I think we can all agree that options are very important financial instruments. However, what exactly is an option? Investopedia states that options are contracts that give the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a certain date. Sounds great and all, but it doesn't help those that don't understand financial speak. So I'm going to describe options so anyone can understand them.
As an analogy, we will compare options to the art of purchasing a car. So you are looking for a car on Craigslist and you find the perfect one. You contact the seller and arrange a viewing of the vehicle. When you pull up, you notice that the car color isn't as vibrant as the online photo. However, you are still very interested in it. You can't make up your mind to throw down for this car because of the cumbersome color; although, you know the price is good.
You walk over to the seller and let him know that you're very interested in the car but are still unsure if you want to purchase it. You ask him if you can have 3 months to make a decision and if he would refuse to sell it to anyone else for the listed price of $10,000. He says he'll only put the sale on hold if you pay $1,000 to cover his storage fees and loss of potential sales. You agree and pay him the $1,000 to have the right, but not obligation, to purchase the car within the next 3 months for $10,000.
Let's say that the car's value increases to $20,000 because it turns out that it miraculously floats on water. You decide that you don't need the car since you hate water. This gives you two options: 1) you can sell the car option contract for more than you paid for it, or 2) you can exercise your contract and purchase the car at $10,000, then resell that vehicle. In either case, you win!
On the other hand, let's say that the car is determined to be a complete lemon by national media. The market value for the car is now $3,000. Your contract to purchase the car for $10,000 is now underwater because why would anyone exercise the option for something they can buy for less. With that in mind, the $1,000 contract itself could have decreased by 5 to 7 times its original value. You allow the contract to expire after 3 months and you walk away losing $1,000 during the ordeal.
And that is how options work. You can own options on company stock and obtain the right to purchase the shares at a specified price. The set prices are called Strike Prices. The cost of the option itself is called Option Premium. Each option has an end date like the 3 month time frame in our car example. This end date for the option is called expiration date.
If you decide to utilize options in your portfolio, I recommend that you start slow and paper trade. Option education courses are available, many of which are taught by proven professional option traders themselves. With a good options education course, you'll learn how to identify risk, how to mitigate them, and learn strategies to maximize profits. Good luck trading!
As an analogy, we will compare options to the art of purchasing a car. So you are looking for a car on Craigslist and you find the perfect one. You contact the seller and arrange a viewing of the vehicle. When you pull up, you notice that the car color isn't as vibrant as the online photo. However, you are still very interested in it. You can't make up your mind to throw down for this car because of the cumbersome color; although, you know the price is good.
You walk over to the seller and let him know that you're very interested in the car but are still unsure if you want to purchase it. You ask him if you can have 3 months to make a decision and if he would refuse to sell it to anyone else for the listed price of $10,000. He says he'll only put the sale on hold if you pay $1,000 to cover his storage fees and loss of potential sales. You agree and pay him the $1,000 to have the right, but not obligation, to purchase the car within the next 3 months for $10,000.
Let's say that the car's value increases to $20,000 because it turns out that it miraculously floats on water. You decide that you don't need the car since you hate water. This gives you two options: 1) you can sell the car option contract for more than you paid for it, or 2) you can exercise your contract and purchase the car at $10,000, then resell that vehicle. In either case, you win!
On the other hand, let's say that the car is determined to be a complete lemon by national media. The market value for the car is now $3,000. Your contract to purchase the car for $10,000 is now underwater because why would anyone exercise the option for something they can buy for less. With that in mind, the $1,000 contract itself could have decreased by 5 to 7 times its original value. You allow the contract to expire after 3 months and you walk away losing $1,000 during the ordeal.
And that is how options work. You can own options on company stock and obtain the right to purchase the shares at a specified price. The set prices are called Strike Prices. The cost of the option itself is called Option Premium. Each option has an end date like the 3 month time frame in our car example. This end date for the option is called expiration date.
If you decide to utilize options in your portfolio, I recommend that you start slow and paper trade. Option education courses are available, many of which are taught by proven professional option traders themselves. With a good options education course, you'll learn how to identify risk, how to mitigate them, and learn strategies to maximize profits. Good luck trading!
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Learn more about supercharging your options portfolio. See why options are important and should be considered for all portfolios.
Ditulis oleh:
Unknown - Monday, October 29, 2012
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