Options Basics &
Using Options as Stock Insurance
Background
- How I got interested in Options
- Motivation
- Disclaimers
- Not good at Stock Picking
- Have not traded options (yet)
Options
- Options are contracts
- Tradable like stock (have value apart from the underling)
- Optional for the buyer
- Obligatory for the seller (there are ways out)
- Contract terms (1w, 1m, 3m, 6m, 1y, 1y+)
- Can be exercised at any time
- Sold in 100 stock units
Terms
- The Underlying
- Optionable
- Premium
- Exercising (American vs European)
- Strike (At-the-money, In-the-money, Out-of-the-money)
- Bullish / Bearish
- Long / Short
- Covered / Naked
- Assignment
What is Stock
- Ownership of a share in profits
- Bullish Investment
- Risky (Can lose entire investment)
Option Types
Call & Puts
Buyers (long) & Sellers (short)
Calls
-
The right to buy stock (Call away)
-
Makes money when the stock price goes up
-
Typically a Bullish position
-
Mimics buying stocks (synthetic stock)
-
As a seller you must have the stock (covered) or a margin account
At-the-money call (40 Strike): $2
Puts
-
The right to sell stock
-
Makes money when the stock price goes down
-
Functions like insurance
-
Typically a Bearish position
-
Mimics shorting stocks
-
Sellers require a margin account
At-the-money put (40 Strike): $2
Functions like Shorting Stock without the risk
Question
What kind of options are company options?
(Calls or Puts)
Advanced Options Strategies
- Combine 2 or more options trades
- Make money any way a stock moves (up, down, stagnant)
- Common Strategies
- Spreads
- Condors
- Straddles
- Strangle
- Butterfly
Option Pricing Components
- Intrinsic Value (amount in-the-money)
- Time Value
Stock: $100
Option (110 Strike): $11
Intrinsic Value: $10
Time Value: $1
Problems with Stocks & Options
- Always expire worthless
- Overleveraging
- Possible to have unlimited loss
- Covered Calls effectively sort out winning stocks
- Can become worthless
- Impossible to time highs and lows
- Limit orders are vulnerable to price gaps
Options:
Stock:
The Solution: Married Puts
- Stock married to a Put Option (2 Leg investment)
- a.k.a Protective Put
- This create insurance on the stock price
- Far out expirations loose Time Value slowly
- Trade the option to capture gains (Rolling the Put)
- This strategy works in IRAs
- No margin account needed
Stock: $52 x 100 = $5200
Option (52 Strike): $4 x 100 = $400
Total Investment: $5600
At Risk: $400 (7.14%) at Expiration
More reasons to do this:
- Prevent loss of already winning stocks
- Lock in gains now and sell later (next year)
- Trade stock knowing maximum loss
- Potentially have a year to make sell desisions
1. "Rule No.1: Never lose money. Rule No.2: Never forget rule No.1" - Warren Buffet
Next Step
- Find Married Puts
- Find position adjustments
- Make the trade riskless
- Notifications
lets build the App!
Additional Strategies
- Sell Puts then Sell Calls
Options Basics
By Tim Santeford
Options Basics
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