Selling Options » Online Trading

Options Trading 101

admin — Tue, 26 Jan 2010 12:32:44 +0000

The individual investor will typically include some stocks in their investment portfolio. And whether they are a long term trader or in it for much quicker returns, many investors understand and feel somewhat comfortable with the concepts and techniques of trading stocks.
Options tend to be much less understood – and therefore avoided. But Options can form an extremely valuable part of your trading strategy as they can provide tremendous returns!
So here I will try and give you some of the fundamental concepts behind trading options.
Options are a contract conferring the right to buy (a call option) or sell (a put option) some underlying instrument, such as a stock or bond, at a predetermined price (the strike price) on or before a preset date (the expiration date). Options officially expire on the Saturday after the third Friday of the contract’s expiration month but because the markets are typically closed on Saturdays, the Friday is commonly used as the expiration date.
A key concept to grasp is that, when you buy an option, you don’t actually own the underlying security. You simply own the right to buy (or sell) at a specific point in time. But, of course, the price of the underlying instrument and the time remaing before expiration both affect the value of the option itself.
So in trading options you have two main ways to make money on them:
- You can hold to maturity and then exercise the option (with the expectation that the underlying instrument is then worth more than what you are entitled to buy it at – your “strike price”)
- You can sell the option itself prior to expiration (in the expectation that the value of the option itself has risen above what you paid for it)
A great many investors do in fact hold until maturity and then exercise the option to trade the underlying asset. Assume the buyer purchased a call option at $3 on a stock with a strike price of $30. (Typically, options contracts are on 100 share lots.) To purchase the stock the total investment is:
($3 + $30) x 100 = $3300 (Ignoring commissions.)
So if, at expiration, the stock is worth more than $33 you’ve made a profit (You can sell your 100 shares for more than $3300 right away).
Speculating on the actual value of the option itself is the second alternative.
Let’s use the same example above.
You bought your options for $3 with a strike price of $30.
If the price of the underlying stock goes above $33 at any time prior to expiration, then naturally more people will want to try and get a hold of that option you own, because they see a high likelihood of making a profit off the underlying security. With the increased demand for that option, the value of the option itself will likely go up. So you can sell the option to that higher bidder for a profit.
For example, if the price of the underlying stock rose to, say $35 then the option itself may become worth, say $4 on the open market. So you sell your options for $4 and make a nice 33% return. Without ever having owned the underlying stock itself.
Those are the kinds of returns that make options so attractive.
Many brokers offer trading accounts to individual investors that allow options trading and frequently at very competitive commision rates.
It really isn’t very difficult to get started.
Options trading is risky, so manage your risk and your assets wisely and only use a small percentage of your overall portfolio for trading options. But do consider them as an additional component of your investment strategy, as they can yield tremendous returns when traded correctly.

Commodity Options Trading – Learn 4 Commonly Used Terms

admin — Wed, 23 Dec 2009 00:10:35 +0000

The markets for trading commodities options are just a venue where the producers of various goods are provided a chance to trade a commodity at preset and fixed rates. This is a lot like a farmer who’s given an opportunity by an insuring firm, the rights to collect on a specific plan and given that his property catches fire, traders of the commodity options could also sell their own options at a set cost if existing market rates fall.
There are two different kinds of basic commodity options. One which takes the job of insuring the products in the event their present market price lowers, whilst the other one insures the products which are bought when the price is high.
Buyers at the commodity option market do hold the rights but not an obligation to exercise the options.
One thing to be kept in mind is, if a member decides to sell beans for $5 per sack, the commodity option market is like one that provides him the opportunity to do that by giving the rate which has already been decided upon. If every sack is right now priced at only $^ each, in such case the commodities option trader has the chance to sell his products at only $6 in which case he makes a dollar on every sack.
Commodity options have 2 basic divisions: the option to call and the option to put. The call option provides one with the right to purchase the underlying commodity, whilst the put option provides you the rights to sell the existing underlying commodity, keeping in mind the predetermined cost of sale.
Some of the usual sale jargon includes:
1. The Underlying commodity
This does not in fact point to a commodity itself, but to the futures agreement for those particular wares. For example, the option for the month of December corn is in fcat the option for the December delivery time of the corn’s futures contract.
2. The Strike price
The cost that was preset and determined before the options were handed out is called the specified price or also the strike price. This is the rate at which underlying commodities may be bought or sold at any given time with in the period in the options contract.
3. Expiration
The values of the commodities options are based only on the future contract of the underlying commodities. Therefore, there is a set date when the options are predicted to mature and to expire. Option traders can thus choose to hold their asset until the last instant in the hope of getting a bigger sum for their option, but analysts warn one against that, as the longer you stick to the option, the more are the risks you may face.
4. The Option premium
By that we mean, the amount which is paid to the options writer in order to get the rights given in the options. It is decided on by public voting and more often than not, changes every single day.

