Understanding options calls and puts

Understanding options calls and puts

Who would want to buy a contract from you that gives them the right to sell it for $685 a share when they could easily sell it for $755 on the open market?

ANewbie's Guide to Reading an Options Chain

Call options gain value as a stock’s price increases. Option traders will buy calls when they think the underlying stock or index will move up. One of the most obvious advantages of a call option is that it is much cheaper to buy than buying the stock itself. However, like all options, you have to plan your trade to make sure you are not taking on too much risk.

Essential Options Trading Guide - Investopedia

Understanding stock options is generally hard at first because there's so much information to take in. That's why I'm not teaching you any advanced strategies. My focus is on the basics.

The put buyer profits when the underlying stock price falls. A put increases in value as the underlying stock decreases in value. Conversely, put writers are hoping for the option to expire with the stock price above the strike price, or at least for the stock to decline an amount less than what they have been paid to sell the put.

A call option gives you the right to buy the stock for the strike price. In the chart below you can see Oracle Corp (ORCL) beginning to break out of a consolidation range in the direction of the prior positive trend.

At-the-Money (ATM)

This rule is simple. You're going to pick the At-the-Money (ATM) stock option. This rule was also covered in the strike price lesson.

Can you afford the option

If you can't afford the ATM option, then you can look for a closer expiration month or move on and find a trade on a stock where you can afford the stock options.

Calls Options and Put Options
Each stock option chain will list out all the call options and all the put options for the particular stock. Depending on which option chain you are looking at, the call options may be listed above the put options or sometimes the calls and puts are listed side-by-side.

Bid
The Bid price is the price that a buyer is willing to pay for that particular stock option. It's like buying a home at an auction, you bid (offer) what you are willing to pay for the home.

Options have a language all of their own and when you begin to trade options, the information may seem overwhelming. When you look at an options chart, it first seems like rows of random numbers, but options chain charts give you valuable information about the security today and where it might be going in the future. Not all public stocks have options, but, for those that do, the information is presented in real-time and in a consistent order. Learning to understand the language of option chains will help you become a more informed trader. It can make all the difference between making or losing money in the options markets.

Real-time option chains can be found on most of the financial websites online with  stock prices. These include Yahoo Finance , The Wall Street Journal Online , and online trading sites, such as OptionsXpress and TD Ameritrade. On most sites, if you find the chart of the underlying stock, there will be a link to the related options chains.

What causes an option’s price to grow at a slower pace than the stock’s is a factor called time value. In the video, we will talk about how time value works in the option market and why it is something you need to understand and plan for.

The majority of the time, holders choose to take their profits by trading out (closing out) their position. This means that option holders sell their options in the market, and writers buy their positions back to close. Only about 65% of options are exercised, 65% are traded (closed) out, and 85% expire worthlessly.

Options are powerful because they can enhance an individual’s portfolio. They do this through added income, protection, and even leverage. Depending on the situation, there is usually an option scenario appropriate for an investor’s goal. A popular example would be using options as an effective  hedge  against a declining stock market to limit downside losses. Options can also be used to generate recurring income. Additionally, they are often used for speculative purposes such as wagering on the direction of a stock.  

A call buyer seeks to make a profit when the price of the underlying shares rises. The call price will rise as the shares do. The call writer is making the opposite bet, hoping for the stock price to decline or, at the very least, rise less than the amount received for selling the call in the first place.

Comparison Shopping

Here you simply look for the best value. Check out the price of stock options for other expiration months and see if you can find a good deal. Maybe you will find a stock option that expires 7 months later, but only costs a few dollars more.

The last price is the most recent posted trade and the change column shows how much the last trade varied from the previous day s closing price. Bid and ask show the prices that buyers and sellers, respectively, are willing to trade at right now. Think of options (just like stocks) as big online auctions. Buyers are only willing to pay so much, and the seller is only willing to accept so much. Negotiating happens at both ends until the bid and ask prices start coming closer together. Finally, either the buyer will take the offered price or the seller will accept the buyer s bid and a transaction will occur. With some options that do not trade very often, you may find the bid and ask prices very far apart. Buying an option like this can be a big risk, especially if you are a new options trader.

For instance, if you bought an IBM December 685 "Put option", the option (contract) gives you the right to "sell" IBM stock for a price of $685 on or before the third Friday of December.

Learning how to read an option chain is a vital component to options trading. Many traders lose money because they don't fully understand option chains.

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