Educational Q & A for Options and option trading

Re: Educational Q & A for Options.

Lets start with the basics. A call and a put. Basically going long or short on a stock?

Strike price?

What stocks can be traded as options?

New to this - bear with me.

Re: Educational Q & A for Options

That helps KB. A couple more questions. How do you find out what options have been issued and for what dates? Is there a website that you use? Could you also post an example of a call and put with actual prices and gain/losses?

Thanks

Re: Educational Q & A for Options.

Three components:

Long CALL or Long PUT * (Experienced options traders with a lot of money can do short CALLs and short PUTs)

Strike Price: A standard set of prices that value an option. A PUT is "in the money" if the stock price is below the strike. A call is "in the money" if the stock price is above the strike price.

Time: An option can only be exercised at a certain time depending on the month you select. The further away, the time is, the higher the premium you pay for the option.


Example:
You buy an April call that is at a strike of $30. This means that if the stock is $30 or higher at the exercise date ( the third friday of the month), it can be exercised.
* If the stock price is $35, it gives you the option to purchase that $35 stock at 30 dollars. That is your reward for guessing the time correctly...

Why allow an investor to do this? Simple! Everyone is happy: Brokerages get lots of commission, Investors can hedge the long or short positions with a cheaper option (more on this later), and market makers can exercise your options for you (because you don't have the cash to do so) and make a nice little premium for 10 seconds of work.)

Options used as hedges: NO ONE IN THIS FORUM PROBABLY DOES THIS, but this is what options are designed to do:

I purchased $5000 of SIRI (sirrius) stock at $9 (before the dump). I want to sell at 10, but I'm afraid that it might go down. To hedge my bet, I buy a PUT at the strike price of 7.50. I am able to get $7.50 stock for .30 cents per share. If SIRI keeps on going up, I lose my entire investment in the option (and make money on my purchase).

If SIRI goes down (like it did) past $7.50, The option I paid .30 for would now be worth 1.50 or so (yes 500% GAIN). This way putting $1000 on the SIRI PUT will successfully protect my $5000 investment. The risk is that I lose the $1000.

How do I completely lose? SIRI goes to 7.50, but not by the exercise date that I selected. My option is worthless and my stock is down.





Options Trading:
Finding stocks with large intra-day up and down trends OR weekly uptrends and downtrends.

Buy an option within 15% of the money (in the money for less risk and less gain/loss, out of the money for more risk gain/loss).

Buy the option with 1-60 days left (depending on how long you anticipate the trend)
Trade with the trend you selected and when the trend turns against you, sell it. (some will buy the opposite and ride the trend the other way)

Be good at chart reading (as you study the charts, you will see that previous resistance support areas will be the locations of future bounces).



Here is an example from today (april currently) (not acutal):

Market open: XOM is at $61.

XOM (exxon mobile) is in a downtrend becasue oil is in a downtrend. The market opened and I bought an APR PUT for $0.45. The stock price fell $60.20 making the option worth $.75. I sell it for a 40% gain because I see the price turning around. I then wait for the price to go back up, if it does, I buy another PUT at $.45 at lunch. There is a lot of uncertainty about OIL on a friday so it decreases rapidly and breaks new lows, down to 60.) making my option worth $.90. I see it for a 100% gain.

I chose an april PUT as opposed to a may or june PUT because it has the most violent *price swings (yes that is the best way to describe the swings - if you buy wrong you will be down a lot of your investment - don't panic unless something changes the trend).

You can do the same thing with near the money calls...

phew... Get it? * ;D

Re: Educational Q & A for Options

Great info. Gonna take a bit to digest. I'll do a bunch more reading and get back with some more questions tomorow.

Thanks for the time guys.

Joe

Re: Educational Q & A for Options

ok im going for a long shot here if u need help with something this is that if u need answer right away if u can wait just post it on the forum.

Re: Educational Q & A for Options

Options are very high risk


here is a book on Characteristics and Risks of Standardized Options its about 60 pages read it before u invest.


Options are very high risk


http://www.optionsclearing.com/publi...s/riskstoc.pdf

Re: Educational Q & A for Options

standard information about options and what not

read this book on understanding stock options.

http://www.888options.com/store/uso.pdf


home / market data / contract specifications

Specifications For All Equity Options

Unit of Trade
100 shares per option contract.