Options Trading Strategies, Basic Concepts

admin — Sun, 29 Nov 2009 01:11:27 +0000

When venturing into the options market, the best way to get the lay of the land is to be acquainted with at least some of the more elementary concepts. These will aid the new investor in successfully executing basic trading strategies.
Two basic terms, the call and the put, are the epicenter of the trading strategies. To buy a call confers the right, not the obligation, to buy at a price that is pre set. Conversely, puts give the buyer the right to sell at a pre set price. Options are both sold and bought, meaning that the seller grants the buyer the right and takes on an obligation to fulfill the other side of the trade.
The variations to this maneuver include:
Long Calls
The long call is the easiest to understand and is the most basic concept. MSFT (Microsoft) traded at $28 with June 31 options that were to expire on the third Friday of June. The strike price was $31, meaning that it was pre set so if exercised it had to be bought at that price.
Short (Naked) Calls
When the writer, the person selling the option, does not own the underlying stock and the option is exercised, then he or she is obligated to sell. Under those circumstances, that action is considered a naked call. Because the person is on the selling side of the contract, his position is considered to be short.
The short call status incurs the most profit by the amount of the premium if the market price of the underlying asset decreases. When the price exceeds the strike price by more than the premium, then the short position takes a loss.
Long Put
When a trader anticipates that the future market price of an asset, such as a stock, will fall before the expiration date is able to sell the stock at a fixed price. The buyer, put buyer, is not obligated to sell the stock, but he or she does have the right.
If the market price does drop below the strike price before the option expires and the decrease is more than the premium paid, then the seller profits. If the price increases or fails to drop enough to cover the premium then the trader will allow the contract to expire worthless.
Short Put
When a trader speculates that the future market price will rise, they can sell the right to sell an asset at the predetermined price.
If the asset’s market price increases, the short put position incurs a profit that is equal to the amount of the premium. This amount excludes any transaction costs and commissions. However, if the price drops below the strike price by more than the premium amount then the writer loses the money.
There are several trading strategies that are basic to the market. These strategies employ the characteristics of four basic trading positions. These strategies have one of several outcomes: pure profit plays, speculating on gaining a profit or creating a combination of speculation and hedging.
When positions move in opposite directions, it is called hedging. Hedging bears a profit less that sheer speculation, but they do compensate by offloading a certain degree of the risk.
Bull spreads and bear spreads are common strategies that can help the trader manipulate the market, depending on the market emotion. Bull spreads utilize a long call with a low strike price and combine it with a short call at a higher strike price and a short put with a higher strike price. On the other hand, bear spreads use a short call with a low strike price and a long call with a high strike price. Alternatively, the short put can be used with a low strike price and a long put can be used with a higher strike price.
There is a great deal of software on the market that can aid in these types of trades. Options trading software can offer users concrete demonstrations of the how these strategies work. They show how they behave under different assumptions regarding future prices, volume and other factors, combined with various expiration dates and strike prices to show how these different scenarios can result in a profit or a loss.

