source http://www.stockpickguide.com
An option is a contract giving the buyer the right, but not the
obligation, to buy or
sell an underlying asset at a fixed price on or before a certain date.
If, over the life of the contract, the asset value decreases, the
buyer can simply elect not to exercise his/her right to buy/sell the
asset. There are two types of option contracts - Call options and Put
options. A Call option gives the buyer the right to buy the underlying
asset, while a Put option gives the buyer the right to sell the
underlying asset.
There are four types of participants in options markets: Buyers of
calls, Sellers of calls, and Buyers of puts and Sellers of puts.
People usually use option for hedging and speculation.
Option strategy can be:
* Long (buy), where you do long call in bullish condition and long put
in bearish condition.
* Short (sell), where you do shot put in bullish condition and short
call in bearish condition.
Option has a lot of advantage than stock. It can control stock with
small money compared to buying the stock it self. Option can also take
advantage of declining stock price by using put strategy.
Before we learn about various strategy, there are various things in
option we should know.
* Equity option contracts usually represent 100 shares of the
underlying stock.
* Strike prices (or exercise prices) are the stated price per share
for which the underlying security can be purchased (in case of call)
or sold (in the case of a put).
* Equity option holders do not enjoy the rights due stockholders -
e.g., voting rights, regular cash or special dividends, etc.
* The strike price and stock price determines whether that contract is
in-the-money(ITM), at-the-money(ATM), or outof-the-money(OTM). If the
strike price of a call option is less than the current market price of
the underlying security, the call is said to IMT. If a put option has
a strike price that is greater than the current market price of the
underlying security, it is also said to be ITM. The converse of IMT is
OTM. If the strike price equals the current market price, the option
is said to be ATM.
* Option price is consisted of intrinsic value and time value. The
amount by which an option is 'in' or 'out' of the money is referred to
as its 'intrinsic value'. If an option is 'in-the-money' it will cost
more than an option which is 'out-of-the-money'. This is because it
has more intrinsic value. For example, stock "ABC" current price is
$10; the call option is $5. The call option is called ITM, and it has
intrinsic value ($10-$5) = $5. Another im****tant factor is the amount
of time an option has until it expires. This is im****tant because the
more time there is until expiry, the more time there is for the option
to move into a profitable position. This is known as the time value of
the option and it reduces significantly when reaching the expiration
date.
* Volatility of the price of the underlying security also affect the
option price. The more price volatility an underlying security has,
the more chance that it will move in a profitable direction for the
option buyer. For this reason, option writers will price high
volatility into option price.
The basic strategy for option is call and put. When you believe that a
stock if going to be up next year, buy call option. But if you believe
the price will go down next year, buy call option. How do you know
whether the stock will go down or up next year? You can read news from
Bloomberg, yahoo, and reuter. From there you should be able to find
out about the company, whether the stock can go up or go down. If you
want to know about Merril lynch, you can check
http://finance.yahoo.com/q?s=MER
or http://stocks.us.reuters.com/stocks/overview.asp?symbol=mer.
From
yahoo, you can know it's one year price estimate, and from router you
can know the recommendation from them, whether it is hold, buy, or
sell. What I do is buy put or call option, depending on their outlook.
I will buy ITM option which is closest to the current price and with
about one year to expire. Hold the option until it reaches your target
price or there has been a change of fundamental which will bring the
stock in the opposite direction from your position. You must also be
careful with expiration date, because your option can worth nothing.
When you buy call and put option, your loss is limited, but your gain
is unlimited.
source http://www.stockpickguide.com
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