Options Trading Education » Put Options

What are Call Options?

Jim Walker — Fri, 04 Mar 2011 23:53:20 +0000

What are call options? In stock trading these are contracts giving the buyer the right to purchase 100 shares of stock per contract. The trader pays a premium to purchase the options contract. He then has the right to buy stock but is under no obligation to do so. The trader will analyze the fundamentals of a stock and do technical analysis of stock price patterns seeking to predict price movement. When he believes that a stock will go up in value he can do a number of things. He can just buy the stock. But then, if the price goes down he has lost money, maybe a lot if the fall is precipitous. He has also tied up a fair amount of capital in the transaction. An alternative is to buy call options. What are call options in this regard? They are a means of reducing investment risk and capital outlay. They are a means of leveraging investment with limited risk. In learning how to trade stock options effectively and profitably the trader will need to understand the stock involved, to have done his fundamental and technical analysis, and to follow the stock that underlies the option as it is the driver of the options price.

An options trader will not always buy calls on a promising stock. He may buy puts as well. The trader buys calls when he thinks that the stock will go up in price. When it does he exercises the contract to buy the stock or simply executes the opposite trade and takes a profit. If he believes that the stock will go down in value he will buy puts. This gives the right but no obligation to sell the stock in question. If the price does, indeed, go down in price he can sell stock that he already owns but at the contract price, the strike price. He can then purchase at the, now lower, market or spot price. If he does not own the stock to begin with he can purchase the stock at the lower price and use that stock to sell when he executes the options contract. Like with calls the trader can also exit his contract and take his profit without touching the stock in question. How to trade stock options, for many, is just like that. Now, what are call options or put options to the seller?

Options writing, or selling options, is typically more profitable over the long term than buying options. Professional options writers only trade stocks in which they have substantial expertise. They are typically large institutional investors with substantial amounts of cash behind them. Thus, when an options trade goes badly, such as with a put option where the bottom falls out of the stock, they have the reserves to absorb the occasional large loss. What are call options and what about selling them for investors who own stocks? This can be a nice source of income, like getting a dividend check in the mail. The owner of a cyclical stock can sell calls on stock that he owns. If he only sells when he believes the stock will not go up substantially in price he will likely not need to sell stock because the buyer of the option will not execute the contract. The investor can sell options on his stock every quarter and profit each time. The down side is that if the stock suddenly moves up in the value the buyer will execute the option contract and the investor will lose out on the price rise of his stock. When to buy calls and when to buy puts is a learned skill. The trader needs to learn fundamentals, practice technical analysis, and engage in risk management. Then what are call options? They can be a profitable way to trade stocks.

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When Do Options Expire?

Jim Walker — Thu, 10 Feb 2011 22:47:06 +0000

A useful piece of information in knowing how to trade stock options is knowing when do options expire. This is basically necessary for options trading as an expired option is a worthless option. When do options expire depends to a degree on the type of option. Regular options expire on the Saturday following the third Friday of each month. If the Friday is a holiday then the expiration is on the Friday. Quarterly options expire on the last open market day of March, June, September, and December. Not all equities have options expiration dates in all months. When do options expire depends upon whether the option is regular, quarterly, weekly, or a LEAP. An equity such as a stock or ETF may have options available in one options expiration cycle, two, or all four.

All optionable equities are traded as regular options. When do options expire for the regular category is, as mentioned above, every month. A regular option will be available for the current month and the next three in succession, always expiring on the Saturday after the third Friday unless the Friday is a holiday in which case the option will expire on the Friday. Regular options contracts are for three months so there is a January cycle, February cycle, and March cycle. The January cycle expires in January, April, July, and October. The February cycle expires in February, May, August, and November. The March cycle expires in March, June, September, and December. When do options expire on a stock is important when deciding when to buy puts and when to buy calls on a stock. The trader will consult the calendar to make sure.

