BUYING OPTIONS CONTRACTS
An option is a contract. People who are new to options investing often ask, “Are options stocks?”. The answer is no. An option is based on a particular stock but it is not the stock share itself. An option contract is an agreement made between the investor, that’s you, and another investor, that’s not you, mediated through the options exchange board or CBOE.
There are two kinds of options contracts: Calls and Puts. This post will be all about Call Option Contracts. There are two avenues open to you for call options strategies. You can buy a call option contract or you can sell one. A contract represents one hundred shares in the underlying equity stock. When you buy a call option contract you are getting the right to buy one hundred shares of the underlying stock at your specified price on or before the expiry date of the contract. The price you choose is called the Strike Price. Almost all options expire on the third Friday of every month. The cost of the option contract is called the Premium and it’s the most you can lose if your contract expires, becoming worthless. Your online brokerage will provide you with the tables of strike prices, expiry dates and premiums available for your chosen stock option to help you make your selection.
So how much money can you make with options? The profits are low but so is the premium. You get to control one hundred shares of stock while just investing a fraction of the cost and limiting your loss to that premium. If you develop your skills as a stock analyst and learn what you can about managing your capital, you’ll have a lot of fun with call options. You’ll enjoy your achievements and step into a steady cash flow. The size of the flow depends on the size of your account.
The second avenue open to the options investor is to sell call options. This is the guy, also known as the writer, at the other end of the trade above. That same contract obliges the writer to sell the shares at the strike price that you chose should it reach it within the term of the contract. The writer has exposure to unlimited loss and, should the underlying stock do a moonshot that nobody expected (my favourite kind), things could get very uncomfortable. Usually, that doesn’t happen and the writer enjoys the benefit of receiving the buyer’s cash up front. Often people who own shares will sell an option on them which would allow them to give over the shares if said moonshot happened, and not have to cough up the cash to cover the call. You won’t be surprised to learn that such a strategy is called “a covered call” and, of course, the scenario where the underlying stocks are not owned and unlimited loss is a possibility, is often referred to as “a naked call”.
As with any unfamiliar trading modality, giving yourself all the practice time you need is recommended. Practising with options is easy once you have a broker and have access to the tools without actually using your money. For a while, just pretend! You’ll know when you’re ready to put on your investing pants.
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