Premium Quotations
Stated in points and fractions. One point equals $100. Minimum tick for series trading below 3 is .05 ($5.00) and for all other series .10 ($10.00).

Strike Price Intervals
2-1/2 points for stocks trading below $25, 5 points for those trading from $25 to $200, and 10 points for those trading above $200.

Exercise Style
American. Option may be exercised on any business day prior to the expiration date.

Expiration Months
Two near-term months plus two additional months in the January, February or March quarterly cycle.

Expiration Dates
The Saturday immediately following the third Friday of the expiration month.

Position Limits
Limits vary according to the number of outstaing share and trading volume. The largest, most frequently traded stocks have an option position limit of 75,000 contracts; smaller capitalization stocks may offer position limits of 60,000, 31,500, 22,500 or 13,500 contracts. Customer hedge exemptions are available.

Minimum Customer Margin for Uncovered Writers
The dollar amount of the premium plus 20% of the underlying security value minus the amount by which the option is out of the money (if any) with a minimum of the premium plus 10% of the underlying security value.

Trading Hours
9:30 a.m. to 4:02 p.m. (Eastern Time).

Exercise Settlement Price
Strike price times $100.

Exercise Settlement Time
Exercise notices tendered on any business day will result in delivery of the underlying stock on the third (T+3) business day following exercise.

Re: Educational Q & A for Options

Great thread!

Re: Educational Q & A for Options

Great idea for a options forum

I believe this will attract a more diverse group of investors to HSM, which is great!

Re: Educational Q & A for Options

Welcome to HSM.

Re: Educational Q & A for Options

I can't believe an idea of starting a thread has become a forum in HSM. You guys have so much to offer and I love seeing this forum grow exponentially.

Karateboy, I think it would be n enhancement if you set some rules for starting threads so we don't end up with social threads all the time. Say a thread should have a strict subject like:

Underlying ticker@Current price/Month/Call or Put/Option ticker/current bidxask

for example:
YHOO@$34.60/APR/PUT/YHQPG.X/.65x.70


What do you say?

Re: Educational Q & A for Options

WHAT IS A STOCK OPTION - A stock option is a contract that gives you the right, but not the obligation, to buy or sell an underlying stock at a specific price (called the strike price) during a specific period of time as outlined by the contract. For this right, you pay the writer of the option contract a premium based on the option purchased.


The price of an options contract is based on a number of factors, including volatility of the underlying stock, time left in the contract and other factors such as the difference in price between the underlying stock and the price at which the contract allows you to purchase or sell the stock. This valuation can be dynamically calculated using a mathematical model called the Black-Scholes Option Pricing Model.
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TYPES OF OPTIONS - There are two types of option contracts: call options, which give you the right to buy a stock and put options, which give you the right to sell a stock. Just remember the following:

You call a stock to yourself when you buy
You put a stock toward someone else when you sell
A call option would be purchased when you expected the price of the underlying stock might rise, while a put option would be purchased if you expected the price of the stock to decline.

If you are correct in your assumption, as the underlying stock changes in relation to the strike price of the option(s), it creates what is called "intrinsic" value in the contract. For example, if you have a contract to buy 100 shares of stock at a fixed price of $50 and the price of the stock suddenly moves to $65 a share - the value of the contract would be the difference in price between the stock and the strike price (in this example $15) plus the time value remaining, multiplied by the number of shares the contract allows you to purchase at this fixed (and more favorable) price.


As mentioned above, the strike price is the price specified in the options agreement or contract which outlines at what price you can purchase or sell the underlying stock. When the price of the underlying stock is near or equal to the strike price listed in the options contract, the contract is said to be "at the money". However, if the price in the options contract allows you to purchase or sell a stock at a favorable gain, then the contract is said to be "in the money". For example, in order for a call option to be "in the money", the price of the actual stock would have to be greater than the price the option allows you to buy it at.


A stock option is said to be "out of the money", when the price of the stock is in an unfavorable relationship to the strike price of the option. For example, on a put option (which gives you the right to sell a stock at a fixed price) the stock price would have to be higher than the price listed on the options contract in order for the put option to "out of the money".

