Stock Option 101 Vincent Tzeng March 25, 2011. What is “stock option”? A contract or right to...

Stock Option 101Stock Option 101Stock Option 101Stock Option 101

Vincent TzengVincent TzengMarch 25, 2011March 25, 2011

What is “stock option”?What is “stock option”?What is “stock option”?What is “stock option”?

A contract or right

to buy or sell a stock

at a certain price

before a certain date

A contract or right

to buy or sell a stock

at a certain price

before a certain date

Key VariablesKey VariablesKey VariablesKey Variables• Type of options = Call or Put

• Contract price = Striking price

• End of contract date = Expiration Date

• 1 Option Contact is based on 100 shares of the underlying stock

• Price of an option changes all the time

• Type of options = Call or Put

• Contract price = Striking price

• End of contract date = Expiration Date

• 1 Option Contact is based on 100 shares of the underlying stock

• Price of an option changes all the time

What are “CALLs” & “PUTs” options?What are “CALLs” & “PUTs” options?What are “CALLs” & “PUTs” options?What are “CALLs” & “PUTs” options?

Call = contract to BUY a stock

Put = contract to SELL a stock

There are agreed price, specific time, and an underlying stock involved in all contracts.

Option Contract Buyer & SellerOption Contract Buyer & SellerOption Contract Buyer & SellerOption Contract Buyer & Seller

Buyer pays a settled price($) to Seller

Buyer gets the RIGHT to buy(call) or sell(put) the stock anytime before the expiration date (Exercise an option)

All options END on the Expiration Date

Seller can end an option by buying back

Why buy a Call Option?Why buy a Call Option?Why buy a Call Option?Why buy a Call Option? Buyer bets the stock will GO UP substantially before the expiration date.

Buyer hopes to buy the stock at lower than the market price.

Buyers usually are aggressors & big risk takers, looking for “quick $ gain”.

Buyers take risk, and lose “most of the times”

It is better to SELL call optionsIt is better to SELL call optionsIt is better to SELL call optionsIt is better to SELL call options

Seller receives instant cash

Seller can reduce cost base

Seller continues to collect dividend

It is like selling “time” for cash!

Sellers win “almost all the times!”

Go Higher

Go Lower

Stay the same

Go Higher

Stock Price may go in 3 WaysStock Price may go in 3 Ways

selling call option reduces your cost base

Starting stock price

Striking price

Stock$ + option$ received

(1) final stock price on expiration, stock will be called

(2) final price, stock will be called

(3b) final price, still own the stock

(3a) final price, still own the stock

Selle

r’s pro

fit

Selling covered CALL options (own stock)

Why Buy a PUT Option?Why Buy a PUT Option?Why Buy a PUT Option?Why Buy a PUT Option?

Buyer bets stock price to go lower

Buyer hopes to SELL the stock at a higher than the market price before the expiration date.

Buyer can reduce down side risk of a stock

Starting stock price

Striking price

Option$ received

(1) final stock price on expiration, you have to buy the stock at striking price.

(2) final price, you have to buy

(3b) final price on expiration date, as if nothing happened

(3a) final price, as if nothing happened

Selle

r’s pro

fit

Selling PUT options

Let’s look at someLet’s look at some

examples, NVDA, GOOGexamples, NVDA, GOOG

Let’s look at someLet’s look at some

examples, NVDA, GOOGexamples, NVDA, GOOG

Example : NVDA

Example : NVDA

NVDA options w striking price at $20

NVDA options w expiration date in September

NVDA options w expiration date in January 2012

GOOGLE options w expiration date in January 2012

APPLE options w expiration date in January 2012

Account Requirement to Trade OptionsAccount Requirement to Trade OptionsAccount Requirement to Trade OptionsAccount Requirement to Trade Options

Need a Margin Account, and brokerage firm’s approval for trading options

Own stock(>100 shs) to sell covered option

IRA or ROTH requires enough cash reserve to sell put options

You can always risk to buy any options

1 contract is based on 100 shares of stock

SummarySummarySummarySummary Stock option can be a good investment tool.

Conservatively, can add to your asset gain.

Get instant cash while holding on your stock

ROTH is TAX-FREE on option gains.

Do options ONLY on “good” stocks.

Understand consequences before trading.

Do SELLING (covered only), not BUYING!

Summary Summary (negatives)(negatives)Summary Summary (negatives)(negatives)

May limit your overall gain

Relatively short term (market timing?)

Tie up your stock under option contract

Tie up your cash from selling PUT

Tax issues on regular stock accounts

More complicated trading than stock

“Naked Writing” can lose your shirts!

WARNING!WARNING!WARNING!WARNING!

SeriousSeriousSeriousSerious

** Option Trading **may NOT be for

Everyone!!!

ReferencesReferencesReferencesReferences

http://www.tradingonlinemarkets.com/Articles/Options/Stock_Options_Explained.htm

http://www.stockoptionsexplained.com/

http://hubpages.com/hub/Stock_Options_Explained

http://www.investopedia.com/university/options/

一寸一寸光陰光陰一寸金，一寸金，

為何不來賣為何不來賣光陰光陰？？On selling stock options On selling stock options - Vincent Tzeng 3.25.2011 - Vincent Tzeng 3.25.2011

一寸一寸光陰光陰一寸金，一寸金，

為何不來賣為何不來賣光陰光陰？？On selling stock options On selling stock options - Vincent Tzeng 3.25.2011 - Vincent Tzeng 3.25.2011