You have to admit that some of the terminology in the financial world is interesting. There is the delta and theta for risk measurement; you can be in-the-money; or you can choose a bull call strategy. The first point that becomes crystal clear is that you need to learn the terminology before you can even begin to think of strategies.
When trading in options, there are different strategies that can be used to lower the amount of risk involved in the trading while increasing the opportunities for profits. Two of the strategies are called covered options call and bull call. Following is a brief review of these strategies that are used by investors.
Covered Call
The covered call refers to a situation where the option writer owns the underlying asset of the option contract. For example, if the option contract has stock as the underlier, the option writer could already own the stock in the contract or would buy the shares after the option contract is written. This is opposed to a naked call where the option writer does not own the underlying asset and would have to purchase it in the market if the option were exercised by a buyer.
In reality the option writer has three choices as far as asset ownership.
- Buy the asset and write the option at the same time
- Write the option on previously owned asset
- Convert a naked call into a covered call
The covered call is used when the stock price is not expected to move by much and you want to make some money on the premiums. The covered call is also used to defend against a drop in stock prices that is expected to last for a short time. The covered call is written out of the money so the most profit that can be earned is at the point where the strike price equals the market price. Beyond that point the option is in the money and the asset will be assigned and no further profits will be earned.
Bull Call Spread
The bull call spread is another options call strategy. This strategy utilizes the purchase of a call option that has a lower strike price, and at the same time, the writing of the sale of a call option that has a higher strike price. In both the purchase and sale, the same underlying asset is used and the same number of contracts is involved on both sides also.
The idea of the bull call spread is to create profit potential through the use of multiple strike prices. The bull call spread strategy also balances risk. The short call option risk is offset by the purchased call option. In other words, you have a long and a short position of the same underlying asset.
The bull call appeals to investors because of its ability to limit risk. On the other hand, the bull call will also limit profit potential because of the short call. You may have to sell when you don’t want to sell.
The covered call and the bull call are just two of the many strategies investors use to increase profit potential while managing risk. These two are presented to give you a taste of the exciting world of options trading. There are many others also to consider when investing in the options call.
Filed under All About Options by on Aug 24th, 2010. Comment. 
Put options are rights to sell an underlying asset of a contract. It may be a stock option or commodity option, but the principles are the same. When you buy a put option, you expect that the market price of the underlying stock or commodity is going to fall, so when trading options put strategies are important.
Puts are basically for bear markets. When you buy a put option with stocks as the underlying asset, for example, you have the right to sell 100 shares of the stock at a certain price called a strike price. The right must be exercised though within a certain period or by the exercise date. If the right is not exercised then the option simply expires. If a bear market exists though, there is a good chance you can make some money.
Buying a put is a good strategy if you believe the underlying stock price is going down. That is because you are able to make money when the price of the stock falls lower than the strike price before the expiration date. You do this by exercising your option to sell the stock at the higher price. This is the simplest explanation and there are a number of strategies that can be used that enhance trading opportunities. For example, puts play a role in spread strategies that involve both puts and calls.
Basically a put works like this: You buy a BBB Company January 40 put. This means you have a right to sell 100 shares of BBB Company stock at $40 a share. The market is falling and the stock price for the BBB company falls to $35 a share. Now the option is out of the money because the stock price is lower than the strike price. You now have a couple of choices. You can either sell a put option that has gone up in price. Or you can buy the stock in the marketplace at $35 and then exercise the option to sell the stock at $40.
The put gives you the right to sell the stock at the specified price which in this case was $40. If the market fooled you and stock prices went up and BBB Company stock rose over the strike price, then you would just let your option expire.
When you are buying options put strategies can reap profits or give you some insurance against a falling market. The put works the same way for stock options and options on futures contracts. One put strategy that has been successfully used involves buying out-of-the-money puts. Because the market price is further from the strike price, continued market falling can lead to bigger profits.
When an underlying asset price drops and you own a put option, there are several different strategies you can follow. For example, you could simply exercise the put option and take the profits. You can exercise the put option and then invest it in another out-of-money put. You can implement a spread strategy in order to build on your profit making ability. There are other possible strategies also.
When trading options put holders need to remember that puts are subject to time decay like call options. As the expiration date draws closer, the value of the put declines. It is these kinds of relationships that are so important to understand.
Filed under All About Options by on Aug 31st, 2010. Comment.