10/27/2016 at 7:12 pm #3759
22 ptsMember since: 10/24/2016 #transactiontrader
- Years Trading : 9
- Biggest Trade: APPL
- Location: Midwest
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.
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.
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.
In the special language of options, contracts fall into two categories – Calls and Puts. A Call represents the right of the holder to buy stock. A Put represents the right of the holder to sell stock.
Buyers Right to buy stock if exercised Right to sell stock if exercised
Sellers Obligation to sell stock if assigned Obligation to buy stock if assigned
A Call option is a contract that gives the buyer the right to buy 100 shares of an underlying equity at a predetermined price (the strike price) for a preset period of time. The seller of a Call option is obligated to sell the underlying security if the Call buyer exercises his or her option to buy on or before the option expiration date. For example, an American-style WXYZ Corporation May 21, 2011 60 Call entitles the buyer to purchase 100 shares of WXYZ Corporation common stock at $60 per share at any time prior to the option’s expiration date of May 21, 2011.
A Put option is a contract that gives the buyer the right to sell 100 shares of an underlying stock at a predetermined price for a preset time period. The seller of a Put option is obligated to buy the underlying security if the Put buyer exercises his or her option to sell on or before the option expiration date. Likewise, an American-style WXYZ Corporation May 21, 2011 60 Put entitles the buyer to sell 100 shares of WXYZ Corp. common stock at $60 per share at any time prior to the option’s expiration date in May.
The Expiration Process
At any given time, an option can be bought or sold with multiple expiration dates. This is indicated by a date description. The expiration date is the last day an option exists. For listed stock options, this is traditionally the Saturday following the third Friday of the expiration month. Please note that this is the deadline by which brokerage firms must submit exercise notices. You should ask your firm to explain its exercise procedures including any deadline the firm may have for exercise instructions on the last trading day before expiration.
Certain options exist for and expire at the end of week, the end of a quarter or at other times. It is very important to understand when an option will expire, as the value of the option is directly related to its expiration.
Exercising the Option
Options investors don’t actually have to buy or sell the underlying shares that are associated with their options. They can and often do simply opt to resell their options – or “trade out of their options positions”. If they do choose to purchase or sell the underlying shares represented by their options, this is called exercising the option.
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