Stock Options

[cessna152]

I've been hearing about Stock Options lately. I don't really understand how they work. Where is the risk?

Essentially, you place a order for the future and only buy if you will make a profit from selling it?

😵

 

[krunchykrome]

I can tell you about executive compenstaion stock options.

 

[GasX]

A call is an option to buy a stock at a set price in the future.

A put is an option to sell a stock at a set price in the future.

You can buy or sell either.

If you buy a call or sell a put, you are basically betting the stock will go up. If you sell a call or buy a put, you are betting the price will go down.

That is options trading at its most basic level.

 

[AnonymouseUser]

Originally posted by: cessna152
I've been hearing about Stock Options lately. I don't really understand how they work. Where is the risk?

Essentially, you place a order for the future and only buy if you will make a profit from selling it?

😵

In a nutshell, yes. You lose the money you spent on the options if you don't exercise them.

A lot of traders "hedge their bets" by using options:

1) go long in a stock and buy put options (@ current price) - minimizes gains (and losses)

2) go long in a stock and buy call options (@ current price) - maximizes gains (and losses)

3) short a stock and buy call options (@ current price) - minimizes gains (and losses)

4) short a stock and buy put options (@ current price) - maximizes gains (and losses)

Of course you can always sell the options before they expire, so if they go up you can still profit.

 

[new2AMD]

Originally posted by: Mwilding
A call is an option to buy a stock at a set price in the future.

A put is an option to sell a stock at a set price in the future.

You can buy or sell either.

If you buy a call or sell a put, you are basically betting the stock will go up. If you sell a call or buy a put, you are betting the price will go down.

That is options trading at its most basic level.

I so want to understand this. In these basic terms it makes sense but I dont understand the risks involved yet to get into it.

 

[GasX]

As for the risk, when you buy an option contract, you own nothing but the right to buy or sell in the future. If the stock doesn't move in the right direction, your option contract will expire worthless. The reward for taking this risk as that you get control of a greater amount of shares per dollar than you would if you bought or sold.

an example:

XYZ Inc. Stock is $50 and you think it will be $60 by October. You have $5000 to speculate with.

You could buy 100 shares at $50 each of XYZ and if you are right, you will make $1000.

You could buy ~500 calls for XYZ with an exercise price of $40 at about ~$10 each. If you are right, you will make $5000.

If the stock goes down to $40 on the other hand, scenario 1 will give you a $1000 loss and scenario 2 will wipe you out.