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 16th. 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!
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