STOCK OPTIONS: The Very Basics
Stock Options are a derivative of a stock. Options are used to lock down the price of a stock whether you’re buying (calls) or selling (puts).
An example. You like Intel (INTC). The stock is $32. You think it will go up. You call your broker (or online) and ask about the $32 call options out a month. The option bid and ask—the bid is where you would sell the option and the ask is where you buy it—is 70¢ X 75¢. Options are in 100 share increments called a contract. One contract would be $75, or 100 times 75¢.
Think of this, for $75 you have locked down the right (but you have no obligation to do so) to buy 100 shares of Intel. $750 would buy 10 contracts, or 1,000 shares. It’s not a down payment, but a “right.”
HOW DO YOU MAKE MONEY?
Most people do not buy options to actually buy the stock. They buy options hoping their option will grow in value, then sell. Let’s think on this. If Intel goes quickly to $33, your option could be worth $1.25 or so. The price is also a function of the time to expiration. The rest is speculative value.
You could sell now and take in $125 or $1,250 with the ten contracts. Here are the operative words: When there is a small movement in the stock, there is a magnified movement in the option. But think, $750 to $1,250 would be a $500 profit for an hour, or a day, or a few weeks.
Oh, it takes 18 seconds on average to buy or sell this option. That’s an amazing factoid. What other business lets you buy or sell anything in 18 seconds?
HOW DO YOU LOSE WITH OPTIONS?
Most people lose with straight options. Darn stocks. They just don’t always do what we need them to do. With any investment that has an expiration date, there is an added element of risk. For example, the stock may go up just a little and your option will go down as time expires. If the stock stays the same, eventually you will lose.
The stock has to go up and go up quickly or you will lose all or part of your money. This is why we like Writing Covered Calls. When we sell an option we put the market force of time to work for us. That’s what we like: stacking the deck in our favor.
Millions can be made with stock options. But the bottom line is that these are a form of gambling. You need a lot of experience and a bit of luck to make consistent profits with straight options.