Spectre's Learning Options for Option Newbies
First, let me start off by saying that this is just a brief and simple look into options. It is not an expert how to book by any means.
A. Understanding Options.
- I look at options in a very off the wall simple way. They are the "mini-stocks" attached to the underlying stock they are associated with. If you think a stock like RIMM is going to make a 10% move to the upside in the next 2 weeks, why buy the stock and make 10%, when you could buy the Calls and make much more. On the flip side, if you think RIMM is going to go down 10%, why short it when you can play the Puts and make much more.
- Calls: A Call is a contract for the right to buy 100 shares of the stock at a certain price. Say RIMM is at 130, but as an investor, you would want to buy the stock if it breaks above 145, you would want to buy the $145 RIMM Calls.
-Puts: A Put is a contract for the right to sell 100 shares of the stock at a certain price. Say you own RIMM, and you don't want to lose any profits, and the stock is at $130. To protect yourself, you would buy the $130 or lower puts, to reserve the right to sell the stock at that strike price of $130.
- When I say right, i mean just that, the right to buy or sell the stock, NOT the obligation to do so. Most of us are Traders Trading the options.
B. Simplifying the above.
- Say you are bullish on a stock, let's continue to use RIMM as an example, and you see it going up to $150 in the next 2 weeks. You would want to buy Call. The further out of the money "away from the current stock price" that the calls are, the cheaper and more risky they are. So, lets say the stock is at $135 and you see it going to $150, and you buy the $150 calls at $2 a piece. As the stock moves closer to $150, the value of your calls go up as well. Like I said, think of them as mini-stocks. On the other hand, if the stock goes down, your calls will decrease in value.
Puts, work on the other side of things. If you think RIMM is going to go down from $135, and you think it will drop to say $120, you would play the $120 Puts. As the stock drops, your Puts go up in value.
C. The Cost of Options.
- Options work like this, say the June RIMM $150 calls are $2, it would cost you $200 to buy 1 Call "as each call is the contract for the right to buy 100 shares at that strike price."
So, if you were to buy 100 Calls for a stock at $1.00, the math would be (100 x 100 x $1 = $10,000).
D. Risk of Options
- There are Two main concerns about playing options.
1. They can expire worthless on you. On the 3rd Friday of each month, that months options expire. If your options are Out of the Money, they are most likely worth nothing, and expire, gone forever.
2. With big swings, your options can have the bid drop out faster than a penny stock. I've see Calls close with a bid and ask of $3.00 x $3.10 and open up the next day after bad earnings at .05 x .30. That's pretty much a total loss.
E. Rewards of Options.
-You can easily get the same huge rewards as in penny stocks with options. Options going up 100% in a day or two happens all the time. Most good options trades regularly get profits over 50% on the majority of their plays. My greatest play ever was calling WCG puts from .10 to $47.50 in 3 days. Yep, 47,500% in 3 days. "Though, I did not play it, so I can't brag too much."
-It is easier to move money in and out of options that have decent volume. I regularly throw $10k+ at an options trade, and the bid and ask don't even blink. Try doing that with most pennies, very hard to do.
F. Where to trade Options.
Most brokers will let you trade options once you apply. I prefer Power Etrade Pro for options the most, but also use ThinkOrSwim as well.
www.ThinkorSwim.com "Has the best paper trading options platform you can get."
Anyway, that is just a basic overview. Once you do a couple paper trades, it will begin to make much more sense and be a lot easier.
And there is no better Options board than here at Options Wonderland.
Best,
Spectre
