| Options are one of the oldest trading | | | | at or below the strike price will be in his |
| vehicles man has ever used. Around a 1000 B.C | | | | favor. |
| Aristotle Thales predicted by the stars that | | | | |
| there would be a bumper olive harvest and | | | | However, here's a very bad scenario. The call |
| bought options on the use of olive presses. | | | | writer sells short a naked call. And the |
| | | | stock leaps 50%. He's got big problems. |
| When the harvest did in fact prove to be a | | | | Somebody's going to want to buy XYZ from him |
| great harvest Thales was able to rent the | | | | for $100 per share, just as the option |
| presses at a significant profit. | | | | contract states. |
| | | | |
| When you buy an option you have the right but | | | | But he doesn't own any shares of XYZ. So he |
| not the obligation to buy (call) or sell | | | | now has to go to the open market and buy 100 |
| (put) a specific underlying asset at a | | | | shares at the current market price, which is |
| prearranged price on or before a given date. | | | | $150 per share. He took in $400 of premium |
| | | | and now has to cover is with a $15,000 stock |
| Similar to futures, options can give the | | | | purchase, for which he will only receive |
| holder protection against adverse price | | | | $10,000. He loses $4600 ($10,000 - $15,000 + |
| moves. | | | | $400). Not a happy ending. |
| | | | |
| Call options when bought allow you to buy an | | | | Do NOT even consider selling naked calls. |
| asset at a fixed price (strike price) on or | | | | Your broker probably would not allow you to |
| before a specific exercise date. | | | | anyway. However, until you really know what |
| | | | you are doing, don't sell naked puts either. |
| Exercise date: some options can only be | | | | When the bottom drops out of a market, naked |
| exercised on a particular date and they are | | | | put holders get very, very badly hurt. They |
| commonly know as European options. Options | | | | are forced to pay high prices for low priced |
| that can be exercised on or before the due | | | | stock. You do NOT want to be in this |
| date are commonly known as American options). | | | | position! |
| | | | |
| A Put options is the reverse of the call | | | | An option gives you something called |
| option. When you buy a put option it gives | | | | leverage. Leverage is when you are able to |
| you the right but not the obligation to sell | | | | control a large amount of money with a small |
| an underlying asset at a predetermined date. | | | | investment. Each option contract lets you |
| | | | control 100 shares of stock for far less than |
| Now let's look briefly at the result of | | | | the cost of buying those shares. But leverage |
| selling naked calls. In this scenario, the | | | | is not the best reason to trade with options. |
| call writer simply sells the call and does | | | | |
| not own any of the underlying stock to cover | | | | True, with the leverage that options afford |
| the short call. If the stock plummets, the | | | | you, you stand to risk less and make more, |
| call writer is very happy and relieved. | | | | assuming things move in your favor AND in |
| | | | your time frame. Remember the expiration |
| The premium of $400 is his to keep, and no | | | | date! You have traded leverage for limited |
| one will be knocking on his door asking to | | | | shelf life. If things don't move your way |
| buy the stock for $100 per share, since it is | | | | soon enough, you lose. So, what is the main |
| available on the open market for $50. It's | | | | reason to trade options? Spreads! |
| his ideal scenario. Actually, any stock price | | | | |