Time Decay Strategies for Options Trading

admin — Sat, 28 Nov 2009 00:20:00 +0000

Time decay, also known as theta, is defined as the rate by which an options value erodes into expiration. The value of the option over parity to the stock is called extrinsic value.

Since an option is a depreciating asset, meaning it has a limited life, the extrinsic value in the option will wither away daily until expiration. This decay is not a linear function meaning it is not equally distributed between all of the days to expiration.

As the option gets closer to expiration, the daily rate of decay increases and continues to increase daily until expiration of the option. At expiration, all options in the expiration month, calls and puts, in-the-money and out-of-the-money must be completely devoid of extrinsic value as noted in the time value decay charts below.

As more time goes by, the options extrinsic value decreases. Again, it is important to note that the rate of this decrease is not linear, meaning not smooth and even throughout the life of the option contract. An option contract starts feeling the decay curve increasing when the option has about 45 days to expiration. It increases rapidly again at about 30 days out and really starts losing its value in the last two weeks before expiration.

This is like a boulder rolling down a hill. The further it goes down the hill, the more steam it picks up until the hill ends.

By selling the option and owning the stock, the covered call seller captures the extrinsic value in the option by holding the short call until expiration.

As mentioned earlier, an options loss of extrinsic value over its life is called time decay. In the covered call strategy the options time decay works to the sellers advantage in that the more that time goes by, the more the extrinsic value decreases.

Key Point The covered call strategy provides the investor with another opportunity to gain income from a long stock position. The strategy not only produces gains when the stock trades up, but also provides above average gains in a stagnant period, while offsetting losses when the stock declines in price.

We have now seen how a covered call strategy is constructed and how it is supposed to work. Keep in mind that the trade can be entered into in two ways. You can either sell calls against stock you already own (Covered Call) or you can buy stock and sell calls against them at the same time (Buy Write).

Example 1

You own 1000 shares of Oracle at $9.50.

The stock has been stuck around this level for a long time now and you have grown impatient. You finally give in and sell the front month (November for example) at-the-money calls. The at-the-money calls would have a strike price of $10 if the stock was trading at $9.50.

You sell the calls at a $.50 premium per contract which creates a $10.50 breakeven point. Remember, in a buy-write, the breakeven point is the strike price plus the option premium. Lets look at what our returns will be in each of the three scenarios.

So You Think You Know Option Trading?