When do options expire on quarterly options? Quarterly options on a stock are only available for four expiration dates a year. These expire on the last trading day of the month for March, June, September, and December. Aside from the reduced number of expiration dates each year how to trade options on quarterlies is the same as on regular options. Quarterlies are typically listed with Q1, Q2, Q3, or Q4 preface indicating the quarter in which they expire. When do options expire for LEAPs? These are long term options contracts and are not available for all stocks. LEAPs stands for Long-Term Antici-Pation Securities. These are available in contacts of up to 39 month duration and expire in January only. They expire on the same day as regular options for that month.

The last batch of options is the weeklies. When do options expire for weeklies and how do options work on weeklies? These options contracts begin on Friday and end on the next Friday. Currently more than 30 Indexes, Stocks and Exchange Traded Funds are traded as options on the CBOE. The CBOE web site lists all of these under the AVAILABLE WEEKLYS category. Traders choose to trade given types of options for specific reasons. Weeklies give the trader a degree of flexibility that may provide more targeted trading opportunities and allow investors take advantage of market events, such as earnings, Fed announcements and government reports.

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Effect of Short Sale Curbs on Options Market

Jim Walker — Fri, 07 Jan 2011 14:38:40 +0000

Many in the options markets are concerned about the effect of short sale curbs on options market trading. How to trade options profitably may change a bit with the new rules. As of the end of February new trading rules will place restraints on short selling. If a stock falls more than 10% in a given day short selling will be prohibited in cases where the sale price is at or below the best bid in national markets. The new rules come on the heels of last fall’s institution of circuit breakers that halt stock trading if the market has fallen 10%, 20%, or 30% in a day. The SEC web site states, “The major securities and futures exchanges have procedures for coordinated market-wide trading halts if a severe market price decline reaches levels that may exhaust market liquidity. These procedures, known as circuit breakers, may halt trading temporarily or, under extreme circumstances, close the markets before the normal close of the trading session. The circuit breakers provide for market-wide trading halts during a severe market decline as measured by a single day decrease in the Dow Jones Industrial Average (DJIA). There are three circuit breaker thresholds—10%, 20%, and 30%—set by the markets at point levels that are calculated at the beginning of each quarter. The formulas for these thresholds are set forth in the New York Stock Exchange (NYSE) Rule 80B.” The indirect effect of short sale curbs on options market trading will likely be a result of the new rule effects on trading itself.

Traders are concerned that so called market maker exemptions were not added to the recent ruling. Without such exemptions the effect of short sale curbs on options market trading and trading in general may be strongly affected. The stock market may see reduced a reduced ability to hedge in the stock market and reduced liquidity on down days. It is a measure of the how controversial this ruling is that it was passed by a divided vote of the SEC and has been delayed once in order to allow brokers and traders to adjust their trading software to account for the new rules. For the day trader when to buy puts will probably be the same. If a stock is going to go down in price the trader should be able to profit from buying puts on it. However, when a trader does not own the stock he will need to borrow in order to sell it. This meets the definition of a short sale. Of course he will be able to buy the stock again at the lower price and realize his profit. The new rules will prohibit a trader from short selling when the market is down substantially. We might assume that the options trader may need to wait a day in order to execute his contract. If this is because the market has fallen substantially it could be more profitable. If he is delayed in executing his contract because of the new rules and the stock rises in price again he will see reduced profits or even a loss in this situation. Thus options traders are wary of the effect of short sale curbs on options market trading, not to mention the effect of short sale curbs on options market profits.

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How Do Puts and Calls Work?

Jim Walker — Mon, 20 Dec 2010 21:46:02 +0000

Puts and calls are types of options contracts. How do puts and calls work? In trading both puts and calls the options trader pays for the right to sell using a put option or right to buy using a call option. Puts and calls are used in trading stocks, commodities, or foreign exchange. The buyer of a put or call retains the option to sell or buy the underlying equity at the contract price, also known as the strike price. The seller of a put or call receives payment and agrees to buy or sell at the strike price no matter what the market price is should the buyer choose to execute the options contract. How do puts and calls work for the various types of underlying equities? When to buy puts is when the investor or trader believes that an equity will go down in price. When to buy calls is when he believes the underlying equity will rise in price.

