Welcome once
again to Wall Street Mentors Weekly Newsletter.
Thank you for
taking the time to review this weeks topic on Stock
Option Basics.
First, we
would like to share a quick testimonial with you.
_______________________________________________________________________________________
Traditionally, the stock market used to scare me to
death. Today, because of The Mentor Center I enjoy
trading
because I know exactly how to find a fundamentally sound
company and subsequently perform a technical analysis
of the stock. Bottom line: thanks to the Mentor Center,
I know what to buy, when to buy and when to sell.
I have shared The Investrio Mentor Center with two
associates of mine and now we are making trades
together!
Dave Nicholson
Lindon, Utah
______________________________________________________________________________________
**SPECIAL
LIMITED TIME OFFER**
Click Here to receive your free 10 day trail of our
Software, Education & Trading System.
This
Week's Topic
F E A T U R E D A R
T I C L E: Stock
Options
An option is a contract giving 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. An option, just like
a stock or bond, is a security.
It is also a binding
contract with strictly defined terms and properties.
Still confused?
The idea behind an
option is present in many everyday situations. Say for
example you discover a
house that you'd love
to purchase. Unfortunately, you won't have the cash to
buy it for another three
months. You talk to
the owner and negotiate a deal that gives you an option
to buy the house in three
months for a price of
$200,000. The owner agrees, but for this option, you pay
a price of $3,000.
Now, consider two
theoretical situations that might arise:
1. It's discovered that the house is actually the true
birthplace of Elvis! As a result, the market value
of the house skyrockets to $1,000,000. Because the owner
sold you the option, he is obligated to sell
you the house for $200,000. In the end, your profit is
$797,000 ($1,000,000 - $200,000 - $3,000).
2. While touring the house, you discover not only that the
walls are chock-full of asbestos, but also
that the ghost of Henry VII haunts the master bedroom;
furthermore, a family of super-intelligent rats
have built a fortress in the basement. Though you
originally thought you had found the house of your
dreams, you now consider it worthless. On the upside,
because you bought an option, you are under no
obligation to go through with the sale. Of course, you
still lose the $3,000 price of the option.
This example
demonstrates two very important points. First, when you
buy an option, you have a right
but not the obligation
to do something. You can always let the expiration date go
by, at which point the
option is worthless. If
this happens, you lose 100% of your investment, which is
the money you used to
pay for the option.
Second, an option is merely a contract that deals with an
underlying asset.
For this reason,
options are called derivatives, which means an option
derives its value from something else.
In our example, the
house is the underlying asset. Most of the time, the
underlying asset is a stock or an index.
Calls and Puts
The two types of options are calls and puts:
A call gives the holder the right to buy
an asset at a certain price within a specific period of
time.
Calls are similar to
having a long position on a stock. Buyers of calls hope
that the stock will increase
substantially before
the option expires.
A put gives the holder the right to sell an
asset at a certain price within a specific period of time.
Puts are very similar
to having a short position on a stock. Buyers of puts hope
that the price of the
stock will fall before
the option expires.
Participants in the Options Market
There are four types of participants in options markets
depending on the position they take:
1. Buyers of calls
2. Sellers of calls
3. Buyers of puts
4. Sellers of puts
People who buy options are called holders and those who
sell options are called writers;
furthermore, buyers are
said to have long positions, and sellers are said to have
short positions.
Here is the important distinction between buyers and
sellers:
-Call holders and put holders (buyers) are not
obligated to buy or sell.
They have the choice to
exercise their rights if they choose.
-Call writers and put writers (sellers) however
are obligated to buy or sell.
This means that a
seller may be required to make good on their promise to
buy or sell.
Don't worry if this seems confusing--it is. For this
reason we are going to look at options from the
point of view of the
buyer. Selling options is more complicated and can thus be
even riskier. At this
point it is sufficient
to understand that there are two sides of an options
contract.
The Lingo
To trade options, you'll have to know the terminology
associated with the options market.
The price at which an underlying stock can be purchased or
sold is called the strike price.
This is the price a
stock price must go above (for calls) or go below (for
puts) before a position
can be exercised for a
profit. All of this must occur before the expiration date.
An option that is traded on a national options exchange
such as the CBOE is known as a
listed option. These
have fixed strike prices and expiration dates. Each listed
option represents
100 shares of company
stock (known as a contract).
For call options, the option is said to be in-the-money if
the share price is above the strike price.
A put option is
in-the-money when the share price is below the strike
price. The amount by which
an option is
in-the-money is referred to as intrinsic value.
The total cost (the price) of an option is called the
premium. This price is determined by factors
including the stock
price, strike price, time remaining until expiration (time
value), and volatility.
This information is
just the foundation. We provide a full stock options
tutorial right from within
The Mentor Center that
covers:
| |
|
OPTIONS BASICS |
Options Overview |
Introduction to Options Strategies |
|
Expiration, Exercise and Assignment |
|
Options Pricing 1 |
|
Options Industry Today |
|
|
PEOPLE AND
ELECTRONICS: How a Trade is Made |
|
The Human Component |
|
The Electronic Component |
|
Market Controls |
|
|
ADVANCED
STRATEGIES |
|
Selling Puts |
|
Vertical Spreads |
|
Options Pricing 2 |
|
Buying Stock with a Ratio Call Spread |
|
|
|
*SPECIAL LIMITED TIME
OFFER*
|
Click Here for a free 10 day trail of our
Software, Education &
Trading System.
Remember our
words of wisdom. No one cares about your money as
much as you do.
Use our
software, training & education to take back
control of your finances. Don't
leave your
retirement & your family's future in someone
else's hands.
|
Thank you again, for
the opportunity to share our knowledge and experience
with you.
For all the latest
information, news & updates please visit us again
online.
Keep an eye out for
our next edition of our newsletter coming to you soon!
“More Millionaires
have been created from the stock market than any other
source”
--Bloomberg Magazine
 
Questions or problems regarding this web site
should be directed to
info@wallstreetmentors.net
Wall Street Mentors Inc.
Copyright © 2000-2003 Wall Street Mentors Inc. All rights reserved.
Revised: .
Member Access
|