Bill Stacy
3rd July 2008, 05:25 PM
STEP 1:
DOWNLOAD & STUDY THE OFFICIAL "UNDERSTANDING OPTIONS (http://www.asx.com.au/markets/pdf/UnderstandingOptions.pdf)" DOCUMENT FROM THE ASX
http://www.onedaywealth.com/images/understandingoptions-asx.jpg (http://www.asx.com.au/markets/pdf/UnderstandingOptions.pdf)
Click the image to download (http://www.asx.com.au/markets/pdf/UnderstandingOptions.pdf)
The Definitions:
What is a Call Option?
A call option is a promise to DELIVER stock at an agreed price on or before a given date.
What is a Put Option?
A Put option is a promise to RECEIVE stock at an agreed price on or before a given date.
The Goods:
The only thing being bought and sold here is a promise (to either deliver or receive stocks/shares).
A promise to either sell stock to you at a fixed price (handy if the stock rises in price) or buy stock from you at a fixed price (handy if the stock drops in price).
The buyer is under no obligation to do anything. When you buy options the only risk to you is the price that you paid for that option.
The seller is the only one at risk because they are the ones who are selling a promise (or a service), they are the ones who must deliver on that promise.
They are either promising to buy stock (selling a Put) or they are promising to sell stock (selling a Call).
If they sell you a Call Option they promise to sell their stock to you (or the holder of the option) for a certain pre-agreed price.
The holder of the option is the only person allowed to exercise that option.
If they sell you a Put Option they promise to buy the stock off you (or the holder of the option) for a certain pre-agreed price.
The holder of that option is the only person allowed to exercise that option.
The Deal:
1) When you buy a call, what are you doing?
When you buy a call, you are buying a promise from someone to deliver their stock to you.
2) When you sell a call, what are you doing?
When you sell a call, you are selling a promise to someone to deliver your stock to them.
3) When you buy a Put, what are you doing?
When you buy a Put, you are buying a promise from someone to receive your stock from you.
4) When you sell a Put option what are you doing?
When you sell a Put, you are selling a promise to someone to receive their stock off them.
The Risks:
The risk of selling a Put is that you will be forced to buy into a falling stock.
(In other words, if you promise to buy a stock at a certain price and it falls below your strike price you will have to buy it as you promised and now you own a falling stock)
The maximum risk of selling a Put Spread is generally defined as the difference between your sold put and your bought Put minus your total premium.
(In other words, if you sell a Put you might have to buy the stock just as you promised if it keeps dropping or has dropped enough you will then have to sell it to your bought protection (your bought put) and lose the difference in strike prices. You then add the gain that you got from receiving a premium which is the difference between what you got for selling your put minus the cost of buying your protection (your bought Put). If you sold a 19.50 Put and bought an 18.50 Put your maximum risk is one dollar (19.50 - 18.50 = 1.00) but you might have got 40c for selling your 19.50 and paid 9c to buy your 18.50 protection so your total gain is 31c (40c - 9c = 31c). So your total risk is $1.00 - 31c = 69c.)
The risk of selling a (covered - which means you own the stock) call is that you will lose potential profit as the stock rises above the price at which you promised to deliver it to someone else.
(In other words, if you promise to deliver stock at $20.00 and the stock skyrockets up to $25.00 you will have to deliver the stock at $20.00 as you promised forgoing the potential profit of the extra $4.00.)
The risk of selling a (naked - which means that you don't own the stock yet) call is that you will be forced to buy the stock at a higher price as the stock rises and then have to deliver it to the buyer at a lower price losing the difference.
(In other words, if you promise to deliver stock at $20.00 and you don't have that stock to deliver and the stock rises above your strike price you might be called upon to deliver that stock and if the stock skyrockets to $25.00 you will have to buy it at $25.00 and deliver it at the $20.00 that you promised - losing $5.00 per stock).
WHEN TO BUY A CALL:
If you think a stock is going to rise you BUY A CALL because the call will be worth more and more AS THE STOCK GOES UP AND UP AND UP.
WHEN TO BUY A PUT:
If you think a stock is going to fall you BUY A PUT because the Put will be worth more and more AS THE STOCK GOES DOWN AND DOWN AND DOWN
CONFUSED? TRY THIS LITTLE EXERCISE...
Get two pieces of paper
One one piece write "CALL OPTION"
On the other piece write "PUT OPTION"
On the call option write "I promise to sell stock to you at $20.00"
On the put option write "I am willing to buy stock off you for $20.00"
Get a partner and one of you be the seller and the other is the buyer. Practice selling the options to each other for $1.00 and then see what happens to you (the buyer) as the price goes up to $25.00 and you (the buyer) as it falls down to $15.00.
Obviously, as the stock rises to $25.00 you are going to wish that you could buy the stock for $20.00 so you could sell it for $25.00 so you can take advantage of the rise and sell for a $5.00 profit.
And equally obviously if the stock falls down to $15.00 you are going to wish that you had a buyer at $20.00 so you could sell the stock to them and make $5.00 more than the stock market is offering you.
