Buying Rights, Selling Obligations

2011-11-25T10:00:00.001-08:00

Here is how options work. In short, a buyer of a call option has the expectation that the underlying security (the related stock or commodity) is going to move up. A call buyer has the right to control a bullish directional position of long 100 shares of stock (in the case of stock options) for a specified period of time (until option expiration day) at a certain strike price level (the price at which you will buy the stock). The buyer pays a fee to the option seller for this right, which is called the “premium.” In the case of commodity options, the call buyer has the right to control one long futures contract for a specified period of time at a certain strike price level. The buyer has no obligation to exercise the option contract and turn it into a bullish position in the underlying security if it is not profitable to do so. The option buyer has a limited loss potential equal to the price paid for the option, but also has an unlimited upside gain potential.

The put option buyer has the expectation that the underlying security is going to move lower in price. A put buyer has the right to control a bearish directional position of short 100 shares of stock (in the case of stock options) for a specifi ed period of time at a certain strike price level. In the case of commodity options, the put buyer has the right to control one short futures contract position for a specifi ed period of time at a certain strike price level. The put buyer has no obligation to exercise the option contract and turn it into a bearish position in the underlying security if it is not profi table to do so. The put option buyer has a limited loss potential equal to the price paid for the option, but also has an unlimited upside gain potential.

Sometimes it’s diffi cult to understand the put-buying side of options. Most people understand call option buying because we’re all so used to going long the market. I think people get caught up in the terminology of buying something to sell it. It sounds confusing. When you buy a put option, you’re giving yourself the opportunity to sell something at a certain price for a specifi ed period of time, no matter where the price of the underlying security may be. As I have already mentioned, the fi nancial markets allow you to sell something that you don’t own fi rst. That’s a hard concept to grasp. If you own a stock and are willing to sell it, either you can just sell your shares or you can buy a put option contract, which allows you to pick the price level at which you may want to sell the stock and the expiration date of when to do it.

On the fl ip side, sellers of calls and puts have different views and obligations. The seller of a call option has a neutral to bearish view of the underlying security and has an obligation to fulfi ll the terms of the contract if the option buyer decides to exercise the option contract. The seller of a put option has a neutral to bullish view of the underlying security and has an obligation to fulfi ll the terms of the contract if the option buyer decides to exercise the option contract. In short, the option seller is at the mercy of the option buyer with regard to exercising the option contract. The option seller has a limited gain potential equal to the price paid for the option by the buyer, but also has an unlimited downside loss potential.

Introduction

2011-11-25T09:30:00.001-08:00

There are two types of options—calls and puts. Call and put options are a direct form of investment
and should be seen as such. You can achieve everything you want on an investment basis with options, just as you would with any stock, bond, or mutual fund. That fact is very important to remember.

Every trading position in options is composed of either all calls, all puts, or a combination of them. One thing to know is that you can sell options as easily as you buy them. One of the great aspects about options trading is that you can sell something first that you don’t own yet. Instead of the usual “buy low, sell high,” we can reverse it and “sell high, buy low.” In this case, the sale transaction comes first.

What are call and put options? In short, options are another form of investment that can be bought and sold just like a stock, a bond, or a commodity. They are referred to as “derivative” investments because an option’s value is derived from other sources. In some of the mainstream literature about options, the examples given from the buyer’s view of the market. It doesn't have to be that way. You don't have to limit yourself to one strategy.

The main purpose of buying options is to gain leverage on your investment and to cut down on your initial capital outlay. Options allow you to take a directional position in an underlying security using a small down payment. The reward is the potential for a big gain. You only have to put up a fraction of the price, yet you get to control the whole house. In simple terms, you’re using options as a substitute for the stock or commodity. But you have to know how to choose your options correctly to maximize your potential gains. And since I’ve found that most option buyers do not do this correctly..

Profitable Options Strategies

Buying Rights, Selling Obligations

Introduction