility, diversification and control in protecting your portfolio or in generating additional investment income. We hope you'll find this to be a helpful guide for learning how to trade options.

Understanding Options.

Options are financial instruments that can be used effectively under almost every market condition and for almost every investment goal. Among a few of the many ways, options can help you:

Protect your investments against a decline in market prices Increase your income on current or new investments Buy an equity at a lower price Benefit from an equity price’s rise or fall without owning the equity or selling it outright.

Benefits of Trading Options:

Orderly, Efficient and Liquid Markets.

Standardized option contracts allow for orderly, efficient and liquid option markets.

Flexibility.

Options are an extremely versatile investment tool. Because of their unique risk/reward structure, options can be used in many combinations with other option contracts and/or other financial instruments to seek profits or protection.

An equity option allows investors to fix the price for a specific period of time at which an investor can purchase or sell 100 shares of an equity for a premium (price), which is only a percentage of what one would pay to own the equity outright. This allows option investors to leverage their investment power while increasing their potential reward from an equity’s price movements.

Limited Risk for Buyer.

Unlike other investments where the risks may have no boundaries, options trading offers a defined risk to buyers. An option buyer absolutely cannot lose more than the price of the option, the premium. Because the right to buy or sell the underlying security at a specific price expires on a given date, the option will expire worthless if the conditions for profitable exercise or sale of the option contract are not met by the expiration date. An uncovered option seller (sometimes referred to as the uncovered writer of an option), on the other hand, may face unlimited risk.

This options trading guide provides an overview of characteristics of equity options and how these investments work in the following segments:

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It’s in the name for good reason—a best-in-class platform for option trading on equities, indexes and futures, built by those who have won both Barron’s “Best for Option Traders” and StockBrokers’s “Best in Class” awards for Option Trading seven years in a row. 4.

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You will pay no per contract or base commission charge when you buy to close an equity option for 10 cents or less.  This allows you to close short options positions that may have risk, but currently offer little or no reward potential—without paying any commissions. There’s no sign up required. This program automatically applies anytime you buy to close an equity option for 10 cents or less.

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Getting Started with Options.

There are so many available options and ways to trade them that you might not know where to.

Options Fundamentals: Introduction.

Review the fundamentals of options before you start trading. This seven part series will help.

Options Fundamentals: Options Pricing.

Review the fundamentals of options before you start trading. This seven part series will help.

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