About Stock Options
Puts and Calls
A call option is the right (but not obligation) to buy
a stock at a
predetermined price until a certain date in the future. A put option is
the right (but not obligation) to sell a stock at a predetermined
price until a certain date in the future. The advantage of options is
that they cost a fraction of what it would cost to purchase the stock
itself and they normally increase in price at about the same rate as the
stock itself does. The disadvantage is that they have an expiration date
at which time they become worthless. Another disadvantage is that you
may lose all the money you invest in options (although you will rarely
lose more that you would have lost had you bought the stock because you
didn’t pay as much to start with).
Options are available in several
different maturity dates as well as prices (called strike prices). The
maturity dates are normally staggered several months apart.
This is the date that the option will expire. They will
normally be two or three months apart with the longest period being
about nine months. An exception is a long-term option referred to as a
leap that may not mature for one or two years. Here is an example of
what might be available in options.
These are options for Renal Care Group (symbol RCI). Notice that the stock is
currently trading at 47.10. We see on the left portion of this example
all call options available for May 06. The strike prices are
40, 45, and 50. The 40 and 45 is referred to as “in the money” since it will
give the owner of the option the right to buy the stock at 40 or 45 and then
sell it on the open market at 47.10. The other option is referred to
as “out of the money”. The 50 option gives you the right to
buy the stock at 50 when you could simply buy it on the open market
right now at 47.10. The difference is that this option will give you the
“option” to buy it at 50 until it expires in May 06 no matter what
the stock does in the meantime. If the stock goes to 53 you can still
exercise your option to buy it at 50 and then sell it on the open market
at 53. This is the attraction of options. You do not have to actually
exercise an option and be involved in the buying (and the necessary
funds to do so as well as commissions) and selling of the stock. As the price of the stock
changes the price of the option will change as well. You will simply
sell your option at a profit.
In the example above the recommended option is the May 06 50 call.
May 06 because it affords us the greatest amount of time before
expiration and 50 because that is the first option that is “out of the
Options do not exist for some stocks. Also some types of brokerage
accounts such as IRA accounts are not eligible to trade options.
This has been a very brief discussion of options. Your broker has
publications that will go into more detail. Your broker will also
require you to sign an options agreement before you may trade options.
Options can give you a great deal more leverage with your money than
buying the stock itself; however, options are considered very
speculative and therefore risky investments. Make sure you have a firm
understanding of options before attempting to buy and sell them.
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Copyright © 2004 - 2005 Harry E. Hooper of M&H Consulting Services LLC - All Rights Reserved.
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