How do puts and calls work in trading stocks? A trader will study stock fundamentals and then study market prices with technical analysis tools. How to trade options on stocks is to decide if the stock price is likely to rise or fall. Then the trader buys a call option for a stock which will probably rise in price or a put option for a stock that is likely to fall in price. Because the buyer of an option is under no obligation to buy or sell stock he need not execute the contract if the price movement of the stock moves against him. If the price of the stock moves in the expected manner he will execute the contract. For a put option he will be able to sell stock at the contract price even if the stock has fallen in price. For a call option he will be able to buy stock at the contract price even though it has risen in price. In each case his profit is the difference between contract price and market price, minus the premium paid for the option and fees and commissions from the purchase or sale of stock.

How do puts and calls work in trading commodities? Puts and calls on commodities work in a similar fashion to puts and calls on stocks. In the case of commodities the buyer is purchasing the right to buy or sell futures on commodities such as corn, cattle, oil, or gold. Holding an option insures him against the risk of an unexpected price movement as he never has to execute the contract. If, however, his analysis is correct and wheat, corn, oats, oil, or silver futures skyrocket he will be able to buy at the contract price and then sell at the much higher spot price for a sizable profit. In the end how to trade futures options is not so much different from trading stock options. Only the underlying is different.

How do puts and calls work in trading foreign exchange? There is symmetry to trading two currencies such that buying calls on Yen with dollars is really the same as buying puts on dollars with Yen. Think of buying dollars with Google stock and you will be on track. As Yuan options trading begins in China next year traders will be able to buy puts and calls on the Yuan with a range of foreign currencies.

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Who Owns Citigroup?

Jim Walker — Wed, 08 Dec 2010 19:19:30 +0000

As the question of who owns Citigroup gets settled, options on Citigroup are through the roof. The news reports that the U.S. government is selling its stake in the financial giant. Who owns Citigroup will no longer be the Feds. Outstanding options contracts on Citigroup surged to over twenty-five million. That translates, of course, to over $2.5 Billion shares that could conceivably change hands. Calls are running roughly two to one over puts as investors assume that the ailing financial giant’s stock will rise. Although Citigroup did not go into bankruptcy and emerge in an IPO like GM did there are some similarities to GM options in this scenario. Both companies survived the market crash with substantial government intervention and have the potential to become very large and profitable business entities again.

Citigroup operates under the Citi brand. It was formed in a merger of Travelers Group and Citicorp in the late 1990’s. After experiencing large losses during the 2008 global financial meltdown the company received $25 Billion in bailout funds from the US government for which it eventually gave 27% of the company’s stock shares to US taxpayers. Despite suffering huge losses in 2008 the company is still the world’s largest financial services network employing over a quarter of a million people throughout the world. Other large shareholders are from the Middle East and from Singapore. Succeeding in options trading of a company such as Citigroup requires an appreciation of its long term potential and the financial clout of who owns Citigroup. The company was not allowed to go under and be broken up and is now poised to rise from its own ashes.

Many buying calls on Citigroup seem to think that these are good times for trading options on this company. One of the four largest US banks, along with JP Morgan Chase, Wells Fargo, and Bank of America, Citigroup has traded between $3 and $5 a share over the last year. A focus of options trading is currently January $5 calls. Considering that Citigroup was selling at $3 a share a couple of years ago many traders are expecting a continued recovery of the company.

As the majority of options contracts are calls traders are predicting a rise in Citigroup’s share price. When to buy puts on Citigroup is, of course, when one expects a fall in its share price and a return to less promising circumstances. With the news of the government selling its shares two things come to mind regarding the question of who owns Citigroup. One is that more shares are now available for the rest of us folks. The other is that Citigroup will not have a government watchdog on its board of directors telling the company what to do. Certainly there is a good argument that the company, as well as most banks and financial institutions, could have used better advice prior to the 2008 crash. However, investors, over the long run, tend to believe that keeping bureaucrats out of the board room leads to more profits. And, the current answer to who owns Citigroup could now include you.

