|
|
Options
The world of options trading has been described as highly complicated. While trading volume of options has been steadily rising -- a testament to their growing popularity -- for most individual investors they may not be appropriate. But for the right individual options can be an effective way to enhance an already well-balanced portfolio.
What is an option?
An option is a contract giving an investor a right to buy (call) or sell (put) a fixed amount of shares (usually 100 shares) of a given stock (or indexes and commodities) at a specified price within a designated time period (usually three, six, or nine months).
The purchaser hopes that the stock's price will go up (if he bought a call) or down (if he bought a put) by an amount sufficient to provide a profit when the option is sold. If the stock price holds steady or moves in the opposite direction, the price paid for the option is lost entirely. Individuals may write (sell) as well as purchase options.
Call Options
A buyer of a call option pays the call option writer a fee called a premium for the right to buy 100 shares of the underlying security at a fixed (strike) price before a specified future date (expiration), If the option is not exercised before it expires, the premium paid is lost. Thus, a call buyer believes that the price of the underlying shares will rise before the option expires. If the call buyer does exercise the option, the shares are bought from the writer at the option's strike price. The amount due to the writer equals the strike price multiplied by the number of shares. A buyer of a call option is generally bullish about the security, or in the case of index options, the market. A writer of a call option usually believes the security or the market will not move substantially up--thus, not making it worthwhile for the buyer to exercise.
Put Options
A buyer of a put option pays a premium to the writer of the put for the right to sell 100 shares of the underlying security at a fixed price before a specified future date, also. A put buyer believes that the price of the underlying security is going to decline. If the put buyer exercises the option, the underlying security shares are sold to the put writer at the option's strike price.
A put buyer is generally bearish about the security or the overall market. The writer typically believes the security or the overall market will not move substantially down--thus, not making it worthwhile for the buyer to exercise.
Buyers of options do not have to exercise an option in order to profit--they may attempt to profit on the option by selling it before its expiration by trading on the rise and fall of premium prices. Writers may also attempt to profit by buying back the option sold at a lower price (or it can expire worthless).
For additional information, please see:
Options trading may not be suitable for all investors and certain strategies may expose an investor to significant risks. To learn more about the risks of options, please call 1 800 927-3059 to receive a copy of the booklet Characteristics and Risks of Standardized Options.
|
|
|
