We have had a few requests regarding options trading so we have put together a few notes on the subject with a few links to web sites that explain options in a lot more detail.
As we see them, an options contract is a bet that the underlying commodity or stock will go either up or down.
If we think that the stock we have in mind is going to go up then we would buy a Call Option, if we think that it is going to go down then we buy a Put Option.
An option is the right to buy, but not the obligation to buy that stock for a stated price on a given date in the future. Our call options on Kinross secured the right to buy Kinross stock in January 2009 for $20.00 per share. In this case each contract contained 100 shares, however do check with your broker as things can vary depending on which stock exchange you are trading on, etc. The attraction for us is that we were getting control of 100 shares for around 10% of the cost of actually buying them. As the stock appreciated so did the price of the option and we were able to generate a profit. However had the stock price depreciated then our options would have also depreciated.
Before buying an option we need to get the direction of the commodity right, choose an associated stock that is oversold and decide on a time period that we think is sufficient for the trade to work. The mechanics of the trade are not difficult to master if we keep it simple. However there some very sophisticated trading strategies available to us and they are deployed by experienced traders. You will see terms such as butterfly, covered calls, naked calls etc, which you can learn about as your understanding of options trading increases. Also remember that an option has a limited life span and then it expires and becomes worthless, it is not an investment that you can buy and hold and wait forever for it to recover.
This is a link to the Chicago Board Options Exchange, which is a useful site.
You can also visit Investopedia by clicking this link.
This is the sort of thing you can expect to find:
A financial derivative that represents a contract sold by one party (option writer) to another party (option holder). The contract offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon price (the strike price) during a certain period of time or on a specific date (excercise date).
Options are extremely versatile securities that can be used in many different ways. Traders use options to speculate, which is a relatively risky practice, while hedgers use options to reduce the risk of holding an asset.
In terms of speculation, option buyers and writers have conflicting views regarding the outlook on the performance of an underlying security.
For example, because the option writer will need to provide the underlying shares in the event that the stock's market price will exceed the strike, an option writer that sells a call option believes that the underlying stock's price will drop relative to the option's strike price during the life of the option, as that is how he or she will reap maximum profit.
This is exactly the opposite outlook of the option buyer. The buyer believes that the underlying stock will rise, because if this happens, the buyer will be able to acquire the stock for a lower price and then sell it for a profit.
You can also try the OIC (The Options Industry Council) just click here, where you find will various definitions such as the following one:
What is an Option?
An option is a contract to buy or sell a specific financial product officially known as the option's underlying instrument or underlying interest. For equity options, the underlying instrument is a stock, exchange-traded fund (ETF), or similar product. The contract itself is very precise. It establishes a specific price, called the strike price, at which the contract may be exercised, or acted on. And it has an expiration date. When an option expires, it no longer has value and no longer exists.
Please talk to your financial adviser before entering into any options trades it is vitally important that you understand the risks involved. It can be a gut-wrenching ride and it certainly isn’t for everyone. Be prepared to lose the total amount that you paid for an options contract, it often happens.
Hope this helps!
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