Introduction to Options: The Versatile Investment Tool
|May 31, 2010
Introduction to Options
Truthfully, you should not require a special introduction to options
because they have been part of your daily lives for years.
Easy to Understand, Risk-Reducing Investment Tools
Options have an undeserved reputation as complicated and risky
Here's the truth
Options are very easy to understand
There are two types of options: calls and puts. As noted above
the call option give its owner the right to buy 100 shares at the
strike price. The put option gives its owner the right to sell 100
shares at the strike price.
a) Have you ever tried to buy a sale item at a
grocery or retail store - only to discover that the item was sold out?
If you received a rain check from that store, then you know how a call
Risky? The only thing that is risky about options occurs when an
investor decides to make a high risk play with options. Options were
designed as risk-reducing investment tools. If you choose to use them
that way, then they are the opposite of risky.
It really is that simple. When you received that rain check, you were
given the opportunity to return to the store to buy the same item that
was on sale - at that special sale price - for a limited time.
Well, that's a call option. The difference? You must buy call
options. No one is going to give away those options.
A call option gives its owner the right (you don't have to take
advantage of that right. You may throw it in the trash) to buy 100
shares of a specific stock at that 'special price' (it's call the
strike price) for a limited time. Options have an expiration date,
after which the option is void.
b) Have you ever made a claim on an insurance policy? That policy is
very similar to a put option. If your insured item is lost, stolen, or
destroyed, you get to sell that item to the insurance company at a
predetermined price. That price is stated in your policy.
A put option works the same. If your stock is hurt or destroyed
(trading at below a certain price - the strike price) you have the
right to sell that stock to someone else. By paying the premium, your
insurance policy is in effect. By paying the option price (also called
the premium) you get the same rights as the owner of an insurance
policy. You can force someone else to buy your stock.
How is that risky? Is is too difficult?
Mark D Wolfinger
Partner and Director of Public Relations
Expiring Monthly: The Option Traders Journal