What are Options?
Do you know what options are? You buy and sell options as a way to take advantage of stocks that are trading on the stock market. You don't actually own the stock. That might sound confusing but as you learn how to trade options online, you'll see how it works.Option Attributes
Here are some of the attributes related to options:- You can buy and sell options.
- Options are traded in terms of contracts.
- One contract represents 100 shares of stocks.
- You must trade options in contracts.
- You can NOT trade less than one contract.
- Options can be mixed together that make up different trading techniques.
- Options are traded on the CBOE.
- Options begin trading 30 minutes after the market opens.
- Options end trading 30 minutes before the market closes.
- Options are a wasting asset. In other words, when you trade options, there will be a date in the future they expire worthless.
- Options expire every 3rd Friday of the month. That doesn't mean your option expires every month you trade in. You select the date when your options expire.
Let’s walk thru two types of options to get a feel for what they are.
Calls and Puts
Remember I talked about trading options in terms of contracts? One option contract equals 100 shares of stock. So when you buy or sell one option contract, that contract represents 100 shares of stock.I also mentioned that you can use options to take advantage of stocks and you don’t have to actually own the stock. With options you can do that through what are called Calls and Puts.
What is a Call Option?
A call option can be bought or sold. When you trade options online, the simplest example is buying one call option that represents 100 shares of a stock.The mindset you are typically in when buying a call option is, you think a stock will go up over a period of time. When you buy a call option and the stock that represents that call option goes up, the value of your call option will typically go up.
When stocks move up it is also referred to a bullish position because bulls represent the market is going up or that particular stock is moving up. So you’ll hear that term in the context of “investors are bullish today” signifying that investors are buying stocks.
Call Option Example One
For this example, we’ll use the website BigCharts. Well use the stock symbol HES for Hess Corporation, a leading global independent energy company. Let’s take a look at the charts for the stock symbol HES from the BigCharts website.
Click image for larger view
To get the chart above, enter the stock symbol HES and press enter or click on the Basic Chart button. The default view is a one year chart.
In the center of the page, above the chart, there is a link called options chain, click on that and you’ll be presented with the options chain page as seen below.
Click image for larger view
The above image is the options chain for the stock symbol HES for January 2010. The data on this page reflects the stock market close as of Friday, December 18, 2009.
There’s a lot on this page and I’ll touch upon a few of the columns of data. When you trade options online, there are some options definitions you need to know about.
Options Definitions
Now that we’ve seen some of the details of call options, we need to talk about some definitions related to both call and put options.1. Expiration – I talked earlier in this article about options being a wasting asset. They are wasting away because options have an expiration date.
In the above chart, the data in the list also reflects the third Friday in January 2010, the expiration date, January 15th, 2010 to be exact. On that date the January options expire and are worth nothing.
Now, you could buy a January call option but you would only have a few weeks to make money. That’s pretty aggressive and risky for some people. You’re betting that if you buy a call option now that it will go up so you can make money before the third Friday in January 2010.
On the other hand you could have bought an option call that expires in January 2010 more than a month ago – two months, 3 months, a year, etc. We’ll get into long term options in another article.
2. Strike Price – If you buy a call option on HES for January 2010, you have to pick a strike price. What’s that?
For our example, the Strike Price is what you think the price of the HES stock will be at sometime on or before the third Friday of January, 2010.
So let’s make a decision to buy one HES call option for January 2010 and we want to buy it using the strike price of $60.00 a share. So we go to the list on the HES calls and puts page of BigCharts.com (shown above) and look at the strike price column for January 2010 $60.00.
Here’s what we’ve got from the screenshot below.
The Symbol of the Jan 2010 60s is IGGAL. Options have their own symbol that represent each option.
The last option was sold for $1.09 as you can see from the Last column.
The Change column tells us the value of the option went up $0.34 cents for the day.
The Volume column (Vol) tells us there was 1,303.00 calls traded for the day on HES.
The Bid column tells us the last bid that someone was willing to pay for the option.
The Ask column is the column that a buyer was asking to pay for the option.
The Open Interest column (Open Int.) is the number of open contracts for an option. This can be an indicator for the amount of interest that traders have in this option. And in our case, 14,898.00 is a lot.
Tip: By the way, when you’re trading options online, you’ll want to make sure there are at least a few hundred under the Open Interest column. If you trade an option with any thing less, it could be harder when it comes time to sell an option.
What’s it All Mean?
With everything we’ve learned so far, here’s what the above means:- We’re going to buy one contract for the Jan 2010 HES 60s and
- we’re going to pay about $1.00 for that contract based on the bid column price.
However, remember that one contract represents 100 shares of HES stock, so we have to take 100 shares x (times) $1.00 which means this trade will cost us $100.00 take get in.
Now, you also have to pay for a transaction fee. We’ll say for this example that to get into the trade the fee will be $10.00. So our total outlay for this trade is $110.00.
The Call Buyer’s Mindset
And the mindset is that we think the stock will rise sometime between now (December 21, 2009) and January 15, 2010 high enough that our call option that we just bought will also go up.Because we paid $10.00 for the transaction fee, we want it to go up at least that fee plus the fee for closing the trade which will most likely be another $10.00. So we’re in this for at least $20.00.
That is pretty aggressive and risky. But this is just an example. If there was some news or compelling reason the stock would rise that much it might work. But again, there would have to be some research that tells us or gives us a reason that the stock would actually go up that much between now and the third Friday of January 2010.
Another mindset perspective here is we are now “controlling” 100 shares of HES. We don’t own the shares but we are controlling them. So if you were to buy 100 shares of HES, you would have to put out 100 x $57.61 or $5,761.00.
That’s a lot of money. So, to take advantage of the stock HES we bought one call option for $110.00. Not a bad deal. So in the worst case scenario, if the stock goes down to $0.00, we only lose $110.00 and not $5,761.00 plus transaction fees. See the difference?
But, we only own the call option for a short period of time and if you owned the stock you’d own it for a long period of time. That is the difference. The stock could possibly come back sometime. However, the call, would be gone forever. But, there are trades you can make with options from hedging your losses. That’s for another article.
I think that’s it for this article. This is one way to trade options online and make money.
Put Options
Now, to get you thinking, imagine the above example (call option) in reverse. That is called a Put Option. The Put Option is where you think the stock is going down. So you would buy a put option, which would actually make YOU money as the stock goes down.Options are great. You can actually make money as the stock and stock market go down. We’ll save Put Options for another time.
We’ll also talk about more definitions and answer those questions that are probably swirling around in your head.
I’ll leave you with this – at some time, you have to decide how much you want to make per trade. To help you set that bar, there is an old saying, “Pigs get fat and hogs get slaughtered.” You want to a pig and not a hog. ;)
