You’ve probably heard people refer to options as a risky business, like gambling. It is true that options trading can be very risky, especially when they participate in with minimal knowledge and preparation. The stockbroker, media or financial planner does not have enough knowledge to guide choices in the use of options in its portfolio. But that does not mean that the options can not play a role in a conservative portfolio of stocks.
Most volume of options trading today stems from institutional money managers who use options to protect their clients’ portfolios of securities. They are using options as insurance. The options can also be used to increase the revenue that may result from a conservative portfolio.
Options written on stocks are called equity options and come in two forms: calls and puts. A call option gives the option holder the right to buy the underlying stock at the exercise price of the option at any time before maturity. A call option is similar to a discount store-pound bag of flour at an attractive price, but the coupon only good for 30 days and is limited to the purchase of a five-pound bag. Similarly, a call option gives the right to buy 100 shares at a specified price and is only good for a period of time.
Put options are opposite in character to the calls and they seem safer, a put option gives the holder the right to sell the underlying security at the exercise price of the option at any time before maturity. Listing Options are often purchased when an action is expected to decrease prices, or can be used as a form of insurance if you already own people, if my price declines in the values, my choice of shows and selling offsets Part or all of that loss. An excellent analogy is the homeowners insurance, if I pay my insurance premium 1 January and nothing happens to damage my house this year, my insurance expires without value, as my put option will expire worthless if my action only continues to appreciate. But if a hurricane damage from my house during the year, my insurance pays part or all of the repairs. Similarly, if my price declines in the values, my put option will increase in value, the replacement of some or all of the loss of my wallet.
Stock options expire on Saturday following the third Friday of each month. It is common to hear or read that equity options expiring on the third Friday. While not technically correct, it is true that Friday is the last chance to trade in those options. Saturday deadline was established to the Options Clearing Corporation and the time to pay brokerage accounts of their clients before the options technically (legally) loses its value.
Consider Hewlett Packard (ticker symbol: HPQ) as an example. HPQ closed May 28, 2009 at $ 34.70, June option of $ 35 is trading at $ 1.00 at closing. In the prices of options on a site like Yahoo Finance, you will see bids and offers posted. The sale price is the quoted price, if I want to buy the option, while the bid price is what you would pay to sell my choice. The options are listed by the underlying shares, but sold as 100 lots contracts covering part of the action. HPQ June $ 35 calls are trading at a sale price of $ 1.00. Each contract is priced at $ 1.00 per share of the underlying shares, because each contract covers 100 shares, the contract is $ 100 and five contracts would cost $ 500. I have the right to exercise the options at any time prior to cease trading on Friday, June 19th and you buy 500 shares of Hewlett Packard shares at $ 35 per share or $ 10,500. OI could just sell my stock options in the offer price at any time before maturity.
The options can be used in several ways a very conservative portfolio. For example, if I own 300 shares of Hewlett Packard (HPQ), but I worry that this market is softening and may take another fall down, I could buy three contracts for June $ 35 puts at $ 1.40 to protect my position. This position put $ 420 it cost me and protects me through June 19. HPQ As price falls; the increase is in the price, to offset some or all of my loss in the stock. This is called “married put” position. However, there is no free lunch in the market, if HPQ trade sideways or up, I will lose my $ 420 of “insurance premium”.
Another conservative use of options is “covered call” strategy. If we continue with our example of HPQ and I think the people are going to trade sideways or slightly over the next few weeks, I could sell three contracts in June $ 35 calls for $ 1.00, so $ 300 in my account. If HPQ is trading unchanged at $ 34.70 on June 19, the $ 35 call options expire worthless, and I have taken $ 300 or 2.9%. But if the operations HPQ upwards of $ 35, my maximum profit is limited to $ 330, or 3.7%.
Trading options can be very risky when used in a speculative, but options can also be used conservatively, with a portfolio of shares, which protects the floor and also increase the income of the portfolio.
