| Owning stock has only two, maybe three, | | | | cost you more than what you pay for the |
| possibilities. The stock goes up. Or the | | | | option. Selling an option can cost you |
| stock goes down. Or, as a third | | | | far more than what you receive for |
| possibility, it does a little of both. | | | | selling the option. |
| If you buy a stock, all you want it to | | | | Let's examine the terminology of calls |
| do is go up. | | | | and puts. The underlying is the actual |
| If you sell a stock short or close a | | | | instrument such as a stock or commodity |
| position (or consider buying it and then | | | | that is being represented by the options |
| decide not to ;), all you want it to do | | | | contract. In the real estate example, |
| is go down. I call this one-dimensional | | | | the house would be the underlying. |
| trading. You're long, you're short, or | | | | Options are said to be derivatives |
| you're flat. Your gains and losses | | | | because their value is directly tied to |
| travel up and down the number line you | | | | or derived from that of the underlying. |
| may remember from elementary school in | | | | An option has no meaning without an |
| lock step with the movement of the | | | | actual asset underlying it. It is the |
| stock. Not only that, but it takes a big | | | | right to buy or sell that underlying |
| move to make a big profit. And a big | | | | asset that gives the option a reason for |
| move against you can mean a big loss. | | | | being and some value. |
| Potentially all the way down to zero. | | | | The strike price is the agreed upon |
| You need to add a second dimension to | | | | price for which the underlying can be |
| your trading. You need more choices than | | | | bought or sold under the terms of the |
| picking a direction and hoping you are | | | | option contract. In the real estate |
| right. You need to limit your losses, | | | | example, the strike price was $100,000. |
| improve your returns, and increase your | | | | The expiration date, obviously, is the |
| flexibility. You need options. | | | | date when the option expires. The day |
| For many people, options are something | | | | after expiration, an option is |
| to avoid, being dangerous, complex, and | | | | worthless. This is the single most |
| scary. I would like to introduce you to | | | | important fact about options that you |
| the joy of options. Any time you think | | | | must remember. This is why your friends |
| you want to buy a stock, I'd like to get | | | | think you are crazy for your interest in |
| you in the habit of first looking at how | | | | options. Unlike a stock, which you can |
| you could do more with less using | | | | hold forever, an option has a clearly |
| options. | | | | defined shelf life. |
| In the stock and commodities markets, | | | | One term remains, and that is the |
| the type of option we just described | | | | premium. The premium is what you pay for |
| would be known as a call. A call | | | | the option, when you are the buyer. Or |
| typically represents 100 shares of a | | | | what you receive for an option, when you |
| stock. In the commodities markets, a | | | | are the seller. In our real estate |
| single option contract represents a | | | | example, the premium was $500. That's |
| single futures contract. (For | | | | what it cost you to hold the right to |
| simplicity, from this point forward, I | | | | buy the house any time in that |
| will talk about options on stock. Just | | | | thirty-day period. The last day of the |
| remember that the same discussion | | | | thirty-day period would, again, be the |
| applies to options on futures.) | | | | expiration date. |
| Owning a call gives the owner the right | | | | We have barely scratched the surface. I |
| to buy 100 shares (usually) of the | | | | say that not to intimidate you, but to |
| underlying stock at the agreed upon | | | | make you realize that you only have |
| strike price at or before the expiration | | | | enough knowledge to be dangerous to |
| date. (I say "usually" 100 shares | | | | yourself. Please do not think that you |
| because, due to splits or acquisitions, | | | | are ready to go out and buy calls or |
| there are times when an options contract | | | | place spread trades. You are not. You |
| may represent something other than 100 | | | | don't know how an option moves relative |
| shares.) Selling a call gives the seller | | | | to moves in the price of the underlying. |
| the obligation to sell, if asked, 100 | | | | You don't know what time does to the |
| shares of the underlying stock at the | | | | value of an option. You don't know what |
| agreed upon strike price any time up | | | | volatility is or how it plays into |
| until the expiration date. | | | | option prices. You don't know the types |
| The other kind of option is called a | | | | of spreads or what they are used for. |
| put, and it is exactly the same as a | | | | Please, please get yourself better |
| call with one simple difference. A put | | | | educated before you start putting money |
| gives the owner the right to sell 100 | | | | into option trades. Resist the |
| shares (again, usually) of the | | | | temptation to buy some cheap options, |
| underlying stock at the agreed upon | | | | just to try it out. This is expensive |
| strike price at or before the expiration | | | | education. There are plenty of |
| date. You can think of a put as | | | | advantages to trading options, but it's |
| insurance. No matter how badly the stock | | | | still a ruthless market, happy to take |
| price crashes, having a put means that | | | | your money, your wallet, and your hand |
| you can sell your stock for the strike | | | | if you give it an opportunity. Learn the |
| price. On the flip side, selling that | | | | rules of the game before you put money |
| put means you may be obliged to buy | | | | on the line. |
| stock at far more than its current | | | | Trading options can be satisfying, |
| market price. | | | | rewarding, stimulating, and fun. I |
| An important distinction to always keep | | | | invite you to add another dimension to |
| in mind: Buying an option gives you | | | | your trading by including options to |
| rights. Selling an option gives you | | | | your repertoire. |
| obligations. Buying an option cannot | | | | |