An option is a right but not an obligation to buy or sell an underlying asset class at a specified strike-price, and the right of which can be bought or sold either on an exchange (exchange-traded) or in the over-the-counter (OTC) markets (off-exchange). The owner of an option contract can exercise this right to buy or sell, up until expiration of the contract at which point the option expires worthless if not exercised.
Although the share of forex options trading overall doesn’t dominate the majority of FX market volumes, it still represents a meaningful share of trading and thus can be a viable instrument and method to consider when investing or trading foreign exchange. Just like options on nearly any financial instrument, in foreign exchange, call options involve the right to buy – and put options convey the right to sell -an underlying instrument at a specified exchange rate, and premiums are paid by buyers and earned by sellers when carrying out forex options trading.
Options contract are typically for a pre-determined quantity of an underlying asset, and will vary depending on the contract specifications of the broker or exchange operator, as well as the specific instrument being traded, such as an underlying currency pair. Options are divided into Puts and Calls, whereas a “Call” is the right to buy an underlying asset at a specified strike-price, and where a “Put” is the right to sell an underlying asset at a specified strike-price. However, Buying or Selling either of these option types can have very different consequences.
Moreover, each option contract conveys a quantity of the underlying asset that will be traded if the contract is exercised by the party that has the right to exercise their option. In the event the buyer of this option exercised the contract, the seller would technically need to deliver the underlying EUROS in exchange for the US Dollars the seller was paying to purchase the 100,000 Euros at the underlying strike price. If you were to exercise your put option after earnings, you invoke your right to sell 100 shares of XYZ stock at $40 each.
The written put option is covered if the put option writer is also short the obligated quantity of the underlying security.
The short put is naked if the put option writer did not short the obligated quantity of the underlying security when the put option is sold. For the patient investor who is bullish on a particular company for the long haul, writing naked puts can also be a great strategy to acquire stocks at a discount.
A Call Option is security that gives the owner the right to buy 100 shares of a stock or an index at a certain price by a certain date. A call option is called a "call" because the owner has the right to "call the stock away" from the seller. The most attractive characteristic of owning call options is that your profit is technically unlimited. Since owning options is always cheaper than owning the stock itself, when you KNOW a stock price is about to move up it is ALWAYS more profitable to own calls on the stock than it is to own the stock itself! Since call options give the owner the right to buy a stock at a fixed price, owning calls allows you to lock in a maximum purchase price for a stock. Calls trade on an exchange (The Chicago Board of Options Exchange--CBOE), just like stocks do.
That sounds great, but watch how buying a call option on YHOO would have given you a 400% return (instead of the 25% return from buying the stock!
Continuing further from our previous article Bear Put Spread: Example with Payoff Charts Explained, here is part II of the same. So, we were having the BLUE graph which was the net Payoff Function for the Bear Put Spread but without the price of Put options being taken into consideration. The Bear Put Spread is profitable only when the underlying stock or index price goes down i.e. A Long Put Butterfly Spread Option Position is traded when the option trader has a neutral view on the price movement of the underlying stock or index - i.e. The Long Put Butterfly Spread Option trading is profitable to the trader when the underlying stock price does not move much in either direction and stays close the middle ATM strike price (see below). An option is a standardized contract providing for the right - but not the obligation - to buy or sell an underlying financial instrument. In exchange for the right to buy ("call") or sell ("put") an underlying security on or before the expiration date, the purchaser of an option pays a premium.
The strike price, or exercise price, of an option determines whether that contract is in the money, at the money, or out of the money.