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GM Options

Jim Walker — Tue, 23 Nov 2010 14:42:49 +0000

After GM’s IPO has returned the auto company to the NYSE the company’s stock will soon be available for options trading. United States options exchanges will be listing call and put GM options as of November 29. Current expectation on the street is that December $35 GM options calls will be around $1.60 bid price and $1.80 offer price. This reasoning is based upon the current interest rate and upon the assumption that GM stock volatility will be similar to that of other major auto makers. Trading GM options will be a means of profiting from both the post IPO volatility of the stock and subsequent GM stock price movement. How to trade options successfully on GM stock will depend on these two drivers of stock price.

When to buy calls on GM options will be when the trader expects the stock to go up and when to buy puts on GM options will be when the trader expects a fall in stock price. In the short term there is a lot of speculation as to how well GM will do coming out of bankruptcy. Traders will use GM options to speculate on price changes. Investors who purchased the IPO at the pre-opening price of $33 immediately profited at the stock rose to nearly $36 and then settled at around $34 a share. Those who believe that there will be no immediate strong gains in GM stock will sell calls with GM options, expecting to earn the premium and still hold on to the stock. This means of “eating your cake and having it too” is a common strategy of those holding long positions in stocks. The only risk in this case is that GM stock will rally and the stock owner will be forced to sell at the strike price when the current market price, the spot price, will have risen. Obviously anyone who believes that the stock is about to rally will be buying calls and not selling them.

Some believe that GM stock will settle lower once all of the excitement of its reemergence on the New York Stock Exchange dies down. These folks will likely be buying puts with the expectation that a drop in stock price will yield them a profit. In the case of those who are currently long in the stock a put in GM options will protect the small price gain that the GM IPO made as it opened for trading. Succeeding in options trading with GM will depend upon an accurate reading of both GM stock fundamentals and technical market indicators. Certainly the fact that GM has accumulated several billions of dollars to start paying off its debt to the US treasury is a strong indication that it is on the road to recovery. However, investor sentiment can be hard to predict. Thus the GM options trader will be wise to keep a close eye on technical stock indicators for GM in order to profitably trade GM options. The continuing one third ownership of GM by the US government is one matter to consider as it limits the freedom of action of the recovering company. As usual our purpose in this article is to walk through the process of evaluating a stock for options trading. Whether the trader chooses to trade these options will depend upon their own careful analysis of the pros and cons.

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When to Buy Puts

T.D. Thompson — Tue, 09 Nov 2010 01:31:53 +0000

Puts are options contracts that give the buyer the option but do not confer an obligation to sell 100 shares of an underlying stock for a price stated in the individual options contract. The same contract will confer upon the seller the obligation to buy the same 100 shares of stock at the contract price, which is called the strike price. When to buy puts is when the trader or investor expects that the stock price may go down. By purchasing a put option the person can exercise the contract in the eventuality of a fall in stock price and receive the contract price for the shares even though the spot price, the market price may have dropped substantially. When to buy puts is not when the person believes that the price of the underlying stock will stay the same or go up. In this case the trader will wish to sell puts. He will receive a premium, the price of the options contract, for bearing the risk of a possible adverse move in stock price. In general how to trade stock options is to follow the stock in question. When to buy calls is when the investor expects the stock price to go up and when to buy puts is when he expects the price to go down.

A specific example of when to buy puts is when an investor has gotten into a growth stock early and has seen a spectacular run up in stock price. He is concerned that the market has overshot on the stock price and is due for a correction. However, the stock keeps going up and he does not want to lose out on more gains. So, he does not sell the stock but he buys puts on the stock. When the stock price goes up he exits the position at the lower price by executing the opposite trade. He buys puts at that price. Then he purchases puts again at the new, higher price. This is a real example of when to buy puts and saved any number of investors during the dot com bubble a decade ago. When the market in dot coms crashed those who had covered their positions by buying puts were able to cash out of their stock positions at the high water mark and not see their gains evaporate along with their stocks. This is an example of how to trade options to protect a stock position. Another trader may simply do the same thing without owning the stock.

