Stock options are contracts to buy (or sell) a stock at a certain price before a certain time in the future. Buyers of options have the right to buy the stock at the specified price, but they are not obligated to exercise their option. Sellers of options have the obligation to sell the underlying stock if the buyer of the option wishes to exercise it.
A contract to buy is called a 'call option'. The buyer of a call option hopes the price of the underlying stock will rise, allowing him to buy it at less than market value. The seller of the call option expects that the price of the stock will not rise, or at least is willing to accept a partial loss of profits made from selling the call option. For example: An investor buys a call option on IBM with a 'strike price'
(the price the stock can be bought) of $50. The current price of IBM stocks is $40 and the cost of the call is $5. If the price rises above $55 (strike price + cost of call) the buyer could exercise his right to buy and make a profit by reselling on the open market. The seller would still gain from the increase in price from $40 to $55 plus the $5 he made by selling the call. If the price remains below $55 the call would not be exercised and the seller would profit by $5 per share and the buyer would lose his $5 per share.
Options are traded on specific stocks. They detail the name of the stock, the strike price (the price the stock can be bought or sold at), the expiration date and the premium (the price of the option itself). After the expiration the option cannot be exercised and is worthless. Options have a value and are actively traded. An option to buy Microsoft, for example, is listed like this:
MSFT Jan 06 22.50 Call at $2.00
This tells us that an option to buy 1 share of Microsoft at $22.50 before the third Friday in January 2006 can be bought for $2.00. Options usually expire on the third Friday of the specified month, and they are usually traded in lots of 100. To buy this particular option you would have to pay $200 (plus brokerage fees).
An option to sell a stock is called a 'put option'. This gives the holder the right (but not the obligation) to sell a particular stock within a certain time period at a certain price. In this situation the buyer is expecting the price of the stock to fall but does not want to sell outright in case the price rebounds. The seller feels that the price is stable or is willing to acquire the stock at the low price.
For example: An investor buys a put option on Microsoft with a 'strike price' (the price the stock can be sold) of $35. The current price of Microsoft is $40 and the cost of the put is $5. If the price falls below $30 (strike price + cost of put) the buyer could exercise his right to sell at a higher price than market. The seller would have to buy the stock at the higher-than-market price but any losses are offset by the $5 he made by selling the put. If the price remains above $30 the put would not be exercised and the seller would profit by $5 per share and the buyer would lose his $5 per share.
As can be seen, stock options can be used to protect against loss or as an investment opportunity in their own right. They are generally used as part of a trading strategy which combines the purchase of stock with the purchase of options.
For example, in a bull (rising) market you could buy stocks and call options and sell put options. This allows you to take full advantage of rising stock prices – the stocks you buy will rise in value, the call options will allow you to buy stock at less than market prices, and if the market dips and the buyer of your put option exercises it, you can pick up additional stocks at low prices. If the buyer does not exercise the option, you make money from the sale of the option.
Conversely, in a bear market, you can sell stocks, sell calls, and buy puts to limit losses and generate profits. Unstable markets can use a mixture of puts and calls to maximize profit potential.
Options are traded on Futures and Options Exchanges. There are 6 such exchanges in the United States including the American Stock Exchange (AMEX) and the Chicago Board Options Exchange (CBOE). In Europe the main options exchanges are Euronext.liffe and Eurex.
******Usman ahmed owner of this blog created this post with his knowledge.All content provided on this blog is not copied from any other blog and site and is for informational purposes only and The owner of this blog makes no representations as to the accuracy or completeness of any information on this site or found by following any link on this site.The owner will not be liable for any errors or omissions in this information nor for the availability of this information. The owner will not be liable for any losses, injuries, or damages from the display or use of this information.
A contract to buy is called a 'call option'. The buyer of a call option hopes the price of the underlying stock will rise, allowing him to buy it at less than market value. The seller of the call option expects that the price of the stock will not rise, or at least is willing to accept a partial loss of profits made from selling the call option. For example: An investor buys a call option on IBM with a 'strike price'
(the price the stock can be bought) of $50. The current price of IBM stocks is $40 and the cost of the call is $5. If the price rises above $55 (strike price + cost of call) the buyer could exercise his right to buy and make a profit by reselling on the open market. The seller would still gain from the increase in price from $40 to $55 plus the $5 he made by selling the call. If the price remains below $55 the call would not be exercised and the seller would profit by $5 per share and the buyer would lose his $5 per share.
MSFT Jan 06 22.50 Call at $2.00
This tells us that an option to buy 1 share of Microsoft at $22.50 before the third Friday in January 2006 can be bought for $2.00. Options usually expire on the third Friday of the specified month, and they are usually traded in lots of 100. To buy this particular option you would have to pay $200 (plus brokerage fees).
An option to sell a stock is called a 'put option'. This gives the holder the right (but not the obligation) to sell a particular stock within a certain time period at a certain price. In this situation the buyer is expecting the price of the stock to fall but does not want to sell outright in case the price rebounds. The seller feels that the price is stable or is willing to acquire the stock at the low price.
For example: An investor buys a put option on Microsoft with a 'strike price' (the price the stock can be sold) of $35. The current price of Microsoft is $40 and the cost of the put is $5. If the price falls below $30 (strike price + cost of put) the buyer could exercise his right to sell at a higher price than market. The seller would have to buy the stock at the higher-than-market price but any losses are offset by the $5 he made by selling the put. If the price remains above $30 the put would not be exercised and the seller would profit by $5 per share and the buyer would lose his $5 per share.
As can be seen, stock options can be used to protect against loss or as an investment opportunity in their own right. They are generally used as part of a trading strategy which combines the purchase of stock with the purchase of options.
For example, in a bull (rising) market you could buy stocks and call options and sell put options. This allows you to take full advantage of rising stock prices – the stocks you buy will rise in value, the call options will allow you to buy stock at less than market prices, and if the market dips and the buyer of your put option exercises it, you can pick up additional stocks at low prices. If the buyer does not exercise the option, you make money from the sale of the option.
Conversely, in a bear market, you can sell stocks, sell calls, and buy puts to limit losses and generate profits. Unstable markets can use a mixture of puts and calls to maximize profit potential.
Options are traded on Futures and Options Exchanges. There are 6 such exchanges in the United States including the American Stock Exchange (AMEX) and the Chicago Board Options Exchange (CBOE). In Europe the main options exchanges are Euronext.liffe and Eurex.
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******Usman ahmed owner of this blog created this post with his knowledge.All content provided on this blog is not copied from any other blog and site and is for informational purposes only and The owner of this blog makes no representations as to the accuracy or completeness of any information on this site or found by following any link on this site.The owner will not be liable for any errors or omissions in this information nor for the availability of this information. The owner will not be liable for any losses, injuries, or damages from the display or use of this information.
Excellent Information!! I must say that before you begin to trade you must make yourself a set of goals, this is essential in any business, because that is what stock options trading is, it is a business and it must be treated as such. I was searching for information on this topic and one of my best buddy told me to search for available resources on the Internet. I checked and found your blog as well as another perfect resource that really helped to get the understanding of this term in depth.
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