So I decided I would start trading options. It seems like many people are scared to trade options because of a stigma that they are risky and or complicated. While both can be true they really are simple instruments, at least in their basic form.
If you buy an option you are paying a premium for the right to buy or sell 100 shares of a stock at a given price. This price is called the strike price. The right to buy is called a call while the right to sell is called a put. Options have a fixed length when then can be used, or exercised. After this date they expire are are worth nothing.
Whats nifty about options versus buying the underlying security is that you neither own the security and don’t pay full price for it, instead you pay a premium, much like in insurance.
While stock xyz may cost $10 a share, a call strike price of $11 that expires in a month might only cost $2.00 a share. Similarly a put strike price of $9 might cost $2 a share. When a call option is above the strike price it is known as in the money, similarly for a put when it is below the strike price. Lets compare the call option to an underlying security for 100 shares.
Cost: 200 – 2,000
Max loss: 200 – 2,000
Max gain: inf. – inf.
Lets look at several potential prices of the stock.
Revenue: -$200 – $0
Revenue: -$200 – $100
Revenue: -$100 – $200
Revenue $0 – $300
This doesn’t look so good, you would have made money on the underlying stock compared to losing or breaking even on the option. Even though the stock move up %30 your income is $0. But lets look further. Say the stock increased %50.
Revenue: $300 – $500
Still the stock seems better right? Wrong. In order to get $500 you had to invest 10x as much capital, $2000, instead of $200! A better metric is your Rate of Return (ROR) which is how much the asset is worth/how much capital you risk.
ROR @$15: 100/200 – 500/2000
50% – 25%
WOW any investor would love a big return like that….
Additionally if you purchased $2000 in options you would have an extra $1000 in cash compared to the underlying stock.
Ok this tutorial is not that good but, there are many more out there…..