For the individual who does not own a stock but spots one due to fall in price this is also an example of when to buy puts. It is also a great example of how trading options can give the individual a great deal of leverage. When to buy puts is when the trader believes that a stock price is about to fall, and when the price of the option is cheap. This can take a bit of fundamental analysis as well as technical analysis but can reward the trader with a more substantial return on investment than if he were to use the same money to sell the stock short. This is because of how a well chosen option costs only pennies on the dollar compared to the price of the stock. The individual will control a larger block of stock with the option than by short selling shares. Just before their recent earnings report came out traders were buying puts on Intel with the expectation of a poor report and a drop in stock price. When to buy puts in this situation was when traders expected a drop in stock price and only wanted to establish the option to profit from a possibly poor earnings report.

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What Are Calls and Puts?

T.D. Thompson — Sat, 06 Nov 2010 01:32:17 +0000

What are calls and puts in options trading? Calls and puts are the names for the types of contracts used to buy and sell stock, commodity, and futures options. The answer to “What are calls and puts?” depends also, to a degree, upon the point of view of the trader. Calls and puts are kinds of options trading that can offer a high degree of leverage to the investor (buying) or the prospect of continuing long term profits in the hands of skilled traders (selling). The options trader looks to buy options which have a low premium (price) and for which the trader believes the underlying equity price will rise (call) or fall (put). When there is a moderate to substantial move in equity price the trader will earn a substantially larger return on his investment than if he had bought the equity or sold short.

Over the long term options writing (selling) tends to be more profitable than buying. However, because of the risk of occasional substantial loss writing options is largely the province of large institution investors with the financial reserves to absorb that occasional loss. What are calls and puts for the professional making a living trading options? They are a means of making a living by anticipating whether a stock price will rise, fall, or stay the same. The options seller looks for equities that are unlikely to go up in price (calls) or down in price (puts).

A call contract gives the buyer the option to purchase the underlying equity which he will do if the equity price moves in the direction anticipated. A call contract confers an obligation on the seller (writer) of the call option to sell the underlying equity if the buyer executes the contract. Similarly a put contract gives the buyer the option to sell the underlying equity which he will do if the equity price moves in the direction anticipated. A put contract confers an obligation on the seller (writer) of the put option to buy the underlying equity if the buyer executes the contract. Covered options trading is when the seller of a call option or buyer of a put option owns the equity in question.

What are calls and puts to buyers versus sellers of options? Buyers of both calls and puts typically engage in uncovered options trading, also known as naked options trading. Because the premium paid for the option is typically a small fraction of the price of the equity, the buyer may gain a multiple of his investment when the equity price moves. Because the options buyer will only execute the contract when doing so is profitable the maximum loss he can incur will be the premium paid for the contract. He does not need to have any collateral in case of a larger loss. On the other hand the seller of a call may well own the stock or other equity in question. Thus he will simply forego the profit if the price of the equity goes up and the buyer executes the contract but will not need to buy the stock at the higher price in order to sell it to the options buyer. What are calls and puts to the owner of an equity? In the case of selling calls it can be an extra source income when the stock price does not go up, a payment for selling a stock whose price has risen, or a means of offsetting loss if the price goes down.

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Buying Puts on the Financial Select Sector SPDR

T.D. Thompson — Tue, 29 Jun 2010 15:01:31 +0000

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Buying puts on the financial select sector SPDR multiplied recently as the government entered into consideration of new regulations. Puts to sell outnumbered calls to buy by roughly twenty to one as the SPDR fund price fell nearly two percent, to just above $14 a share. The huge difference has arisen as congress is debating the final terms of new regulations for the financial industry. Poor oversight and banking sector excesses are commonly blamed as major causes of the 2008 market crash. However, many banking insiders are concerned that the upcoming restrictions will damage the financial industry as it tries to get on its feet again. An example of the proposed regulations is that banks may be restricted from trading derivatives. SPDR funds are shares of a family of exchange-traded funds (ETFs) traded in the United States. These funds are managed by State Street Global Advisors. The acronym SPDR comes from the first ETF in the fund, Standard and Poor’s Financial Services Depository Receipts which is designed to track the S&P 500. These funds are set up as unit investment trusts. The financial select sector SPDR a range of financial service firms including JPMorgan Chase, Wells Fargo, and BankAmerica Corp. With new regulations on the way it may be bad times for the financial sector but times of volatility are good times for trading options.