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THE LEVERAGE POWER OF OPTIONS - One of the most attractive aspects of options (as well as one of the most dangerous) is that they can provide you with the ability to greatly leverage your money. This is because with an options contract, you can - in effect - control a fairly large amount of stock with a relatively small amount of capital (at least when compared to the cost involved with buying the stock outright). The problem (or risk) is not so much this leverage, but when this leverage is abused.


In fact, when used correctly, options can actually reduce risk. Options can allow you to control a desired number of shares of stock for a specific time period with a fixed and completely limited "down side" (i.e. the price of the options). Trouble arises when investors buy beyond their means and/or subject all their capital to the risks associated with options. Namely, the risks associated with their volatility based on the movement of the underlying issue, as well as the loss of value as the contract begins to expire. Keep in mind, sometimes as little as a one or two point move against you in a stock's price will drop the value of an options contract (at least one that is at the money) as much as 50 to 75 percent in some cases (this is especially true of options with little time value remaining).


With respect to the actual leverage provided, this ratio can be calculated by dividing the strike price of the contract by the actual cost of the contract. Typically, when dealing with stock options the leverage provided can be as high as to 10 to 1 as compared to buying the stock itself.


Consider the following example: You purchase a call option on XYZ stock. XYZ stock is currently trading at $40 a share. Let's assume a one month call option on this stock with a strike price of $40 is selling at $4 per option.


Options are sold by number of contracts. A contact by definition is a group of 100 options. As such, "one contract" would be $4 multiplied by the number of options in the contract (100) for a price of $400. This would give you the right to purchase 100 shares of XYZ stock at a fixed strike price of $40 for the next month regardless of what price the stock might move to.


Cont:

Re: Educational Q & A for Options

Now let's look at how the option price moves in relation to the stock. Assuming the stock did not move, the option would slowly deteriorate in price until it was worthless after one month.

However, if the stock were to move to $44 a share before the option began to significantly deteriorate with regard to remaining time value, we could see the option value move up to $8 per contract. Only a 10% move in the stock price itself, however a 100% move in the options contract value. At this point, assuming the options were selling for roughly $8 each, your contract would now be worth approximately $800 (note that this example does not take into account market prices nor specific time valuations).


In fact, on the subject of specific time valuations, let's keep in mind that if the stock did not move up to $44 a share until the last day of the option contract, there is a very good chance that the option would drop by $4 due to expiration of time, while at the same time increasing by $4 due to the move in the stock - thus the drop in time value and the increase in intrinsic value would cancel each other out - leaving the option valued at $4 each.


Finally, let's consider the case where the stock fell to $35 a share. Certainly, holding a contract that allowed you to purchase the stock at $40 a share, while at the same time the stock was selling in the open market at $35 a share would not be a very valuable situation. This would leave the contract with only time value left, which would most likely not offset the drastic "out of the money" condition. However, if during the one month period, the stock returned to $40 or greater, value would subsequently return in the options and the contract as well.
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THE OPTION WRITER - When you purchase an option on a stock, you are actually purchasing it from another individual and/or firm on Wall Street that is writing the actual options contract. If you stop and think about it, this is a somewhat startling fact, since it means someone is actually betting directly against you being correct in your assumption of profitability on the final outcome of the option. While it's true option writers may hedge themselves to limit and/or reduce risks, at the same time, the basic idea is that you are taking up a position against someone who is pricing the option in an effort to ensure you will not take his or her money. When trading options, you need to always keep this point in mind.


Also understand that while options are traded in a market very similar to stocks, there is much more latitude as far as how pricing can work between buyer and seller. The bottom line is that if someone is silly enough to over pay for an options contract, there will most likely be someone willing to write that contract and sell it. If you really want to see a first hand demonstration of this, just place a market order for an option contract sometime. Look out!


Additionally, spreads between the price which you must pay to open the position and the price available to you should you decide to close the position, can be extremely high from a percentage standpoint of view. When taking up or selling option positions, a good rule of thumb is to only use limit orders - unless you absolutely need in or out of a position and are willing to be exposed to a possible big hit by the markets in the process.
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CLOSING YOUR OPTION POSITION - Selling options is basically very straight forward. Assuming there is value left in your position and/or it in the money, you have one of two choices. You can either sell the option to someone else and reap the profit, or you can exercise the option and take over the stock.


