No lack of OPTIONS

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PebbleTrader
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Postby PebbleTrader » Fri Feb 22, 2013 11:55 pm

- Outcome. Let's examine a few scenarios to see how this trade
might work out:

1. At expiration, ZYX is at $71. Your stock is called away for
$70. You have made $2 per share for the call that you sold,
and the stock is being sold for $3 more than the $67 it was
worth when you sold the option. Thus, you have a $500 gain
since the time that you initiated the option trade.
Things look a little different if ZYX is $74 at expiration.
Your stock will still be taken away at $70, and you have
exactly the same $500 gain that you had when ZYX closed
at $71. But in this case, you could have made $700 on the
stock if you had not sold the option. Of course, that $700
gain is unrealized unless you actually sell the stock at $74.
One benefit of the covered call trade is that it forces some
discipline upon you to take a profit and get rid of a stock
that possibly has little upside left in it.

2. If ZYX is slightly above $70 as expiration nears, you might
decide that you do not want to part with your stock. Then
you must buy back the short call. If ZYX is hovering around
$71 on the expiration day, you can probably buy back the
call option for a bit more than $1 a share (even at expiration
it will cost you a little more than its intrinsic value). This
gives you a profit of the difference between the $2 that you
took in from the sale of the call less your approximate cost of
$1 from buying it back. Now you get to keep your stock, but
if its price soon begins to fall, you may regret the decision to
keep it.

3. If ZYX is only $69 at expiration, the call that you sold
expires worthless. You already have the $2 from selling the
option, and you also retain your stock. The cost basis for
your stock has been lowered by $2 per share. Now you can
repeat the process in the next month. If you were able to
continue bringing in $200 every month with this covered call
strategy, that represents a 36 percent annual return on a
$67 stock that does not even need to go up in price. If the
stock goes up gradually and each month you can sell a call at
a higher strike price, things are even better.

4. Suppose that ZYX has pulled back to $64 at expiration. Now
your stock has lost $3 per share from the time that you sold
the call. This unpleasant situation is somewhat relieved by
the $2 per share received for the call that you sold. In this
case, your net loss is only $1 per share.
Life is just a journey

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Postby PebbleTrader » Fri Feb 22, 2013 11:56 pm

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Life is just a journey

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Postby PebbleTrader » Fri Feb 22, 2013 11:57 pm

The Put Option

The buyer (owner) of a put option has the right to sell 100 shares of
stock at the strike price designated in the contract. This right to sell can
be exercised anytime before the contract expires. Typically, the time
frame of the option extends through the third Friday of the expiration
month stipulated in the contract.

The seller (writer) of a put option has the obligation to buy 100 shares
of stock at the strike price, if so requested by the owner of the option.
This obligation to purchase the stock may be required at any time
before the contract expires. As a practical matter, the stock is never
"put" to seller if the stock price is above the strike price. Even if the
stock price is below the strike price, the put assignment typically does
not happen until near the expiration date.
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Postby PebbleTrader » Fri Feb 22, 2013 11:59 pm

BUYING A PUT OPTION

The motivation to buy a put option could be based on your expectation
that the price of XYZ stock will soon fall from its current level. Let's set
up a possible trade, clarify its risk, and examine some possible outcomes
resulting from the trade:

- Trade. In early February, with XYZ trading at $39, you decide
to buy one put contract to benefit from the expected fall in the
stock price. Because you expect XYZ to decline following an
earnings report in early March, you choose a March option.
You also decide on a strike price of $40. Let's say this put
option costs $3 per share. Because the option covers 100 shares
of stock, this means that you pay $300 to become the owner of
this particular put contract. You are now "long one XYZ Mar 40
put." This gives you the right to sell 100 shares of XYZ stock at
$40 per share anytime before the close of trading on the third
Friday of March. This right to sell at $40 per share is a slight
improvement over its current price of $39; however, that gain
of $1 per share is offset by the $3 per share paid for the option.
Why have you paid $3 for something that has an intrinsic value
of only $1? Again, "time is money" and you have paid an extra
$2 per share of time value in order to play XYZ for a downward
move until the put expires in March.

