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Log for Options Study

Options

Securities that gives owner right to buy underlying asset at a specific Strike Price by specified Expiration Date. Price you pay to own the option is called Option Premium. Sounds familiar!! Yeah…it does sound like insurance premium (but it is not the same).

There are only two type of option:

  • Call Options: Gives holder right to buy (go long) an underlying asset at specific price by specified time.
  • Put Options: Gives holder right to sell (go short) an underlying asset at specific price by specified time.

Traders buy combination of Call and put options to form option strategies to profit from.

Note:

Options for stocks are mostly traded in multiples of 100.

Options holders have right to exercise the option, but not obligated to do so. The cost of not doing so is the option premium.

Option writers are the  obligated to deliver the underlying asset (sell or buy), when option holder decides to exercise valid option.

Lets do some math:

Let create a Profit/(Loss chart) for a stock “βθ”, when you purchased its options.

[table id=1 /]

In effect at time of exercise we will pocket a total profit of cool: 1500+600-300-200 = $1600.

NOTE:

  • This calculation doesn’t include brokerage fee.
  • Options are mostly traded for premium and not exercised.

LEAPS (Long Term Equity Anticipation Securities)

Basically long term options, which expire upto three years from issue date.

Option Strategies:

1. Protective Puts

This strategy is same as buying insurance. If owner of a share is concerned that price of an asset may fall, he/she can buy the same number of puts as asset held by paying the premium. Now if  price does go down, puts can gain in value providing the value conservation.

2. Selling a cover Call:

When you own a stock and want to sell the Option for that stock, you simply sell covered call. This means that you are obligated to sell the stock, when buyer of the call options decides to exercise it.

You profit from this when:

  • You think that stock price is not going to go beyond the strike price.
  • You sell the “Calls” and pocket the premium and when share price stays below the strike price the call becomes worthless.

NOTE:

“Covered” mean you own the underlying asset. Your risk is limited to the delivery of underlying assets.

Similarly, Selling an uncovered call means that you d0’nt own the underlying asset.  The risk is you may need to buy the underlying asset and deliver it.

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