03-01-2008, 09:18 PM
If Microsoft is at $27, and you think it will go to $37 by next January. One option is to just buy the stock. You spend $2,700 for 100 shares. If it goes up to $37, you make $1,000. If it stays at $27, you make and lose nothing. If it goes to $17, you lose $1,000. That's Scenario 1
In addition to buying or selling stocks (or indexes or ETFs) , you can buy derivatives ("options") of those underlying securities.
A "call" option is the ability to buy a stock at a later date
A "put" option is the ability to sell a stock at a later date
In the Microsoft example, another option is to buy a call. So instead of buying the stock, you buy an option to buy the stock at say $35 in January. So they would be "January $35s"
You would spend about $.77 per share (based on the last price - each option has a different premium) for that ability (the cost of time). To buy an option for 100 shares would cost you $77. If it went to $37 in December, you would make $200 (the $2 difference between $37 and $35). You subtract the $77 you spent on the premium, and you've made $123. Scenario 2. However if the stock only goes to $34, you get nothing back, and you lose your $77
under scenario 1: You came up with $2,700 and made only $1,000 (a 37% return)
Under scenario 2: You came up with only $77, and made $123 (a 159% return). The downside of scenario 2 is that you can lose all of your money.
You can also sell calls and puts to other people and instead of coming up with the $77, people give it to you. But you'll have to deliver the stock if the strike price is hit.
So, I bought puts in the S&P for December '09. Which means that in December '09, I'll be able to sell the S&P for $1,200. It's at about $1,330 now. If the S&P is below $1,200 in December '09, I make money. If it's above $1,200, I lose my premium. The further below $1,200 - the more I make.
In addition to buying or selling stocks (or indexes or ETFs) , you can buy derivatives ("options") of those underlying securities.
A "call" option is the ability to buy a stock at a later date
A "put" option is the ability to sell a stock at a later date
In the Microsoft example, another option is to buy a call. So instead of buying the stock, you buy an option to buy the stock at say $35 in January. So they would be "January $35s"
You would spend about $.77 per share (based on the last price - each option has a different premium) for that ability (the cost of time). To buy an option for 100 shares would cost you $77. If it went to $37 in December, you would make $200 (the $2 difference between $37 and $35). You subtract the $77 you spent on the premium, and you've made $123. Scenario 2. However if the stock only goes to $34, you get nothing back, and you lose your $77
under scenario 1: You came up with $2,700 and made only $1,000 (a 37% return)
Under scenario 2: You came up with only $77, and made $123 (a 159% return). The downside of scenario 2 is that you can lose all of your money.
You can also sell calls and puts to other people and instead of coming up with the $77, people give it to you. But you'll have to deliver the stock if the strike price is hit.
So, I bought puts in the S&P for December '09. Which means that in December '09, I'll be able to sell the S&P for $1,200. It's at about $1,330 now. If the S&P is below $1,200 in December '09, I make money. If it's above $1,200, I lose my premium. The further below $1,200 - the more I make.