Options Talk-N-Trade (Options TNT) #1
What is an option? Well basically it’s a contract. The contract gives a buyer or seller an “option” to buy or sell a security. There are two basic types of contracts that options traders deal. They are called “Calls” or “Puts.” We must really get familiar with these two types of contracts before we just jump in. But, before we do, let’s discuss the basic set up for a contract.
CALLS – If we are bullish on a stock and believe that the stock will rise in price, we look to buy CALLS.
PUTS - If we are bearish on a stock and believe that the stock will fall in price, we look to buy PUTS.
Strike Price – Our “target” price of where we believe the future price of the stock will be.
Expiration – Each contract has a period of time in which the agreement will last. Be very aware of this date!
Premium – The price of the contract.
Now that we have these very basic terms defined we can look a little deeper. We must understand the in most cases, whether we buy a CALL or a PUT, each contract is for one hundred (100) shares. For example, if we buy a CALL, we agree to pay a premium now for the right to purchase one hundred (100) shares of a stock at a future date. If we buy a PUT, we agree to pay a premium now for the right to sell one hundred (100) shares of a stock at a future date. I suggest that you really read those last two sentences again. It’s what makes the understanding of options really possible.
Once we really understand what we are buying, it’s important to understand that these contracts expire. When we buy a stock, we can hold it indefinitely. We hope that someday the stock will rise in price and we can sell it for a profit. This is NOT the case with options. They have a lifespan. They all expire at a certain date. We must always be aware of this expiration!
Let’s move on. It’s also important to know how much each contract costs. When we look at quote for a stock, it’s pretty straight forward. We see the symbol, and then we see the price. It’s simple. Well, it’s pretty straight forward for the options as well. We first find the symbol. We then go to the options quotes. We then narrow it down to the month of expiration. Then we narrow the field further to the strike price we want. Finally, we see the bid and ask price, just as we would for the stock.
Once we find the price of the option, we need to add just one more step to find the true out-of-pocket cost for the contract. Since each contract is for one hundred (100) shares, we must multiply the contract price by a factor of one hundred (100). For example, company XYZ has a stock price of $25.00. When we look at the call options for the next month we might see the $30.00 call options priced at $3.50. Therefore, when we multiply the contract price by one hundred (100) we see that our out-of-pocket cost is $350.00 for one (1) contract.
$3.50 (contract price) X 100 (shares per contract) = $3.50 (out-of-pocket costs)
I’ll end this post at this point. We have talked f many terms here today. It’s best for folks that are new, to digest what has been discussed. In our next post, we will delve a little deeper. Have a great day folks!
Boca_Bobby
Mom said there would be days like this!