admin — Thu, 19 Nov 2009 12:42:26 +0000

We all know that many opportunities exist in Option Trading today. Wherever you turn, someone is waiting to inform you of the tremendous profits to be realized within the stock and the futures markets. Nevertheless, many people are unaware of the derivative trading possibilities that are available within and across several different markets.
Option Trading is just one of the leading many ways to participate in such type of secondary markets. And in contrast to the popular belief, this potential trading arena is not limited strictly to the practice of selling or writing options.
Option Trading is an important element of investing in markets, serving a function of managing risk and generating income too.
Contrasting to most other types of investments today, Option Trading provides a unique set of benefits to its clients. Not only does Option Trading provide an economical and effective means of hedging one’s portfolio against adverse and unexpected price fluctuations, but it also offers a tremendous exploratory dimension to trading.
One of the foremost primary conveniences of Option Trading is that an option contracts enable a trade to be leveraged, allowing the trader to control the full value of an asset for a fraction of the actual cost.
Then since an option’s price mirrors that of the underlying asset at the very least, any constructive return element within the asset will be met with a greater percentage return resource within the option provides limited risk and unlimited reward.
With Option Trading the buyer can only lose what was paid for the option contract, and not a penny more, which is a fraction of what the actual cost of the asset would be. However, the profit potential is unlimited because in Option Trading the option holder possesses a contract that performs in sync with the asset itself.
If the outlook turns out to be positive for the security, so too will the outlook be for that asset’s underlying options. Option Trading also provides their owners with numerous trading alternatives. Option Trading can be customized and combined with other options and even other investments to gain the benefits of any possible price dislocation within the market.
Option Trading enables the trader or investor to acquire a position that is pertinent for any sort of market outlook that he or she can have, and then be it bullish, bearish, choppy, or silent. It doesn’t matter at all.
Risks Involved In Option Trading
While there is no disputing that Option Trading offers many investment benefits, it also involves risk and is not for everyone. For the same reason that one’s returns can be large, so too can the losses.
Also, while the potential for financial success does exist in Option Trading, the means of realizing such opportunities are often difficult to create and to identify. With dozens of variables, several pricing models, and hundreds of different strategies to choose from, it is no wonder that Option Trading and its pricing have been a mystery to the majority of the trading public.
Quite often, in Option Trading a wonderful deal of information must be processed before a knowledgeable trading decision can be reached. Computers and sophisticated trading models are often relied upon to select trading candidates.
However, as humans, we like things to be as simple as possible in Option Trading. This often creates a conflict when deciding what, when, and how to trade a particular investment. It is much more easier to buy or sell an asset outright than to challenge with the many extraneous factors of these derivative markets.
If an investor thinks an asset’s value will appreciate, he or she can simply buy the security; but if an investor thinks an asset’s value will depreciate, he or she can simply sell the security. In such scenarios, the only thing an investor must worry about is the value of the investment relative to the value of the prevailing market. If only Option Trading were that easy!
Generally, Option Trading is more awkward and complicated than stock trading because here the traders must consider many variables aside from the direction they believe the market will move.
The effects of the passage of time, variables and delta, and the underlying market volatility on the splendid price of the Option Trading are just some of the many items that traders need to gauge in order to make informed decisions. If one is not prudent in one’s investment decisions, one could potentially lose an enormous number of money trading options.
Those who actually ignore cautious and sound money management techniques often find out the hard way that these factors can promptly and easily grind down the value of their Option Trading portfolios.
Due to the risks and benefits, Option Trading offers tremendous profit potential above and beyond trading in any other device, including the underlying security itself. This is the moment at which theoreticians enter the picture. Once the benefits have been defined, it is then just a matter of determining how to matchlessly attain them.
Up till now, the vast majority of Option Trading techniques have been elaborate mathematical models designed to help identify when option writing or selling opportunities exist.
On the other hand, we hope to break used ground by introducing simple market-timing techniques to Option Trading that will enable the traders to buy options with greater confidence and with greater success in Option Trading.

Options Trading – The A,B,C Of Options Trading

admin — Wed, 18 Nov 2009 14:04:48 +0000

Like futures trading, an option gives a trader the right, but does not obligate him, to buy the underlying stock at whatever the specified price on a preset time in future.
You make profits if the stock value ends up higher than what you purchased at. On the flip side, if the prices drop, then you lose out on your investment.
There are 2 kinds of options: the put option and the call. When you purchase a call option, you expect that the value of your investment will rise and you buy a put option when you expect the prices to fall.
In either case you make a profit, provided your foresight was correct, unlike other derivatives where you get a profit only when value of shares increases.
You could use the hedging strategy when you are unsure if the price of your stocks is going to go up or fall down. What you should do in such case is go for a put option. If the price dips, you make a profit and if it goes up, at least you do not lose the investment, only the profits.
If you are sure your stocks are going to dip in value, it would be better to sell out and re invest in put options.
Another strategy could be to sell out before the expiry date of your options so you can purchase the underlying profitable stocks. Selling on the options is not a problem because there are bodies responsible for the purchase of so as to maintain a balance in the system.
Do take the time to be a part of forums and online discussions on the possibilities of options trading. You will find up to date information there that no book can provide. Some websites can offer free training material as well, which is a great boon for beginners.
Like any investment, options trading requires you to be updated with regularity, on the economy and businesses of different trading companies, if you would like to buy stock options on their company. It is great when you have a good idea of who you will need to trade with.
When you have the adequate information on the goings-on of the market, you are best equipped to make your self a good profit. Secondly, the timing with which you make your moves is vital, so make sure you make regular observations of the market if not continous in your business day.
To conclude, although trading with options can be a risky business, it can give you good returns when you play your cards right. So make sure you are getting regular information updates and that you have a strategy to work with.

