Introduction
Shares of a stock / company = Shares of a stock / Company
Options = Each option come with the right or obligation to 100 shares of a stock.
Options are financial instruments that derive their value from another underlying asset or financial measure. options come in two forms, calls and puts, adding them to
your current investing and trading tools allows you to benefit from both bullish and bearish moves in either underlying you select. You can do this to limit your total assets at risk or to protect an existing position.
Options
An option contract is a unique security that comes with contract rights and obligations.
When used correctly, an option contract provides you with leverage while still allowing you to reduce overall trade risk. Of course there’s another side to that leverage, which is why you want to take the time to understand the risks and characteristics associated with these contracts.
Options provide you with some distinct trading advantages, but as with other types of securities, they are not without risk. In fact, used the wrong way, they can be very risky. By understanding option styles and the risks associated with each you can manage that risk. Even if you choose to use options on a limited basis, you can consider a few core strategies to limit your overall market risk. These can be implemented with existing stock positions, single option positions, or through combination option positions.
Options Buying Vs Selling
A listed stock option is a contractual agreement between two parties with standard terms. When creating a new position, buying an option gives you rights and selling an option leaves you with obligations. These rights and obligations are guaranteed by the Option Clearing Corporation (OCC) so you never have to worry about who’s on the other end of the agreement.
A primary risk you encounter with options is time risk because contracts have a limited life. A call option gains value when its underlying stock goes up, but if the move in the stock is too late the call can expire worthless. On
the plus side options have expiration periods as late as 9 months to 2 and a half years.
Option Buying
Options come in two types: calls and puts. When you own a call, you have the
right to buy a certain stock at a specific price by a certain date. As a put owner,
you have the right to sell certain stock at a specific price by a specific date.
The rights you have as an option owner are at your discretion — you don’t
have to exercise them when the option expiration date approaches. Between
the time you purchase an option and the date it expires you can do as follows:
Sell it for a profit
Sell it for a loss
Exercise it Let it expire with no value (for a loss)
Option Selling
As an option seller, you’re obligated to complete certain transactions. You
have less choices and the market generally dictates your fate in terms of
meeting those contract obligations. As expiration approaches you can do as
follows:
Buy it back for a profit
Buy it back for a loss
See it expire with no value (for a profit)
To remember your call and put rights, think about calling the stock away
from someone (buying) and putting the stock to someone (selling).
Option Greeks – These Are Important to Understand
Five Types of Option Greeks
Delta
Theta
Gamma
Vega
Rho
How Are The Greeks Useful?
Here’s how:
- 1.Understand the likelihood of the option expiring in the money with Delta.
- 2.Calculate how Delta would change with the change in stock price with Gamma.
- 3.Gauge how much the value of an option reduces as expiration comes close with Theta.
- 4.Analyze the effect of volatility on the price of the option with Vega.
- 5.Evaluate how the price of the option changes with an increase of decrease in interest rate with Rho.
- 6.Greeks help traders eliminate the guesswork out of options trading and make calculated, informed decisions.
