What is option price?
Posted on October 23, 2008
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Option Price also called option premium is the amount per share that an option buyer pays to the seller. The option premium is primarily affected by the difference between the stock price and the strike price, the time remaining for the option to be exercised, and the volatility of the underlying stock. Affecting the premium to a lesser degree are factors such as interest rates, market conditions, and the dividend rate of the underlying stock. Because the value of an option decreases as its expiration date approaches and becomes worthless after that date, options are called wasting assets. The total value of an option consists of intrinsic value, which is simply how far in-the-money an option is, and time value, which is the difference between the price paid and the intrinsic value. Understandably, time value approaches zero as the expiration date nears.
What are LEAPS?
Posted on September 26, 2008
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Long-Term Equity Anticipation Securities (LEAPS) are Long-term stock options or index options, with expiration dates up to three years away. LEAPs are very similar to standard options except for the fact that they expire much further in the future. They can be safer than traditional options because it is somewhat easier to predict stock movement over longer periods. Like options, they allow an investor to lock in a fixed price for the underlying security. Therefore, like options, they can be effective for both leverage and insurance purposes. Expiration generally occurs 36 months after purchase, and LEAPs are American style, so they can be exercised at any time before expiration. Strike prices usually range around 25% above or below the price of the underlying stock when the LEAP is first offered.
What is a Bull Call Spread?
Posted on September 9, 2008
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Establishing a bull call spread involves the purchase of a call option on a particular underlying stock, while simultaneously writing a call option on the same underlying stock with the same expiration month, at a higher strike price. Both the buy and the sell sides of this spread are opening transactions, and are always the same number of contracts. This spread is sometimes more broadly categorized as a “vertical spread”: a family of spreads involving options of the same stock, same expiration month, but different strike prices. They can be created with either all calls or all puts, and be bullish or bearish. The bull call spread, as any spread, can be executed as a”unit” in one single transaction, not as separate buy and sell transactions. For this bullish vertical spread, a bid and offer for the whole package can be requested through your brokerage firm from an exchange where the options are listed and traded.
What is the break-even point of an option?
Posted on August 28, 2008
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The price at which an option’s cost is equal to the proceeds acquired by exercising the option. For a call option, it is the strike price plus the premium paid. For a put option, it is the strike price minus the premium paid.
What is an Option Contract?
Posted on August 1, 2008
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The right, but not the obligation, to buy (for a call option) or sell (for a put option) a specific amount of a given stock, commodity, currency, index, or debt, at a specified price (the strike price) during a specified period of time. For stock options, the amount is usually 100 shares. Each option contract has a buyer, called the holder, and a seller, known as the writer. If the option contract is exercised, the writer is responsible for fulfilling the terms of the contract by delivering the shares to the appropriate party. In the case of a security that cannot be delivered such as an index, the contract is settled in cash. For the holder, the potential loss is limited to the price paid to acquire the option. When an option is not exercised, it expires. No shares change hands and the money spent to purchase the option is lost. For the buyer, the upside is unlimited. Option contracts, like stocks, are therefore said to have an asymmetrical payoff pattern. For the writer, the potential loss is unlimited unless the contract is covered, meaning that the writer already owns the security underlying the option. Option contracts are most frequently as either leverage or protection. As leverage, options allow the holder to control equity in a limited capacity for a fraction of what the shares would cost. The difference can be invested elsewhere until the option is exercised. As protection, options can guard against price fluctuations in the near term because they provide the right acquire the underlying stock at a fixed price for a limited time. risk is limited to the option premium (except when writing options for a security that is not already owned). However, the costs of trading options (including both commissions and the bid/ask spread) is higher on a percentage basis than trading the underlying stock. In addition, options are very complex and require a great deal of observation and maintenance. also called option.
Why Should I Trade Options?
Posted on July 2, 2008
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Countless traders and investors categorize options trading as too complex and too risky when, in reality, they can actually offer a greater risk/reward ratio when compared to simply purchasing the underlying equity. Options present a fine method for investors and/or traders to realize the gain on equity movements without actually purchasing the underlying securities. Unfortunately, there is only a small fraction of people who utilize options in their portfolios.
One of the main reasons people veer away from options are because their value decays over time. But, in certain situations, options can actually supply investors with a superior way of multiplying their profit while simultaneously reducing risk. On some occasions, utilizing options in lieu of equity in the long-term can also considerably increase risk vs. reward.
Since trading options is defined by a particular strategy and there is considerably less capital at stake, the additional benefit here is that you are able to make more rational decisions as there is less emotion involved.
For many investors and traders, options provide the ideal alternative for equity, enabling them not only the opportunity to increase their rewards but also to minimize their risk. Nonetheless, not all options are perfect for everyone in every situation – they should always be researched thoroughly.