Options Trading – Calls and Puts

admin — Mon, 16 Nov 2009 12:37:19 +0000

Options are contracts on an underlying trading instrument such as shares of stock, bonds, a commodity, a mortgage loan and many others. However, there are common features among all options. It does not matter if it is a share of stock or a mortgage loan; they all have certain things in common. One such commonality is the contract feature that specifies what the option owner has actually contracted.
Options traders have two situations that may influence their buying and selling: calls and puts. There terms are used to indicate specific behaviors of options at various points of the option’s life.
CALLs
A call bestows on the contract holder the right to purchase an asset at a particular price on or before the option’s expiration date. This is only a right to buy, it is not an obligation. The call owner always has the choice to allow the option to expire. This does mean that all the initial money that was invested in purchasing the contract is lost, but the choice still stands.
Call buyers are gambling on the underlying asset’s behavior; that it will increase in price before it reaches its expiration date. Also that it will not only rise, but will rise significantly enough to show a profit.
In order to show a profit, the price must rise enough to cover the difference between the market price and the strike price. The strike price is that price at which the stock must be bought. But, because the option has a cost attached to it, the price must exceed that amount enough to cover the additional amount. This cost is referred to as the premium.
The premium of an option, whether call or put, is determined by a variety of elements. These include, but are not limited to, the price of the underlying asset, the strike price and the time remaining on the option.
The time remaining on an option is vital. The shorter the time remaining, the greater the risk and vice versa. For example, if there are 90 days left to exercise an option, the risk is somewhat lower than if there was only 1 day left. This is because within that 90 day period the price could rise enough to show a profit. With just 1 day remaining, however, the odds are considerably lower.
For example, on April 1, MSFT (Microsoft) has a market price of $27. Call options for June 30 are selling for $3 with a strike price of $30. One contract for 100 shares is purchased.
If the contract is held until the expiration date, the trader either loses $300 ($3 X 100, the initial price of the contract not including commission) or the trader can purchase the underlying stock at $30. If the current market price was $35, then the trader has profited by $200 ($35 – ($30 + $3) = $2 per share X 100 shares, sans commission).
When the market price of a share rises above the strike price, the option holder is “in the money.” If the market price drops, then the holder is “out of the money.”
PUTs
A put gives the option buyer the right to sell an asset at a particular price by a specified date. Again, like a call, this is a right, not an obligation.
Put buyers are anticipating the stock prices to fall before the option’s expiration date. Therefore, in such cases, the market price must drop below the strike price in order to show a profit from exercising the option. For simplicity purposes, the cost of the put is ignored. Under those circumstances the option holder is in the money.
Still using the previous example, maintain the same situation, but this time the option is a put. If the market price falls to $25, the profit would be as follows:
First, $3 x 100 = $300 = Cost of put, excluding commissions.
Purchase 100 shares at $25 per share = $2,500 this is to repay the broker ‘loan’ (this broker loan is a part of shorting stock which is borrowing shares you don’t own, then repaying later).
Sell 100 shares at Strike price = $30, 100 x $30 = $3,000
Profit = ($3000 – $2500) – ($300) = $200.
It is the broker who handles the underlying mechanics. All the investor has to do is order the trades at a given time and date.
Wise investors do their homework and research their strategies, no matter if they are investing in calls or puts. Options trading does present risks and is rather complicated when compared to simple stock trading, although all trading contains an element of complication and risk. But investors in this line should study the history, volatility and other vital factors of both the option contract and the underlying asset.
A trader should never enter the market blindly and trade without doing the proper research first. The failure to do adequate research and go into the trade informed puts the trader at a must greater risk of losing money and not showing a profit.