Think about it.
DOWNLOAD & STUDY THE OFFICIAL "UNDERSTANDING OPTIONS (http://www.asx.com.au/markets/pdf/UnderstandingOptions.pdf)" DOCUMENT FROM THE ASX
http://www.onedaywealth.com/images/understandingoptions-asx.jpg (http://www.asx.com.au/markets/pdf/UnderstandingOptions.pdf)
Click the image to download (http://www.asx.com.au/markets/pdf/UnderstandingOptions.pdf)
The Definitions:
What is a Call Option?
A call option is a promise to DELIVER stock at an agreed price on or before a given date.
What is a Put Option?
A Put option is a promise to RECEIVE stock at an agreed price on or before a given date.
The Goods:
The only thing being bought and sold here is a promise (to either deliver or receive stocks/shares).
A promise to either sell stock to you at a fixed price (handy if the stock rises in price) or buy stock from you at a fixed price (handy if the stock drops in price).
The buyer is under no obligation to do anything. When you buy options the only risk to you is the price that you paid for that option.
The seller is the only one at risk because they are the ones who are selling a promise (or a service), they are the ones who must deliver on that promise.
They are either promising to buy stock (selling a Put) or they are promising to sell stock (selling a Call).
If they sell you a Call Option they promise to sell their stock to you (or the holder of the option) for a certain pre-agreed price.
The holder of the option is the only person allowed to exercise that option.
If they sell you a Put Option they promise to buy the stock off you (or the holder of the option) for a certain pre-agreed price.
The holder of that option is the only person allowed to exercise that option.
The Deal:
1) When you buy a call, what are you doing?
When you buy a call, you are buying a promise from someone to deliver their stock to you.
2) When you sell a call, what are you doing?
When you sell a call, you are selling a promise to someone to deliver your stock to them.
3) When you buy a Put, what are you doing?
When you buy a Put, you are buying a promise from someone to receive your stock from you.
4) When you sell a Put option what are you doing?
When you sell a Put, you are selling a promise to someone to receive their stock off them.
The Risks:
The risk of selling a Put is that you will be forced to buy into a falling stock.
(In other words, if you promise to buy a stock at a certain price and it falls below your strike price you will have to buy it as you promised and now you own a falling stock)
The maximum risk of selling a Put Spread is generally defined as the difference between your sold put and your bought Put minus your total premium.
(In other words, if you sell a Put you might have to buy the stock just as you promised if it keeps dropping or has dropped enough you will then have to sell it to your bought protection (your bought put) and lose the difference in strike prices. You then add the gain that you got from receiving a premium which is the difference between what you got for selling your put minus the cost of buying your protection (your bought Put). If you sold a 19.50 Put and bought an 18.50 Put your maximum risk is one dollar (19.50 - 18.50 = 1.00) but you might have got 40c for selling your 19.50 and paid 9c to buy your 18.50 protection so your total gain is 31c (40c - 9c = 31c). So your total risk is $1.00 - 31c = 69c.)
The risk of selling a (covered - which means you own the stock) call is that you will lose potential profit as the stock rises above the price at which you promised to deliver it to someone else.
(In other words, if you promise to deliver stock at $20.00 and the stock skyrockets up to $25.00 you will have to deliver the stock at $20.00 as you promised forgoing the potential profit of the extra $4.00.)
The risk of selling a (naked - which means that you don't own the stock yet) call is that you will be forced to buy the stock at a higher price as the stock rises and then have to deliver it to the buyer at a lower price losing the difference.
(In other words, if you promise to deliver stock at $20.00 and you don't have that stock to deliver and the stock rises above your strike price you might be called upon to deliver that stock and if the stock skyrockets to $25.00 you will have to buy it at $25.00 and deliver it at the $20.00 that you promised - losing $5.00 per stock).
WHEN TO BUY A CALL:
If you think a stock is going to rise you BUY A CALL because the call will be worth more and more AS THE STOCK GOES UP AND UP AND UP.
WHEN TO BUY A PUT:
If you think a stock is going to fall you BUY A PUT because the Put will be worth more and more AS THE STOCK GOES DOWN AND DOWN AND DOWN
CONFUSED? TRY THIS LITTLE EXERCISE...
Get two pieces of paper
One one piece write "CALL OPTION"
On the other piece write "PUT OPTION"
On the call option write "I promise to sell stock to you at $20.00"
On the put option write "I am willing to buy stock off you for $20.00"
Get a partner and one of you be the seller and the other is the buyer. Practice selling the options to each other for $1.00 and then see what happens to you (the buyer) as the price goes up to $25.00 and you (the buyer) as it falls down to $15.00.
Obviously, as the stock rises to $25.00 you are going to wish that you could buy the stock for $20.00 so you could sell it for $25.00 so you can take advantage of the rise and sell for a $5.00 profit.
And equally obviously if the stock falls down to $15.00 you are going to wish that you had a buyer at $20.00 so you could sell the stock to them and make $5.00 more than the stock market is offering you.
Think about it.