Question about shorting stock options...

[Maetryx]

Maetryx here,

definitions:
option - the right to buy or sell a stock at a particular price in the form of a contract that expires after a certain number of days (30, 60, and 90 are common). These contracts are sold on the open market. Some are so outrageous that they sell for less than a $1 i.e. the right to buy XYZ stock for $55 within the next 30 days when it is currently trading for $30 or so.
short - the act of selling stock now, and then purchasing the stock later to "cover the short". If the stock price falls, you can purchase it cheaper than you originally sold it for and keep the difference. It's betting that a stock price is going to drop. You can also short options if you think their value is going to drop or even become worthless.

I've been doing a lot of reading about optioins online and even in books(!) and I understand the vocabulary and the basics. But it seems that I have discovered a loophole that would lead to almost always "winning" at the stock market. In other words, I'm wrong.

Someone tell me why this wouldn't/doesn't work.

Why can't I look up all the options that are expiring shortly (less than, oh say a week or two) and that are WAY outside of the money (i.e. nearly worthless) and *short* those options at whatever price anyone will bid? Don't the vast majority of options expire without exercise? Wouldn't shorting those options be almost a sure thing?

So what if I can only short an option for $0.75 (x 100 = $75). If I could get someone to actually buy those options at such "bargain" basement prices over and over, I could eventually get rich slow.

 

[Russ]

Actually, what you would be doing is buying "puts", instead of "calls". I don't think you can technically "short" options. Many people have made some good money in the options market, but it really isn't quite as simple as you make it sound.

Russ, NCNE

 

[Bozo Galora]

because you have to pay a commission coming and going of 2-4%


your post is a bit confusing
options on stocks have two measures of value - time and intrinsic
an option is a right to buy something at a certain price up to a certain date you specify.
assuming the strike price (your choice) of the option is $10 (X100 shares) = $1000 option value, if stock is
currently $11, $1 intrinsic, 2 months time value if they were May expiration
4 months time value means you pay more since there is more time for stock to rise or fall, depending if you
are long or short
if you think nvda is going down, you short the options, say, sept. and pick a strike price of $55. Since nvidia
closed at $58.91, you have ~$4 intrinsic value plus 6 months time value worth, say, $5, so you will have to
pay at least $9 for this "in the money" trade. Still, you are controlling 7 times the stock for same money.
you will also pay a comission of 2-4% coming and going. Normally, you will only have to have a minimum
in your account to buy, until things go against you.
If nvidia jumps to $63, you are now $4 out of the money, quite possibly triggering a margin call for the
UNDERLYING VALUE OF THE STOCK. vs. your strike price or $6300 - $5500 = $800 in the hole.
if you bought 100 $55 May short options (10,000 shares), you would be $80,000 in the hole
your option now has no intrinsic value, only time, which drops in an increasing intensity.
fact: 80% investors LOSE money in stock and commodity options.
fact: most investors hold their commodities or options right to the end, and ignore the daily fluctuations.
fact: professional traders use options as hedges, are in and out on a daily basis, see trades in real
time, dont pay your commissions, and view the public as chumps/first class.

the best way to go for broke is to buy BOTH puts and calls (the right to buy an option) on the S&P 500,
so you are not trying to outsmart the insiders, then pray for a big move - like Sep11. You can never lose
more than the price of the put or call. Investers use sophisticated strategies like straddles and strangles
and spreads to buy, for instance, BOTH puts and calls on the same item, so that only if the stock or index
stays unmoving do they lose.

Its all about hedging you bets, covering your butt. You will never beat these guys - they do it 8 hrs.
a day

 

[911paramedic]

You can do something like what you are talking about, in fact many people do. It limits your gain as well as your loss though.

Like it was stated above, shorting a stock and options are totally different animals. Shorting a stock just means that you think that it will go down in value, so you SELL it (at a higher price) before you BUY it (at a lower price).

 

[Maetryx]

Thanks, Russ. I just checked though, and I *know* I can short an option (put or call) with my Ameritrade IRA account. But the more I stared at the numbers, the more I realized the risk involved.

I was looking at Goldman Sachs (a big bank). They last traded at $89.52. That makes the March 2002 options with a strike price of 90 very interesting, right? The puts are $0.48 in the money while the calls are $0.48 out of the money. But since they are close, there is speculative value in them. The price wouldn't have to change much to make a holder of the strike 90 options (put or call) in a better/worse position. Options expire on the Saturday that follows the 3rd Friday of the month. So in March (which had a Friday on the 1st) the last trading day for the March 2002 options is the 15th, a mere 10 days from now.

Anyway, I kind of think that Goldman Sachs and other big bullion banks are going to be screwed, but I don't know if that's going to happen in the next 10 days (If I knew for sure, I'd be rich, and then I'd be on my way to jail for insider trading). So let's take the March 2002 Call options with a strike price of 90 ( the right to buy Goldman Sachs shares at $90 each before close of business on March 15th). If you exercised that option today, you'd be retarded. You could buy them today for $89.52, so why exercise your option to buy at $90? The wager is that the stock price will exceed 90, and your option to buy at 90 will then be worthwhile (because you can exercise the option, and then immediately sell the stock at it's going price which in this wager, is greater than 90. You keep the difference).

But I just *said* I thought Goldman Sachs was going down. So if I short the March 2002 Calls with a strike price of 90, I'm pre-selling some contracts to some yahoo that thinks it's going to go up. He buys 100 contracts from me for like $2.00 each so I get his $200 in my account. Then I just sit around. If I'm right, and the price doesn't exceed 90 by March 15th, 2002, I simply keep his money. The option expires and attains the value of $0, so I have nothing to repay.

Of course, if I'm totally wrong, and the price of Goldman Sachs jumps to $110, I'm in a lot of trouble. Essentially, at $110, the call options with a strike of 90 will be worth the difference, i.e. $20. So I would have to purchase 100 options for $20 = $2000 to cover my short position. I'm out $1800 in that example.

And that's why I didn't press the Confirm button. I may get some guy's $200 to keep, but I could find out my crystal ball is broken.

 

[Maetryx]

<< Like it was stated above, shorting a stock and options are totally different animals. Shorting a stock just means that you think that it will go down in value, so you SELL it (at a higher price) before you BUY it (at a lower price). >>



I'm not confused on the difference between options and shorting. I may be inarticulate, and unable to convince that I know the difference, but I do know the difference .

My questions is about shorting options. In my second post, I concentrated on the aspect of options with a strike price that was near the market price. But in my original question, I was more concentrating on options that are WAY out of the money, and trading for pennies. Why not short these to everyone under the sun that is silly enough to give you money for an option that is *almost* certainly going to expire without value?

The answer is bracketed by asteriks above.

 

[911paramedic]

My bad, I just saw that in your last post.

 

[Maetryx]

Okay, here's another question about options. Let's say I buy a call option (the right to BUY) on 100 shares of Ford Motor Company. Let's say that the expiration day approaches, and amazingly enough I'm in the money. I've done well. The stocks have moved above my strike price.

So Ameritrade has a policy of automatically exercising any options that are 3/4 points or better in the money. So they would then.... what?

Purchase me 100 shares of stock at the strike price and place them in my account?

OR

Purchase me 100 shares of stock at the strike price, immediately sell them at the higher market price and put the difference in my account?

Finally, what do they do if when they go to auto-execute my option I have no funds with which to purchase 100 shares of Ford? Shrug and let my options expire, even though they have intrinsic value?

?