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I really want to get into trading options. I understand the risk involved and also plan to use only a small percent of my account value to start. I have read almost every article I could find on the internet, but still am slighty confused. If someone could tell me if I understand it correctly, that would be great!
I "bought to open" 1 call contract of BAC at a price of $1.31 with a strike price of $17 that expires in August.
In order for me to break even, the stock price has to reach $18.31 (17+1.31) before the third week of August. If BAC's stock price reaches $18.5 in July, I can "sell to close" and will make a profit of whatever the current contract price is worth minus my premium.
If you sell BAC in July at $18.50 for something you will paid $18.31 (17 cost to you +1.31 prepaid) for your profit is 19 cents.
You have to have approval from your broker to trade options with a certain (lg) account balance on record. Inexperienced traders will likely be denied.
Most often they are used to cover positions. Say you short a stock which has an unlimited floor the purchase of an option will allow you to get out without much damage.
The example I gave is an actual trade I did a few days ago. I bought 1 contract, so I only have about $140 invested, so no big deal if I loose it. It's worth the experience.
Why would someone buy an option, when they could just buy actual shares of a stock?
I have an idea of the answer to the question, but it seems like more people just talk about options rather than trade them. Most people stick with actual shares.
Why do people talk about options, but in the end, don't trade them and just trade actual shares?
Why would someone buy an option, when they could just buy actual shares of a stock?
I have an idea of the answer to the question, but it seems like more people just talk about options rather than trade them. Most people stick with actual shares.
Why do people talk about options, but in the end, don't trade them and just trade actual shares?
The answer is quite simple...options are much more complicated and risky. However, you are able to leverage your investment. I'm sure you know Cramer from Mad Money. He made his money from options. He started with $8,000. Bought I believe three month stock options for Merck. The company went from $80 per share to $100, which gave made his investment worth $80,000 minus his premium of $8,000, so his net profit was $72,000 in less than three months from an $8,000 investment. He then traded more stock options and three months later had around $500,000. That's when he started his hedge fund and became extremely rich. If he were to have simply bought stock shares, he would have only $1,600. It sounds like easy money, but it's not. Options can be very complicated and RISKY, but you have the potential to make a much HIGHER return without having to invest a lot of funds.
The answer is quite simple...options are much more complicated and risky. However, you are able to leverage your investment. I'm sure you know Cramer from Mad Money. He made his money from options.
Yes, he had some luck with his investments and the hedge fund, but I guarantee you he makes more money from his tv show than his investing. Jim Cramer is usually wrong more than he is right, therefore, I discredit anyone who buys what Cramer says to buy without really doing their own research. He's basically the WWF of investing. Pretty much entertainment. But anyways...
Quote:
Originally Posted by Jonotastic
He started with $8,000. Bought I believe three month stock options for Merck. The company went from $80 per share to $100, which gave made his investment worth $80,000 minus his premium of $8,000, so his net profit was $72,000 in less than three months from an $8,000 investment.
How does that work? The stock went from $80 to $100 (or up 25%) so his $8,000 investment turns into $72,000?
Can you break that down for me so I can understand how that happened?
Quote:
Originally Posted by Jonotastic
He then traded more stock options and three months later had around $500,000.
Um...right.
Quote:
Originally Posted by Jonotastic
It sounds like easy money, but it's not. Options can be very complicated and RISKY, but you have the potential to make a much HIGHER return without having to invest a lot of funds.
Yes, I know that, that's the text book answer, but why?
Can you explain it more? This is what I keep on hearing and reading about people talking about options, they never explain anything.
Oh it's just complicated, yeah we know. Can someone explain it though?
Most traders trade in options and never actually exercise them to buy the stock. Leave that to the big institutions who can make money off of arbitrage. If you do actually plan to use them, then it's better to buy LEAPS, which are options for more than a year in the future, usually in a January. Options have a thing called "time value," which is the cost of deferring your purchase and "locking in" the price you pay. LEAPS give you the cheapest time value. Shorter terms have the most expensive time value. So if you're using them because you want to buy 100 shares in the future, but you don't have the money for it yet or don't want to risk the full value of the shares, that's the way to go. If the stock stays below the strike price, then the option you bought will become worthless and all the money you invested goes poof, so use them sparingly.
Another option you might consider is selling a cash-secured put. This is actually a very good alternative to actually buying stocks. Let's say you want to buy a stock and you know you will keep it for at least two months. So what you do is sell open a put that's two months out, that's in the money or close to even. So let's say the stock is $13 now, sell a put at $15 and collect the premium, let's say 2.50. If it stays below $15, then you get the stocks plus a little extra for your trouble. If it goes over $15, then that's $250 in your pocket. The only downside is, you need to have $1500 in your account at all times so that you can buy the stocks at any time if asked. It carries no additional risk beyond the risk of buying the stock in the first place, and in fact the premium you get provides a slight buffer against losses.
I really want to get into trading options. I understand the risk involved and also plan to use only a small percent of my account value to start. I have read almost every article I could find on the internet, but still am slighty confused. If someone could tell me if I understand it correctly, that would be great!
I "bought to open" 1 call contract of BAC at a price of $1.31 with a strike price of $17 that expires in August.
In order for me to break even, the stock price has to reach $18.31 (17+1.31) before the third week of August. If BAC's stock price reaches $18.5 in July, I can "sell to close" and will make a profit of whatever the current contract price is worth minus my premium.
Am I correct?
Thanks!
Let's stick with the OP's call option.
So basically, call options need big moves (in the underlying stock price) in a short amount of time in to be profitable?
So the OP bought 1 contract, 100 shares of BAC, at $1.31, + commission, which is about $140 invested. But if you choose not to buy the contact and just let it expire, don't you just lose your $1.31 + commission? You don't lose your whole $140, do you?
Ok so if in July the price of BAC goes to $20, he exercises the call option, he buys 100 shares at $17 and gets the ability to sell @ $20?
So $170 puchase, and a direct sell when worth $200, he made $30.
So he took $1.31 + commission and turned it into $30?
Can someone explain? And if you do this through an online broker, is there always someone out there willing to sell at the price you ask?
In July if the market price is $20 he makes $300. Here's how,
Excerise option to buy 100 shares @ $17....= $1,700
Turn around and sell 100 shares @$20........= $2,000
Profit $300( excl comms & any appl taxes)
1. So he only invested $1.31 + commission, and turned it into $300?
2. When he exercises it, will there always be someone to fill the order?
3. The turn around and sell, is this done automatically via an online broker? How does it work?
4. What if the price goes down to $15 a share, You don't exercise. Does it just become worthless? How much do you actually lose? $1.31 + commission or the full $140?
Thanks for your help!
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How does that work? The stock went from $80 to $100 (or up 25%) so his $8,000 investment turns into $72,000? 
