Introduction to Options: The Versatile Investment Tool
May 31, 2010
Introduction to Options
Easy to Understand, Risk-Reducing Investment Tools

Truthfully, you should not require a special introduction to options because they have been part of your daily lives for years.

Options have an undeserved reputation as complicated and risky investment products.

Here's the truth
Options are very easy to understand
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 option works.

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? 
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.
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.

Mark D Wolfinger
Partner and Director of Public Relations

Expiring Monthly: The Option Traders Journal