Intrinsic value describes the amount the stock price is above the strike price (for calls), or below the strike price (for puts). If the stock were at 500 when you bought a 510 call, the option is again all time value, since it has to rise $10 to be in the money. Again using Google for an example, the GOOG December 500 call option gives you the right to buy 100 shares of GOOG for $500 per share up until the expiration date in December. Let's say you purchased the GOOG 500 call option for $25 when the stock was trading for $500. The flip side is that if the stock does not move up, then the option will lose all of its value by expiration. In this case, let's say you were concerned about the downside, so you purchased the GOOG 500 put option for $25 when GOOG the stock was trading for $500. Selling the put - Once a put is bought it can be sold at any time, and this is the most common way of exiting a long position. Letting it expire - If a put gets all the way to expiration, it will expire, worthless if it is out of the money (when the stock price is above the strike price - See Options Pricing). Regardless of whether you are buying calls or puts, there are some general rules to follow. Two, options should generally be bought when the time value - primarily influenced by a factor known as implied volatility, or the expected price swings of the underlying - is expected to stay flat or to rise. Finally, when you buy an option, generally you will want to sell it, ideally for a still-greater premium. By way of explanation, let's say you sold the GOOG 500 call option for $25 when GOOG was trading for $500. Letting it expire -If the option gets all the way to expiration, it will expire, worthless if it is out of the money. Assignment - American-style options (all equity and ETF options) can be exercised at any time before expiration. Selling options is best done when implied volatilities, and therefore option premiums, are high and expected to fall. Since we already know that time decay is greatest in the last 30 to 45 days, this is typically the best time to sell options.
Example: Apple (AAPL) is trading for 175, a price you like, and you sell an at-the-money put for $9. Example: You own 100 shares of AAPL at 190 and want to protect your position, so you buy a 175 put for $1. The process in which the buyer of an option takes, or makes, delivery of the underlying contract.
The process by which the seller of an option is notified that the contract has been exercised. In consideration of your time, we'll send the first two chapters of Jon and Pete's latest book, How We Trade Options. The maximum profit possible in a Long Put Option Position is when the underlying stock price goes to Zero i.e. The maximum loss possible in Long Put Option Position is complete loss of option premium or price you pay to buy the put option. In the above example, if the price of underlyng micrsoft stays above $30, the Put option cannot be exercised.
However, one more important thing that you need to consider is the brokerage you pay for trading options contracts. CommissionsFor ease of understanding, the calculations depicted in the above examples did not take into account commission charges as they are relatively small amounts (typically around $10 to $20) and varies across option brokerages.However, for active traders, commissions can eat up a sizable portion of their profits in the long run.
All the options trader across the globe know that one of the simplest and most effective option combination is the Long Straddle Option Trading Strategy.
A Long Straddle Option Position is a net BUY (also called net LONG) option position where the option trader purchases 2 options - 1 ATM Call and 1 ATM Put Option. Also note that usually since the ATM call & put are bought, which are known to have the highest time decay value, the net price to be paid is usually high. Hence, the above case for GE makes it an ideal scenario for an option trader to get into a Long Straddle Option position. A Long Straddle Option Trading position can be constructed or configured by simply buying the SAME strike, SAME expiry Call & Put Options on the same underlying stock or index. In addition, as will be revealed below, sellers of options, known as writing options, carries its own set of differences when compared to buying options, and understanding currency trading options can be a valuable tool in a forex trader’s portfolio.
The way that such measurements are made depends also on what type of option position is being taken, whether a Call is being bought or sold, or whether a Put is being bought or sold, as will be described below. For example, buying a call gives the buyer the right to buy at the underlying strike-price of the option, whereas selling a call requires that the seller must be able to deliver the underlying asset and sell it to the buyer at the underlying strike-price if the buyer decides to exercise their option prior to expiration.
The put option writer is paid a premium for taking on the risk associated with the obligation. When the options trader is bearish on particular security, he can purchase put options to profit from a slide in asset price.
A put option contract with a strike price of $40 expiring in a month's time is being priced at $2. With this crash in the underlying stock price, your put buying strategy will result in a profit of $800. See our long put strategy article for a more detailed explanation as well as formulae for calculating maximum profit, maximum loss and breakeven points. Put option writers, also known as sellers, sell put options with the hope that they expire worthless so that they can pocket the premiums. The covered put writing strategy is employed when the investor is bearish on the underlying. Put spreads limit the option trader's maximum loss at the expense of capping his potential profit at the same time. This shows that Microsoft (MSFT) is at $25.81 and that the April options expire on April 16, 2011 and that the strike prices for the call and put range from at least $23 to $28 and are at every dollar in between. It is a maximum purchase price because if the market price is lower than your strike price, then you would buy the stock at the lower market price and not at the higher exercise price of your option.