The kinds of options trading that are most profitable will depend upon what the market in the underlying equity is doing. Put call ratios are running around sixteen to one on individual stocks across the financial sector as traders fret over the consequences of tougher regulations on financial sector profitability. Traders buying calls is a sign of faith in the likelihood of stock prices going up. Traders buy puts in the belief that a stock price will go down. If the large majority of traders buying puts are correct then they will be able to sell Financial Select Sector SPDR shares at the strike or contract price at a time when the spot price or market price has dropped substantially. Traders will buy at the spot price and sell at the strike price, pocketing the profit. Traders believe that buying puts on the financial select sector SPDR will lead to profits.

As usual we are not suggesting buying puts on the financial select sector SPDR or buying calls for that matter. This is an exercise in watching market indicators such as the daily put to call ratio and using that information to find advantageous situations for uncovered options trading. When a trader sees a great deal of market volatility but does not know which way the market will go he or she may engage in a long straddle options strategy. In this strategy the trader will buy a call and buy a put on the same equity with the same option expiration date. This strategy costs the trader two premiums but insures that he or she will profit no matter which way the equity price goes. The only way to lose on a long straddle is if the market quiets down and the equity price remains stable. In that case the trader is out the cost of two premiums. If the trader really believes that the equity in question has stabilized then selling both puts and calls can be profitable. This is a short straddle. The profit is two premiums if the equity price does not change but the loss can be substantial in either direction if the price moves dramatically. The point of being aware of the fact that the market is buying puts on the financial select sector SPDR is that knowledge properly used leads to profits in options trading.

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Writing Puts in Options Trading

T.D. Thompson — Sun, 10 Jan 2010 01:56:39 +0000

Writing puts in options trading is the same as selling puts. The seller of a put option sells the right to sell a stock at a set price, the strike price, on or before a future date. In return the writer or seller of the put option receives the payment of a premium. Writing puts in options trading is done when the writer believes that a stock price is stable or will go up. The buyer of a put believes that the price of the stock will, or may well, go down. Of the various kinds of options trading, writing puts can be the most dangerous or it can be very profitable.

It is always wise to practice risk management in options trading. In the case of writing puts in options trading it is important that the put seller or writer be very sure of the trend of the underlying stock. The profit from selling puts lies solely in gaining the premium when a previously volatile stock stabilizes or a stock on its way up does not correct, as the buyer of the put think possible.

The risk of writing puts in options trading is that the underlying stock will fall in price and that the buyer of the put will exercise his or her option. In that case the amount of loss for the option writer will be the amount that the stock drops in price below the strike price multiplied by 100 shares for each contract written. The potential loss is the entire value of the stock. Thus this options trading technique should be reserved for those with substantial experience in options trading and in depth knowledge of the stock involved. It all has to do with predicting the future difference between strike prices and spot prices in options trading.

The trader needs to ask himself or herself when is trading put options a good option? For the owner of a stock that has gone up dramatically buying put options on the stock insures against a precipitous correction. There are individuals who were not wiped out when the dot com bubble burst because they used exactly this technique. They bought put options on their stock. Those who believed that writing puts in options trading on the same stocks did, in fact, suffer serious financial loss.

If put writing were always incredibly dangerous no one would ever write puts and no one would ever be able to buy puts. But, these options contracts are bought and sold. When trading options in relatively stable stocks the risk of selling puts is substantially offset by the premium paid. For someone with intimate knowledge of the underlying stock this options trading technique can be a recurrent money maker. This individual may well be a person who is making a living trading options which means they have the time to devote to detailed study of appropriate stocks and market conditions. Writing puts in options trading is probably not a options trading technique that should be used by someone who engages is occasion options trading. When writing puts it is all important to know the underlying stock and its market sector very well. It also important to have sufficient capital reserves in case of loss.