Welcome To Options World!

What’s up everyone!  It’s a rainy day here in North Florida but its 65 degrees so who’s complaining.  Well, lets get right to it shall we? 

In the last post we starting talking about Call and Puts.  Remember that buyers of call options are betting a stock price will go up and buyers of Puts are betting a stock price will go down. The next thing we need to cover is exactly what the rights and obligations are for both the buyers and sellers of options.  Let’s talk about the buyers first.

When a person buys an option they have purchased the right, but not the obligation to buy an agreed number of shares of a stock from the option seller at a certain time and at a certain price.  In order to obtain these rights from the seller the option buyer has to pay the seller a fee.  In Options World the “certain time period” I mentioned is called the expiration date.   The “certain price” is called the strike price. And lastly the “fee” is called premium. Did you notice the bold print there!

When a person sells an option he is obligated to sell an agreed number of shares at a certain price should the option buyer exercise the rights I explained above. 

So how does all this buying and selling play out in real life?  Good question!  In real life a person who buys a call profits if the price of the underlying stock rises above the strike price before the expiration date of the option.  The higher it rises above the strike price the more money the call buyer makes.

On the other hand the option seller is hoping for the opposite outcome.  The seller is betting that the stock will not rise above the strike price before expiration.  Remember the call buyer paid a sum of money (premium) to the seller at the beginning of the transaction.  The maximum profit a seller can make is just the premium he received from the buyer.

So for example, lets say a call buyer pays $200 in premium to a seller hoping that the price of stock ABC will be above $45 before March 16^th.   If the stock is below $45 at expiration he loses.  If the stock is $60 he wins big!  The maximum profit for the buyer is unlimited but the maximum loss is limited to the premium he paid for the option.  If the seller wins he gets to keep the $200 premium paid by the buyer. 

In my opinion, unless you have insider information or a crystal ball, investing is straight calls and puts is like riding a motorcycle without a helmet.  Very risky behavior my friend!

Does all this sound a little bit like gambling?  Well, it sorta kinda is.  However, the major difference between options and Vegas is that option traders can employ techniques to significantly increase their odds of winning!  You can be the House!

I think that’s enough for now.  Plus it’s time to put the kids to bed.  Next time we’ll dive into some basic option strategies and look at some real world trades.  I’m building this house one brick at time.  So far, so good!

What In The World Are Options?

Hey everyone!  In my last post I mentioned I picked up a book that changed the way I looked at the stock market.  I think the book was called "Make a Killing with Options" or "Get Rich With Options" or something along those lines.  It had a catchy title that made me pull it off the shelf and start reading.  What I found was very interesting.  Up until that point the only way I knew how to make money in the stock market was to buy something at one price and "hope" at some later date I can sell it for a profit.  You know the old saying, "Buy low...sell high."  As I was reading, I realized there were ways (lots of ways) to make money in the stock market using these things called options.

Did you know that with options you can make money if a stock rises, falls or doesn't move a penny?  Did you know that with options you can "insure" stock positions you own in case the bottom falls out? Did you know that you can actually calculate the probability of a having a winning trade before you put  any of your hard earned money on the line?  Believe it or not, all these statements are 100% true.  And that's just the tip of the iceberg my friends.

Now you're broker or financial advisor may have told you options are dangerous and too risky.  I would agree that if not done the right way you can lose your pants pretty fast.  But I'm here to share with you what I think the right way......or let me just say the safe way is to use options to reach your financial goals.

Before I go on I think the first thing I should do is explain just what an option is.  There are hundreds of books and thousands of web pages devoted to explaining options but I'm gonna try to break it down to the lowest common denominator.  Options are simply contracts made between a buyer and a seller on the open market.  A "buyer" of an option has the "right" to do something as it relates to..... let's use stock ABC for example.  A "seller" has an "obligation" to do something as it relates to stock ABC.  In options there is always a buyer and a seller.  It's important to understand the basics so I'll use the next few posts to get you up to speed one step at a time.

First things first.  There are two types of options.  The first type is called well....a "Call".  If a trader were to purchase a Call on stock ABC he would be betting that ABC's price was going to rise during a certain time period.  The second type of option is called a "Put".  When a trader purchases a "Put" he is betting that the price of a stock will go down in a certain time period.  Notice I mentioned with both calls and puts the movement of ABC has to take place within a certain time period.  One way to look at this is with real estate.  When you sign a contract to buy a home you normally promise that you will go to closing within a certain time period right?  It's the same with options.  A trader who "buys" either a call or put is betting the stock will move (one way or another) within a certain time period.  Some option periods last one week, others last a month and some can even last a year or longer.

Did any of you guys see the James Bond movie Casino Royale?  The movie gave a perfect example of how options work!  The bad guy (Lashiff or something) got all this money from the African guy to invest.  Well, remember Lashiff had a plan to blow up that plane right?  The reason he wanted to blow it up was because he bought a gazillion dollars worth of "Puts" against the company who manufactured the plane.  Lashiff knew that if he blew up the plane the shares of the company would crash and he would make a killing with the "Puts" he bought.  As it turned out James Bond thwarted his plan and Lashiff ended up having one mad African hunting him down.  Although entertaining, I wouldn't suggest using terrorism to make money with options!

I think this is a good place to call it quits for now.  Next time I'll explain more about the "rights" an options buyer has.  Stay with me guys!  I promise we're going somewhere with all this!

Why I Stopped Investing And Started Trading

 

As a kid growing up in suburban Maryland no one ever taught me about the wonders of the stock market. Both of my parents were federal government employee's and looked forward to generous pensions when they retired. Their financial future never depended on the stock market so that probably explains why they never shared its existence with me.

After high school I went to college and later to the U.S. Army. Even during that six year period the stock market and investing wasn't a part of my consciousness. It wasn't until I began working for the federal government that I was introduced to investing. For those not familiar with the federal system, government employees have a 401k like benefit plan called the Thrift Savings Plan or TSP. Within the TSP I found out I had the option to invest in five different "funds". The TSP opened my eyes to benchmarks like the S&P500 and the Russell 2000. When I learned about dollar cost averaging and compound interest I just knew it would be just a matter of time before I became a millionaire. At the time, my plan was to max out my TSP contributions and then with my extra savings mirror my TSP fund allocations in a regular brokerage account.

So how did things go? Well, for a while everything went great! For a few years it seemed like the market was headed for the stars. Everyone at work bragged about how fast their accounts were growing. The real estate market was also going bananas at the time. I should have known something was wrong when all my neighbors talked about how large their lines of credit were. The idea that it all (or at least a good chunk of it) could disappear almost overnight never even occurred to me. Well, as we all know the bottom fell out. And as I now know the market moves in cycles. No matter how smart you are or how much you've mastered technical analysis (and all that other fancy stuff) I'm convinced no one can time the market. All we know is that it will rise and it will fall. This cycle just repeats itself over and over again.

After experiencing my first crash I must admit I became shell shocked. I didn't know if I should stay the course, forget stocks and move to bonds, focus on REIT's and dividend paying stocks, buy gold or just bury my money in the back yard! During that period I tried EVERYTHING! And just like the market my brokerage account went up and down. I knew there had to be a better way. I just didn't know where to turn or who to trust. Luckily, one day in my local Barnes and Noble I came across a book about trading options. I'll explain in my next article how that book opened up a whole new world for me. That book was the beginning of my transformation from an investor to a trader!