Like all securities, all calls and puts have a unique ticker symbol and their prices are determined by the market's buyers and sellers. And as explained in the last part, we considered the prices as follows: the ITM Long Put Option will cost you $5 and OTM short Put Option position will get you $2. There are 2 LONG PUT and 2 SHORT PUTS required for this Long Put Butterfly Spread Option trading. If the strike price of a call option is less than the current market price of the underlying security, the call is said to be in the money because the holder of the call has the right to buy the stock at a price which is less than the price he would have to pay to buy the stock in the market. If GOOG were trading at $500 when you bought a 490 strike call option for $25, then $10 of the option's value would be intrinsic value.
You would do this with the expectation that the price of the option will rise, usually through the rise in the price of the underlying stock. This is the most common way of exiting a long position, and the only way of exiting a long call that captures any remaining time value in the option. Puts give the buyer the right to sell a specific number of shares (usually 100) of an underlying stock at the strike price until the expiration date. This is the only way of exiting a long position that captures any remaining time value in the option. One, the expiration should give the option enough time to perform without being overexposed to time decay. Buying options is a limited-risk strategy, and all of that risk lies in the premium paid for the option. When option premiums are high (that is, when implied volatility is high), some traders turn to selling options.
Here we the ideal is to have the options expire worthless, and we are not interested in buying back the options we have sold unless necessary.
INTC moves up to $28 and so your option gains at least $2 in value, giving you a 200% gain versus a 12% increase in the stock. Option chains show data for a given underlying's different strike prices and expiration months.
This information neither is, nor should be construed, as an offer, or a solicitation of an offer, to buy or sell securities by OptionsHouse.
Payoff Charts Explained and discuss the limited profit limited loss potential for a Long Put Option Position.
FinanceCharacteristics of a Long Put OptionAnother popular option trade with retail investors is buying a straight put option. Long Straddle is one of the most popular and heavily traded option combination and works best with a long time to expiry when the option trader is expecting a big move in the underlying stock or index price. Since there are 2 buys, it is a net debit position which means that the option trader has to pay premium (net outflow) while getting into the trade.
The price of the asset must move significantly below the strike price of the put options before the option expiration date for this strategy to be profitable. In other words, the owner of the option (also known as "long a call") does not have to exercise the option and buy the stock--if buying the stock at the strike price is unprofitable, the owner of the call can just let the option expire worthless.
It is called "a call option" because it allows you to "call" the stock away from somebody (ie, buy it).
In this article, we will discuss the same Long Butterfly Spread but now constructed with the Put options - Long Put Butterfly Spread Options Position and how that can be traded. Likewise, if a put option has a strike price that is greater than the current market price of the underlying security, it is also said to be in the money because the holder of this put has the right to sell the stock at a price which is greater than the price he would receive in the market.
Therefore an at-the money or out-of-the-money option has no intrinsic value and only time value. This gives you a 100 percent return on the call option based on a 10 percent return on the stock. Long calls are almost always sold before expiring, since at that point they will have lost all time value. Long options are almost always sold before expiring, as at that point they will have lost all time value. Since options have an expiration date, a large part of their value is time value (for more, see our lesson on Options Pricing). All else equal, if there is a rise in implied volatility, then there will be a rise in the option premiums.
It is also the reason that selling calls is considered the options strategy with the highest risk. Another way to buy stock for less than the current market price is an options strategy called cash-secured puts.
Traders sell puts if they think the stock is going to stay flat or go up slightly, but only if they are willing to buy the stock if assigned. For instance, if you sold a call, the stock went up through your strike, and you do not want to be assigned and forced to sell the stock, you could buy back the option to close the position.