Note that in some cases (generally with very large option positions) you may not have the cash available in your account to "buy" the stock of the underlying position. In this case you would typically sell the contract without exercising it, however, if you run into a situation where there are no buyers and/or the market does not appear to be favorable for selling the contracts, you can in fact direct your broker to exercise the options and then simultaneously flatten the position by selling the stock at the market. This should not generate a margin or house call in your account, since you have effectively bought and sold the stock at the same moment. Normally this is not required, since options generally can be sold into the market.

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Cont:

Re: Educational Q & A for Options

OPTIONS EXPIRATION - Options expire on the 3rd Friday of the month in which the option is written. For example, a January call option will expire on the 3rd Friday of January. Technically it expires on Saturday, but Friday is the last day you can trade it. Note that options which expire with a value of 3/4 of a dollar or more are automatically executed in your account. Those with a value less than $0.75 must be manually executed or they will expire worthless.


Options are cleared through the OCC - the Options Clearing Corporation. Questions regarding the finer points of options can be found at their website or at the additional links listed at the end of this document. The OCC's website is located at:

http://www.optionsclearing.com
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OPTION TICKER SYMBOL FORMAT - Options trade under ticker symbols, much like stocks do. However, they use a somewhat strange notation system which at first glance is a bit confusion to the novice.


Typically a stock option will have an "options root" associated with it which identifies the underlying stock. NYSE listed stocks often use the original ticker symbol, while Nasdaq listed stocks use a root which is partially derived from the name in most (but not all) cases.


A list of option roots for most stocks can be found at the Chicago Board of Options Exchange via the following URL and/or at most on-line brokerage web pages and via most quote services:



http://www.cboe.com/TradTool/Symbols...lDirectory.asp

Finally, a two letter suffix is added to the end of the root to denote the month of the option and whether it is a call or put, plus the strike price (respectively).

As an example,
an IBM November $150 call would be: IBM KJ.
A Microsoft January $70 put would be: MSQ MN


The chart below will help you in determining the proper stock option symbol (using what is called the 'short format' for option symbols). The symbol for a stock option is formed by combining the stock option root with a single letter code representing the month & type of option (call or put) along with a single letter code representing the strike price of the option.


· OPTION MONTH & PRICE CODES ·




Month & Type Codes
*Options Futures
Month Calls Puts Calls Puts
January *A *M *F *A *
Feburary *B *N *G *B *
March *C *O *H *C *
April *D *P *J *D *
May *E *Q *K *E *
June *F *R *M *I *
July *G *S *N *L *
August *H *T *Q *O *
September *I *U *U *P *
October *J *V *V *R *
November *K *W *X *S *
December *L *X *Z *T

Strike Price Codes
Price *Code *
05, 105, 205, 305, 405... *A *
10, 110, 210, 310, 410... *B *
15, 115, 215, 315, 415... *C *
20, 120, 220, 320, 420... *D *
25, 125, 225, 325, 425... *E *
30, 130, 230, 330, 430... *F *
35, 135, 235, 335, 435... *G *
40, 140, 240, 340, 440... *H *
45, 145, 245, 345, 445... *I *
50, 150, 250, 350, 450... *J *
55, 155, 255, 355, 455... *K *
60, 160, 260, 360, 460... *L *
65, 165, 265, 365, 465... *M *
70, 170, 270, 370, 470... *N *
75, 175, 275, 375, 475... *O *
80, 180, 280, 380, 480... *P *
85, 185, 285, 385, 485... *Q *
90, 190, 290, 390, 490... *R *
95, 195, 295, 395, 495... *S *
100, 200, 300, 400, 500... *T *
07.5, 37.5, 67.5, 97.5... *U *
12.5, 42.5, 72.5, 102.5... *V *
17.5, 47.5, 77.5, 107.5... *W *
22.5, 52.5, 82.5, 112.5... *X *
27.5, 57.5, 87.5, 117.5... *Y *
32.5, 62.5, 92.5, 112.5... *Z *