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