Options Trading For Dummies: How To Get Started

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In this options tutorial article, we'll discuss the very basics of Option Contracts. That is, what is an option? Put simply, an option is a contract which you can buy from someone or sell to someone. Your responsibilities depend on whether you are the one buying or selling. Now before getting into those responsibilities, lets talk about some important characteristics of an option contract and then we'll build slowly on an example. An option contract will always have an expiration date. An option contract will always have what's called a Strike Price.

An option contract can be one of two types: Call or Put Lets talk about each bullet in more detail. I mentioned that an option is simply a contract, but a contract to do what? It is a contract which gives the buyer the right to trade the underlying stock. One option contract is good for shares of that underlying stock. The contract will also enforce a time frame to make that trade.

An option will expire at the close of the third Friday of the stated expiration month. In addition, the contract will specify a strike price. This is referring to the price of the underlying stock not the option itself. Call vs Put But wait, there is something we're still missing.

You may be asking yourself, well so what? That's where another very important characteristic comes into play and options puts and calls for dummies is Call vs Put. So which one do you choose? That depends on your personal belief on how IBM stock will behave. Remember that an option contract has an expiration date. In our example, it is May 15, Options puts and calls for dummies then you want to buy a Put Option. To summarize, a Call Option gives you the right to buy low while a Put Option gives you the right to sell high.

Remember that buying the option contract gives you that right. Which means the person selling you the contract is actually giving you that right. In both scenarios you are buying low and selling high! Now options puts and calls for dummies I say you are buying and selling shares, it's not exactly correct. That's called an Option Assignment. And your brokerage firm will charge you a small fee for handling the nitty gritty transactions in the back end.

Option Premium The one thing we didn't talk about so far is how much does it cost to buy an option contract? That depends on two factors. How close the current market price is to the strike price and how much time is left before the option expires. These two concepts are called Intrinsic Value and Time Value. A Call Option options puts and calls for dummies said to have intrinsic value if the current market price is above the strike price.

The rest of the option price is the Time Value. A quick side note about how option premiums options puts and calls for dummies stated. When you see an option price quote, you will typically see the price divided by It's stated that way because one option controls shares. Don't be confused or mislead and buy more options than you can handle! For a Put Option, obviously the Intrinsic Value would be based on how much lower the market options puts and calls for dummies is relative to the strike price.

Time Decay An important factor to consider is the decay of time. The Intrinsic Value doesn't decay, just the Time Value. Buying and Selling Options All this discussion was assuming the fact that you would keep the option contract until expiration.

But the fact is you may not want to. In reality many people do not buy and hold the option that long. If they see options puts and calls for dummies increase in the option they bought they will most likely sell the option and take their profit. Now you know options puts and calls for dummies as time proceeds the decay in Time Value will decrease the value of your option.

So the only way to make money is to hope that the underlying stock moves in your favour. But if IBM's market price increases as well, the decay in time value may be offset. You can probably guess by now that the closer the market price is to the strike price, the more the option is worth.

Now you can wait and see what happens on May 15th, but if you just wanted to take advantage of a short term price swing you can take options puts and calls for dummies profits right now and run. This section about reading options chains has been out dated, but it is still worthwhile to read through because you may still encounter these in various other websites. Click here to find out the latest method of reading options chains. Now that you know so much about options, lets talk about how to find them and how to interpret what you see.

You can look at the diagram below or go directly to Yahoo by opening another browser page and entering the URL http: As you can see there is a table like the one below: The red circle indicates this is for May The first column shows all the available strike prices. The green circle shows a weird looking symbol. It's certainly not the symbol for IBM, but it looks similar. There is a standard for listing option quotes which you can see by going to the cheat sheet see options puts and calls for dummies on the right hand navigation.

You can probably figure out the rest of the circles if you've seen stock quotes. A couple of things to point out is the pricing standard and the highted area. It is divided by and then listed. The volume however, has not been divided by anything! It really is The final thing to note is the area highlighted in yellow. Remember we talked about Intrinsic Value? The yellow highlighted options are referred to as "In the money" options. Buyer Beware Until now I've just been giving pure facts about options.

Now I'm going to give some advice. You have to be very careful when trading options. People often tout the upside to options investing while playing down the risks involved. If you watch T. While it is true that you can realize tremendous profits, options puts and calls for dummies chances of you realizing tremendous losses are just as great.

Even the best and brightest investment professionals cannot predict price movement especially over the short term. They get it wrong just as often as they get it right. At the end of the day, options are meant to add another dimension to your entire investment strategy, so be careful not to get wiped out as soon as you enter the option world. It's best to start out playing 5 to 10 options at options puts and calls for dummies time. If you find you've made some money doing it, then you can risk more capital.

New Options Chains As mentioned above, there is a new way to read options chains and it is quite easy to understand.

You will see below: You can see it is almost self explanatory. The red circle represents the underlying stock symbol, the blue circle represents the expiration date, the green circle represents the type of option "C" for Call, "P" for Putand the black circle represents the the strike price. The one small catch is that the expiration date is stated as the day after the actual expiration date.

I know weird, but the option actually expires as of close of market the day before. In the example above, the expiration date of '' readsMarch 22nd. That is, the option is already expired as of that morning. But for your trading purposes you have to make sure that whatever trade you want to make has to get in before the close of market onMarch 21st.

