Stock Options. How do they work?

Question

For example I wanted to buy a stock with a contract price of $1 with a strike price of $10. I guess 1 contract is worth 100 shares of stock. So I would pay $100 for the contract if that contract price goes down to $.50 then I would lose $50? but if the stock goes up to $20 I could buy 100 shares at $1 then my shares would be worth $2000? Am I right?

Answer 1

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Correct. Unless an option has been adjusted for a split, merger, extraordinary dividend or spin-off the underlying is 100 shares. The contract price is given per share so a $1.00 price means $100.00 per contract. I would say "the muliplier is 100" or "the underlying is 100 shares" instead of saying the contract is "worth" 100 shares.

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Correct.

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No. The price you would pay per share is the strike price, not the original premium. So you could buy 100 shares for $10.00 per share, or $1,000.00, if you exercised the option. (I am assuming it is a call option and not a put option.) You could also simply sell the option for about $1,000, or maybe more, without ever owning the stock. Of course, all this assumes the stock went to $20.00 per share before, not after, the expiration date.

Answer 2

You were right right up until the last bit. Stock goes to $20 on a $10 strike. You own 1 contract which is 100 shares. You can buy the stock at $10 a share per your contract, costing you $1000, and sell it on the open market at $20, or $2000, making you a total of $1000. This is rarely done, as you would more likely seel the option back. If it's close to expiration, you would get $10 a contract for it in intrinsic value, for a $900 profit on a $100 investment.

Options are a cool way to leverage your profits. They are also an evil way to leverage your losses against you. Practice good money management and know exactly what you are doing.

Used to be you could structure hedged positions, using calls, puts, different strikes and different expiration dates. The market has become much faster and much more efficient, and the edge these strategies give you are being considered by the market makers on the bid/ask, and they stack the odds against you. Your best bet is to find a trending stock and ride it with options. Know exactly how much you're willing to lose on each trade, and never risk more than 2% of your capital on a single trade (impossible if you're trading less than $50K)

Answer 3

There are call and put options. Calls give you the right to purchase the stock at the strike price, while puts give you the right to sell at that price, anytime up to the close of the expiration date. The price is a composite of the intrinsic value (if any--out-of-the-money options have none), the time value (which decreases toward 0 as expiration nears), and the delta (based on an algorithm for determining the ratio of stock price movement to option price movement at any given point in its life).

You are correct about the intrinsic value under the hypothetical conditions, but there may also be a time-value and delta component as a premium to an option not yet ready to expire. On the other hand, if you hang onto an option up to its expirations and it never goes into the money, it expires worthless. If it expires either in or even at the money, you should have a standing order with your broker, so you are not caught with an automatic exercise you didn't intend or plan for.

So far, I've been referring to trading options, which is where all my experience lies. Writing of options is another topic, with the risk determined by whether the option is naked or covered. The writer of the option is betting that the underlying stock will not move significantly out of its trading range within the exercise period. To me, this seems self-defeating, because I would not want to hold a stock that is that boring, and I don't do short sales.

Answer 4

When an option is "excercised" the buyer is buying the shares at the STRIKE PRICE of the option contract not at the premium price.

In the second part of your question you would be buying 100 shares at a strike price of $10.00 for $1000.00. But the market price is $20.00 so your shares are worth $2000.00.

Answer 5

The procedure that you're relating to is known as Selling Covered Calls. It was once popularized within the past due ninety's through Wade Cook as a way of supplementing your revenue. Mr Cook made the procedure look very handy and with out danger. Based upon the truth that his organization is now bankrupt and dealing with numerous complaints, I might say he was once flawed. The procedure works as follows: You first ought to have a brokerage account with choice buying and selling approval. You then might both purchase a minimum of one hundred stocks of a inventory or transfer the stocks that you just owned earlier into the brokerage account. Check yahoo finance or every other supply to be certain that the inventory that you're making use of has choice chains assigned to it. Let's say for instance that you just purchase your one hundred stocks at $20 in keeping with proportion. You might investigate the choice chains in your inventory and uncover that there are a few strike fee 25 choices that expire three months out that experience an ask fee of $one million.00 in keeping with agreement. You might then SELL one September 25 Call choice towards your one hundred stocks of inventory. By doing this you're announcing that someday among now and September, if the inventory fee reaches 25, you might comply with promote your inventory for $25 in keeping with proportion. So now you ask, Where's the secondary revenue? When you offered that one September 25 Call choice for $one million.00 you got $one million.00 for every proportion that you just possess for a whole of $one hundred. This is yours to maintain and do anything you desire with it. In this situation, if the inventory fee did achieve 25 earlier than September you might then promote your inventory for a $five.00 in keeping with proportion benefit. If the inventory fee does not achieve $25 through September, you get to maintain the $one hundred that you just made and also you get to maintain the inventory. You might then promote yet another name choice towards your one hundred stocks of inventory. In idea, you might do that time and again. I disregarded commissions and taxes in my dialogue however they might ought to be factored into the situation as good. The procedure can paintings however there may be extra danger and paintings worried than Mr Cook led his readers into believing. Good success and Be cautious.