- Risk. Your risk on this trade is limited to the $300 paid for one
put contract.
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Postby PebbleTrader » Sat Feb 23, 2013 12:01 am

- Outcome. Let's examine a few scenarios to see how this trade
might work out:

1. The earnings report for XYZ is indeed weak and the stock
sinks to $34. Now your right to sell XYZ at $40 per share
looks good. Does it matter that you do not own any XYZ
stock to sell? No, because if you are ready to take your profit,
all you need do is sell the option. The option you bought for
$3 is likely to now be worth $7. So, the contract for which
you paid $300 can now be sold for $700, giving you a nice
$400 profit. That represents a 133 percent profit on the
option, whereas the stock dropped only about 13 percent.
Why is the option worth $7 when its intrinsic value is only
$6 (40 ? 34 = 6)? As said before, time is money, and the
person who buys your put option for $7 is paying an extra
$1 per share over its intrinsic value in hopes that XYZ will go
even lower before the March expiration.

Let?s see why selling the option is better than exercising it. To
assign the option, you would first need to buy the stock at
$34 per share and then exercise your right to have someone
buy the stock at $40 per share. Your gain would be $600 on
the stock less the $300 you paid for the option, giving a net
profit of only $300. So, exercising the option yields a
100 percent profit as compared with the 133 percent profit
received from selling the option.

2. In contrast to the happy Scenario 1, let's see what happens in
the case when the price of XYZ stock is still at $39 when the
March options expiration date arrives. The earnings report
failed to negatively impact the stock price and you have
stubbornly refused to accept that outcome until the end.
Then you would have seen the value of your option shrink
from $3 down to its intrinsic value of $1. You could then sell
the option for $100, which represents a $200 loss based on
the $300 paid for the option.
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Postby PebbleTrader » Sat Feb 23, 2013 12:05 am

SELLING A PUT OPTION

Suppose that you shorted 100 shares of ZYX stock when it was $65 a
share. It has fallen to $62 in early February, but seems to be stalled at
that price level. You do have a $300 profit, but your original goal was to
ride this stock down to $60 for a profit of $500. This could be the
motivation for selling a put option. Selling a put would immediately bring
some cash into your brokerage account, and if ultimately you are
required to close your short position at $60 per share, that is an additional
gain. Let's set up a possible trade, clarify its risk, and examine
some possible outcomes resulting from the trade:

- Trade. In February, you decide to sell a March contract so as to
have an early resolution on the position of being short ZYX
stock. You find that you can sell the March $60 put for $2 per
share, which brings $200 into your brokerage account. You are
now "short one Mar 60 put." This means that you might be
required to buy 100 shares of ZYX at $60 per share at anytime
before the March options expiration date. For all practical purposes,
this is not going to happen unless ZYX is below $60 as
the expiration date nears. If you are required to buy the stock at
$60, your broker will immediately use those shares to close
your short position in ZYX, which you initiated at $65.

- Risk. Your risk here is the usual risk of being short a stock,
because its price could rise significantly. To a small degree, this
risk is offset by the decrease in value of the short put.
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Postby PebbleTrader » Sat Feb 23, 2013 12:06 am

- Outcome. Let's examine some scenarios to see how this trade
might work out:

1. Suppose that ZYX is still at $62 when the March expiration
date arrives. Because the stock price is above the strike price
at expiration, the option expires worthless. Now you can keep
the $200 that you received from selling the put option and
your short position in the stock remains in place. Thus, you
have managed to make some additional profit on this short
position, even though the stock is right where it was when
you sold the put.

2. If the price of ZYX is at $59 at expiration in March, you
would be required to buy 100 shares of the stock at $60 per
share. These purchased shares would immediately close your
short position in ZYX. Now you have achieved your original
goal of riding the stock down from $65 to $60, plus you have
brought in an extra $2 per share from selling the put. This
yields $500 from the short sale of the stock plus $200 from
the option for a total profit of $700.
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Postby PebbleTrader » Sat Feb 23, 2013 12:07 am

Time is money. This phrase should always be in the back of your mind
as you deal with options. Remember that the value of an option
decreases in time when everything else remains unchanged.

When you own an option, time is your enemy. When you have sold an option, time is your friend.
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Postby PebbleTrader » Sat Feb 23, 2013 12:07 am

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Those above examples are from an options book I started reading...
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Postby PebbleTrader » Sat Feb 23, 2013 2:37 am

Those are all pretty detailed examples of the concepts thus discussed, anybody have any questions?

Or shall we move along?
Life is just a journey

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