Retail Investors Expand Into Options
Posted on June 27, 2008
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Trading of equity options has flourished in the past decade and it is not just the professionals leading the way. Retail equity investors have also started taking the initiative in the use of such derivatives.
Traditionally, retail investors are usually seeking stocks that are likely to stay range-bound over the short term, rather than deploying more aggressive strategies. The expansion into the buying of options can help investors to insulate their portfolio against a sharp decline in equity prices and also allow them to profit from a market rally. Selling options then generates income that can boost the bottom line, so long as equity prices do not change much over the life of an option contract.
By writing options, the investor receives an upfront premium. Should the price of a stock not deviate greatly, they can retain that income and do not have to compensate the buyer of the option.
In the event that the stock price rises significantly and triggers the option, the investor already owns the stock and thus faces a reduced profit as they compensate the option buyer. If the stock stays steady or falls, the investor keeps the premium. Such an approach lowers the risk of being burned through the use of more aggressive option trading, which can tempt some investors.
With online trading platforms and an expansion of education about options providing a fertile ground for retail investors, they are breaking away from relying on putting their money strictly into mutual stock funds. A recent Charles Schwab survey of 500 active retail investors showed that 40 percent of traders surveyed now regularly trade options.
Nearly half of the traders were over 55 years of age. Schwab said 95 percent of them expect to maintain or increase their options trading during the next six months. The survey also found that 75 percent of traders who incorporate options in their portfolio do so with the goal of generating income or hedging for risk management.
During 2000, the exchange reported 279 million equity contracts traded, representing options on 27.9 billion shares of underlying stock. For 2007, 501 million equity contracts were traded, representing options on 50.1 billion shares of underlying stock.
What is a strike price?
Posted on June 6, 2008
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The strike price is specified price on an option contract at which the contract may be exercised, whereby a call option buyer can buy the underlier or a put option buyer can sell the underlier. The buyer’s profit from exercising the option is the amount by which the strike price exceeds the spot price (in the case of a call), or the amount by which the spot price exceeds the strike price (in the case of a put). In general, the smaller the difference between spot and strike price, the higher the option premium. also called exercise price.
What are Employee Stock Options Plans?
Posted on June 4, 2008
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An employee stock option plan (ESO) is a private contract between a company and its employees wherein the employees are given the option to buy a certain number of shares of their employer’s stock at a fixed price over a certain period of time (e.g. ten years). Companies that offer stock option plans are nearly all publicly traded or will soon go public.
Most commonly, ESO’s are offered to members of the company’s management team as part of their compensation package. However, there are many instances where, especially if a company is not yet profitable, ESO’s are offered to lower staff. In fact, they can even be offered to non-employees: lawyers, suppliers, board of director’s members, etc. Anyone who is granted these stock options expects to profit by exercising their options at a higher price then when they were granted.
Compensation, retention, and attraction of new employees are all direct benefits of companies using ESO’s. In an attempt to align the employee’s interest with that of the company, some restrictions on the options due exist (i.e. vesting and limited transferability). Nonetheless, if the company’s stick rises, then the employees who hold options will be subjected to financial benefit as well. By having an employee invest in the stock of their company it will cause them to perform in ways that will raise the company’s stock price.
What is an Option?
Posted on June 3, 2008
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An option or option contract is the right, but not the obligation, to buy (for a call option) or sell (for a put option) a specific amount of a given stock, commodity, currency, index, or debt, at a specified price (the strike price) during a specified period of time. For stock options, the amount is usually 100 shares. Each option has a buyer, called the holder, and a seller, known as the writer. If the option contract is exercised, the writer is responsible for fulfilling the terms of the contract by delivering the shares to the appropriate party. In the case of a security that cannot be delivered such as an index, the contract is settled in cash. For the holder, the potential loss is limited to the price paid to acquire the option. When an option is not exercised, it expires. No shares change hands and the money spent to purchase the option is lost. For the buyer, the upside is unlimited. Options, like stocks, are therefore said to have an asymmetrical payoff pattern. For the writer, the potential loss is unlimited unless the contract is covered, meaning that the writer already owns the security underlying the option. Options are most frequently as either leverage or protection. As leverage, options allow the holder to control equity in a limited capacity for a fraction of what the shares would cost. The difference can be invested elsewhere until the option is exercised. As protection, options can guard against price fluctuations in the near term because they provide the right acquire the underlying stock at a fixed price for a limited time. Risk is limited to the option premium (except when writing options for a security that is not already owned). However, the costs of trading options (including both commissions and the bid/ask spread) is higher on a percentage basis than trading the underlying stock. In addition, options are very complex and require a great deal of observation and maintenance.