Summary Okay, we've gone through a lot of material here. And you might still be confused. I suggest you read the material again or at least the parts where you got lost. Also from options puts and calls for dummies menu above you can refer to a cheat sheet which lists all the important things you need to know about options without the long boring explanations and examples. And don't forget to come back soon for any updates or new material I add to this site. Options for Dummies Learn how to trade options.

Basic Options - What is an option? Designed by The entire content of this website is meant for educational purposes only.

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In finance, a put or put option is a stock market device which gives the owner of a put the right, but not the obligation, to sell an asset the underlying , at a specified price the strike , by a predetermined date the expiry or maturity to a given party the seller of the put. The purchase of a put option is interpreted as a negative sentiment about the future value of the underlying.

Put options are most commonly used in the stock market to protect against the decline of the price of a stock below a specified price. In this way the buyer of the put will receive at least the strike price specified, even if the asset is currently worthless. If the strike is K , and at time t the value of the underlying is S t , then in an American option the buyer can exercise the put for a payout of K-S t any time until the option's maturity time T.

The put yields a positive return only if the security price falls below the strike when the option is exercised. A European option can only be exercised at time T rather than any time until T , and a Bermudan option can be exercised only on specific dates listed in the terms of the contract. If the option is not exercised by maturity, it expires worthless. The buyer will not exercise the option at an allowable date if the price of the underlying is greater than K. The most obvious use of a put is as a type of insurance.

In the protective put strategy, the investor buys enough puts to cover his holdings of the underlying so that if a drastic downward movement of the underlying's price occurs, he has the option to sell the holdings at the strike price. Another use is for speculation: Puts may also be combined with other derivatives as part of more complex investment strategies, and in particular, may be useful for hedging.

By put-call parity , a European put can be replaced by buying the appropriate call option and selling an appropriate forward contract.

The terms for exercising the option's right to sell it differ depending on option style. A European put option allows the holder to exercise the put option for a short period of time right before expiration, while an American put option allows exercise at any time before expiration. The put buyer either believes that the underlying asset's price will fall by the exercise date or hopes to protect a long position in it.

The advantage of buying a put over short selling the asset is that the option owner's risk of loss is limited to the premium paid for it, whereas the asset short seller's risk of loss is unlimited its price can rise greatly, in fact, in theory it can rise infinitely, and such a rise is the short seller's loss. The put writer believes that the underlying security's price will rise, not fall. The writer sells the put to collect the premium. The put writer's total potential loss is limited to the put's strike price less the spot and premium already received.

Puts can be used also to limit the writer's portfolio risk and may be part of an option spread. That is, the buyer wants the value of the put option to increase by a decline in the price of the underlying asset below the strike price. The writer seller of a put is long on the underlying asset and short on the put option itself. That is, the seller wants the option to become worthless by an increase in the price of the underlying asset above the strike price.

Generally, a put option that is purchased is referred to as a long put and a put option that is sold is referred to as a short put. A naked put , also called an uncovered put , is a put option whose writer the seller does not have a position in the underlying stock or other instrument.

This strategy is best used by investors who want to accumulate a position in the underlying stock, but only if the price is low enough. If the buyer fails to exercise the options, then the writer keeps the option premium as a "gift" for playing the game.

If the underlying stock's market price is below the option's strike price when expiration arrives, the option owner buyer can exercise the put option, forcing the writer to buy the underlying stock at the strike price. That allows the exerciser buyer to profit from the difference between the stock's market price and the option's strike price. But if the stock's market price is above the option's strike price at the end of expiration day, the option expires worthless, and the owner's loss is limited to the premium fee paid for it the writer's profit.

The seller's potential loss on a naked put can be substantial. If the stock falls all the way to zero bankruptcy , his loss is equal to the strike price at which he must buy the stock to cover the option minus the premium received.

The potential upside is the premium received when selling the option: During the option's lifetime, if the stock moves lower, the option's premium may increase depending on how far the stock falls and how much time passes.

If it does, it becomes more costly to close the position repurchase the put, sold earlier , resulting in a loss. If the stock price completely collapses before the put position is closed, the put writer potentially can face catastrophic loss. In order to protect the put buyer from default, the put writer is required to post margin. The put buyer does not need to post margin because the buyer would not exercise the option if it had a negative payoff.

A buyer thinks the price of a stock will decrease. He pays a premium which he will never get back, unless it is sold before it expires. The buyer has the right to sell the stock at the strike price.

The writer receives a premium from the buyer. If the buyer exercises his option, the writer will buy the stock at the strike price. If the buyer does not exercise his option, the writer's profit is the premium. A put option is said to have intrinsic value when the underlying instrument has a spot price S below the option's strike price K. Upon exercise, a put option is valued at K-S if it is " in-the-money ", otherwise its value is zero.

Prior to exercise, an option has time value apart from its intrinsic value. The following factors reduce the time value of a put option: Option pricing is a central problem of financial mathematics. Trading options involves a constant monitoring of the option value, which is affected by changes in the base asset price, volatility and time decay.

Moreover, the dependence of the put option value to those factors is not linear — which makes the analysis even more complex. The graphs clearly shows the non-linear dependence of the option value to the base asset price. From Wikipedia, the free encyclopedia. This article needs additional citations for verification. Please help improve this article by adding citations to reliable sources. Unsourced material may be challenged and removed.

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