To go short on stock short selling is used which means you are selling something you technically don’t own. In other words, you “borrow” an asset from the broker, use them as the underlying asset in an options contract, and then return what you borrow at the time the option expires.
Keeping the Account Straight
If the option is exercised and it is necessary to produce stock short sellers will buy the asset or stock and clear the obligation to the broker. In options trading, a margin account refers to a broker account where you only deposit cash equal to a percentage of the value of the underlying asset. You are selling stock that is not fully covered by your account and that is where the borrowing comes into play. The broker is agreeing to hold securities equal to the amount you write an option on.
Covering the Position
The intention is that the stock short sellers use as the underlying asset can be purchased for less than the strike price in the options contract. The risk of loss lies in the fact that the stock price could rise above the strike price forcing the short seller to pay more for the stock than earned on the option. When buying the stock short sellers are said to be covering their positions.
Profit on the sale of stock short sellers receive is net of all transaction costs. Naturally the broker is not going to let you borrow an asset without charging a fee.
Filed under All About Options by on Jun 3rd, 2011. Comment. 
Stock and option trading has special value components that make up the premium. The premium is the determination of the option’s value and it is also the price at which the option was traded most recently.
You may think that stock and option trading bidders or traders bid on option contracts using the strike price. That is not true. A trader makes a bid on an option price and is actually bidding on the option premium. On the other side of the transaction, the trader makes an offer which is the premium price he or she is willing to sell the option at.
In stock option trading, when you bid on an option, you must have the amount of the premium in your trading account. At the end of each day, it is the premium value that is used to calculate account value for reporting your option position. This is an important concept to understand in stock and option trading because it is the foundation of the profit or loss calculation.
Intrinsic and Time Value of the Premium
Understanding what makes up the premium is very important to understanding what makes options tick. The stock and option trading premium has two major components.
Intrinsic Value
Intrinsic value applies to options that are in the money. In the money is a term that applies to options in which the price of the underlying asset is higher than the option strike price. Intrinsic value is the actual value related to the strike price and the futures price. This is the first value component in stock and option trading.
When a call option (right to buy or go long) has a strike price that is lower than the futures price, there is intrinsic value. For example, a stock has a futures market value of $20. An $18 call would mean there is $2 of intrinsic value in the premium.
A put option (right to sell or go short) has a strike price that is higher than the futures price. In another example, a stock with a futures market price of $20 and a $23 put then there is $3 intrinsic value.
Time Value
Time value, or risk value, is the extrinsic value of the stock option. It is the amount of premium that is above the intrinsic value. If the strike value equals the futures value, there is no intrinsic value so the entire premium is made up of time value only.
In other words, time value is the portion of the premium value that is related to the risk of selling the option. An option that is out of the money (futures price has not hit the strike price in direction of the option) or at the money does not have intrinsic value.
When stock and option trading, the longer the time left until the expiration date, the more risk there is of the market changing so time value is higher. The time value will decline the closer the option gets to the expiration date. This is referred to as time decay in stock and option trading.
In stock and option trading, the value of time and the concept of time decay are important to understand. Time value decay, as it concerns buying and selling options, is how you can measure the possible rate of premium loss.
Filed under All About Options by on Apr 2nd, 2011. Comment.
When you begin doing research on futures option trading, don’t be surprised when you read a warning that trading futures and options involves substantial risk of loss. The warning will go on to remind you that past performance is not indicative of future performance.
Isn’t that true for almost all investments? It certainly is true but those pursuing futures option trading do involve substantial risk because, like in any options trading, you are using leverage and more or less betting on future prices of commodities or securities. Betting is really not the right word though because you need to rely on your market research and knowledge before investing as opposed to taking a blind chance that prices will roll your way.
Defining Futures Options
Futures are legally binding contracts between two investors. One investor has agreed to buy an asset and the other investor has agreed to sell an asset. Both parties agree on the buy-sell price called the strike price. The futures option trading contract extends into the future with the specified date by which the buying and selling of the asset must take place is called the settlement date.
There are future markets in commodities, currencies, and financial securities. Financial securities include bonds, stock index futures, and treasury bills. There are also options on futures.
The options on futures can be confusing because you are not contracting for stocks or bonds. You are contracting for the right to buy or sell future contracts. Another way to state it is that you get the right, but not the obligation to buy or sell a futures contract and not the underlying asset.
Types of Options on Futures
Though the calculation of the margin requirements for futures option trading is different than it is for stocks, there are many concepts that are the same. For example, you can buy a call option which gives you the right to buy the underlying asset, the futures contract, at a certain price by the expiration date.
Or you can buy a put which gives you the right to sell the underlying asset, the futures contract, at the strike price by the expiration date.
There are more complex strategies that can be used also in futures option trading including spreads, strangles and straddles. You also must be familiar with terms like out of the money (strike price is greater than asset market price), at the money (strike price equals market price), delta (effect of change in price of underlying asset on option premium), and volatility.
The important point to know right away is that you need to understand the futures option trading contract before you risk futures option trading on those contracts. In other words, if you are going to trade futures contracts on stock index futures, you need to understand the rules of the stock indexes and the stock index futures.
Futures option trading is a highly sophisticated investment choice. Learn the basics of options trading first and then begin to move into the complex futures option trading once you are comfortable with the concepts.
Filed under All About Options by on Mar 11th, 2011. Comment.