All good things must start somewhere and in stock options it begins with calls and puts. Stock options convey a right but not an obligation to buy or sell stock at a specified price and within a certain period of time. But creating stock options requires a method of buying and selling options contracts and that is where calls and puts enter the picture.
It takes two sides to create a transaction, so you can buy and sell calls and puts. A call is merely the right, but not the obligation, to buy stock at the specified price and within the specified period. The put is the right, but not the obligation, to sell the stock at a specified price before the contract expiration date.
The specified price is called the strike price. Options are merely contracts and not underlying assets. In other words, when you buy or sell stock options you are creating contracts but you are not buying or selling the stock itself.
Buying Calls
When buying calls, you are actually paying someone for the right to purchase the stock or underlying asset at the strike price. A long call is a term referring to the right to buy. You will make a profit on the call when the stock price increases.
Buying Puts
When buying puts, you are paying someone for the right to sell the stock or underlying asset at the strike price. A long put means there is a right to sell. Puts are bought when the stock price is expected to fall below the strike price before the options contract expires.
Selling Calls
When selling calls, you are giving a buyer the right buy stock at a specified price and by a set date. A short call is an obligation to sell the shares. If the stock price rises above strike price, you are then obligated to sell the stock to the person who paid you for the option. The maximum loss is technically infinite. The maximum profit is the premium.
Selling Puts
When selling puts, you are obligated to purchase the stock if the put buyer exercises the option. A short put means an obligation to buy. If the stock price falls below the strike price, you are obligated to buy the stock. The maximum loss is experienced if the stock goes to zero. The maximum profit is the premium.
Persons new to stock options trading have been known to sell a put when what they really meant to do was write a call. The stock option transaction only works if there are offsetting positions. If you write a new option rather than offset an option you can lose money twice!
Because of the possible mistakes that can be made when placing an order, you should not begin trading options until you are quite comfortable with the terminology. Trading stock options is not like trading stocks but newbies to this type of investing are sometimes tempted to interchange the terms stock options and stocks.
Filed under Option Trading Strategies by on Jan 28th, 2011. Comment. 
There are a number of stock option strategies that have been developed. The best approach is to learn the basic bull call spread and then learn more sophisticated strategies one by one.
Stock Options Strategies for the Conservative and the Daring
Stock options are like any other investment in that there are various strategies you can implement. The strategies cover the risk spectrum too ranging from the most conservative to the quite daring. In the final analysis, you will need to decide if you are going to be an investor who wants to hedge your investments in order to preserve gains or an investor ready to speculate and take on higher risk.
Of course, no matter what type of investor you are the goal for all investors is to make profits. This requires monitoring the market so that you can choose the strategy that best matches the market and thus increases your chances of making a profit.
Strategies are categorized into major groups such as vertical spreads, ratio spreads, delta spreads and credit spreads. Different strategies work for different types of markets. For example, the ratio spread is a good strategy for a market going sideways. On the other hand, a vertical spread, straddle or strangle strategy can be used to your advantage in either a bull or bear market.
Understanding the Variations of Strategies
Each group of strategies has a broad definition.
- Vertical spreads – buying and selling options at different strike prices and in different contract months with one option offsetting risk in other option
- Ratio spread – using an unequal number of short and long securities to offset risk, i.e. 2:1 ratio spread
- Delta spread – creating a neutral position by taking into account the deltas of the options; delta of option purchased is divided by delta of option written
- Credit spread – selling an option position that is close to the current market while buying an option position that is further from the market but in the same direction
There are also variations within the strategies – variations with the variations so to speak. In fact you will find a wealth of strategies and this is why stock options trading is one of the more sophisticated investment methods.
For example, vertical spreads include:
- Bull call spreads – One of the most common of the purchased spreads, it involves the buying of a call option at a lower strike price while selling a call option at a higher strike price.
- Bear put spreads – The opposite of the bull call spread, you are buying an option at or near to the money than the option that is shorted.
- Risk reversal spread – An aggressive spread strategy that combines a long option and a short option in a way that both benefit from the same directional movement of the underlying futures.
Other strategies you can implement include the ratio call spread, the ratio put spread, butterfly spread, the back spread, long and short strangles, long and short straddles and the condor spread.
One of the first things you need to do is learn the most basic investment strategy like the bull call spread and then learn about more advanced strategies one by one. A good place to start is simply by reading through the definitions provided by the Chicago Board Options Exchange at (http://www.cboe.com/learncenter/glossary.aspx#A).
Filed under Option Trading Strategies by on Jan 14th, 2011. Comment.
When the market is neutral to bullish on the underlying stock, the covered call is an options strategy that is used by investors. It is a classic strategy that is also called a Covered Buy Write or a Covered Call Write.
This common strategy refers to a situation where the investor writes a call option contract and at the same time owns an equivalent number of shares of the underlying stock. It is when the underlying asset is bought at the same time as the call contract is written that the strategy is called the Covered Buy Write or “buy-write.” When the investor already owns the stock and then buys call contracts then the strategy is called an “overwrite.”
Generate Monthly Income
This options strategy is used by many beginning investors because it is fairly simple. It is also a strategy used to generate additional income or a monthly income through the sale of call options against the stock. The intent is that the covered call provides some protection against a short term fall in the price of a stock.
The true income comes from the fact the investor is able to keep the premium generated from writing the call. The investor also owns the underlying stock and is still earning dividends. Of course, if the written call is exercised the shares will have to be sold.
The covered call is used when the stock price is expected to be stagnant but the investor still wants to make monthly income from the stock. The covered call is also a good options strategy when the stock price is expected to experience a small price dip.
Easy to Implement
The covered call is easy to implement. You would write 1 contract for out-of-the-money call options for the standard unit of 100 shares of the underlying stock. There are 3 ways the order can be placed.
You can write the out-of-the money call option at the same time you buy the stock. Another option is to buy the stock after the contracts have been written and you expect the stock to rise a bit in the near future. In that case the stock is bought to hedge against the increase in the stock price.
The third option is to write the options contract on stock you already own. This protects the stock that you expect to fall a bit in price in the near future.
The profit that is earned at expiration if assigned is equal to the premium plus the difference between the stock purchase price and the strike price. The profit that is earned if the expiration is not assigned is equal to the stock value increase plus the premium received.
The most profit that can be made is when is the price of the underlying stock is at least equal to or above the strike price of the call option. You can lose money if the price of the underlying shares falls as the written call options expire. You can lose the difference in the stock price between the price you bought it at and the price it falls to by the call’s expiration and you can lose the premium received when you sold the call.
Filed under Option Trading Strategies by on Jan 7th, 2011. Comment.