If it is in the money by $.01, it will be automatically exercised and you will be assigned, automatically selling stock if you were short a call or buying stock if you were short a put. It is important to remember, however, that selling options involves considerable risk, and high implied volatility can always go higher. If the stock is still at 34 at expiration, the option will expire worthless, and you made a 3% return on your holdings in a flat market. This should not be considered a solicitation to open an OptionsHouse account or to trade with OptionsHouse. OptionsHouse does not offer or provide any investment advice or opinion regarding the nature, potential, value, suitability or profitability of any particular investment or investment strategy, and you shall be fully responsible for any investment decisions you make, and such decisions will be based solely on your evaluation of your financial circumstances, investment objectives, risk tolerance, and liquidity needs.
Since each put option contract covers 100 shares, the total amount you will receive from the exercise is $1000. This diagram shows the payoff for owning call options with a strike price of $40 and a cost of $2. Long Butterfly Spread offers the options trader a limited risk limited profit potential and is considered to a direction neutral strategy - which means traders should get into this Long Put Butterfly Spread Option trading when they dont expect the underlying stock or index to move much and remain confined to a limited price range. The higher the implied volatility, the more expectation that the underlying stock will make big moves, increasing the option's chances of being in the money.
This time value will deteriorate as that expiration approaches; time decay increases exponentially in the last 30 to 45 days of an options life, so this is usually not the time to own options. This increase can produce profits for long options, even if the stock price doesn't move, because the chance of movement has increased. If a call buyer decides to exercise the long call, that exercise is put out randomly to a seller -any seller - of that call, and the individual is obligated to sell stock to the call buyer. For this reason, selling puts can be an excellent way to initiate long stock positions, and get paid to do so. If you are using cash-secured puts to acquire stock, then assignment means you have achieved your objective at a below-market price. 2) Time to expiration: this is the time remaining on the option before which you have the right to exercise the put.
As you had paid $200 to purchase this put option, your net profit for the entire trade is $800. You will notice that if the stock price closes at or below $40, you lose the $200 ($2 price times 100 shares) cost of buying the option (note the horizontal line intersecting the y-axis at -$200). If the strike price equals the current market price, the option is said to be at the money. This also makes them a way to protect positions as insurance (see the lesson on Protective Puts). Conversely, if you buy options when implied volatility and premiums are high, such as before earnings, then the stock can move in the direction that you want and you can still lose money, because with the news out, the implied volatility could fall. At expiration, if the price of the stock is lower than the strike price of the options (Option is said to be In-the-money), then there are two choices an investor can make: a) Sell the option with the profit equivalent to the intrinsic value of the option (Strike price-Stock Price), or b) Let the option be exercised and have the stock sold at the pre-defined strike price. This is a neutral to bullish strategy which can be used to generate income, or to enter long stock positions.
Your profit in both instances will be same but the tax treatment will be different on the put sale compared to the short position you will have in the other instance.
Finally, notice that the up sloping line become profitable at $42, which is the strike price of $40 plus the $2 cost of buying the option. Theoretically the stock price can go to infinity so that is why they say the earnings from owning a call option are unlimited.
It is for largely that reason that most retail options traders underestimate the challenge of making money with options. The rule of thumb is that for a purchase of a put option (long put), the farther out the expiration date the higher the cost of the option and the lesser the decay on the option. Buy long out-of-the money puts only when there is a high probability of a move towards the option strike price prior to expiration.
In this case you could purchase a December expiration put option with strike $21 for $1.31 ($131 outlay per contract). The $1.31 is all extrinsic value on the option, as the stock is still trading above the strike price.
As the stock moves towards $21, the option should gain value as long as the move happens before there is substantial time decay on the option. If the stock falls under $21, the option will then have extrinsic value and intrinsic value. Suppose by December expiration BBY is trading at $18; then the option you purchased will be worth $3 (21-18), of intrinsic value.
If BBY remains above $21 prior to December expiration, then the entire $131 premium for the option is lost as the option expires worthless.
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