| The world of options is an exciting one. Unfortunately, | | | | of an option, we will use...your car! |
| many stock market traders and investors miss out on | | | | Next, “during a specific period of time”. Let’s |
| trading options because they do not understand how | | | | describe this part by saying that options are contracts |
| they work. It is understandable. When someone | | | | that expire. For example, say you told me that I could |
| explains options to you for the first time, you might | | | | buy your car from you for the next two weeks at |
| shake your head and decide to stick with mutual funds. | | | | $500. If I wait longer than two weeks, well, I might have |
| But like anything worth knowing, once you do the | | | | to pay more. So we have a contract that expires in |
| investigation, the reward far outweighs the effort. | | | | two weeks. Simply enough, that contract I just |
| So in an attempt to help people better understand | | | | described is an option! It is the option to buy your car |
| options, we will present a series of articles starting | | | | from you at $500 for the next two weeks. |
| from the beginning and covering many topics related | | | | Said another way, I have the right, but not the |
| to trading options. So check back regularly. | | | | obligation, to buy your car from you for the next two |
| So to get started, what are options? The official | | | | weeks. So why the right, but not the obligation? We |
| definition of an option might go something like this: | | | | signed a contract. That gives me the right to buy your |
| The right, but not the obligation, to buy (for a call option) | | | | car at $500. But If I choose not to, it is okay. I may |
| or sell (for a put option) a specific amount of a given | | | | have to pay more after two weeks, but I can also |
| stock, commodity, currency, index, or debt, at a | | | | choose not to buy it at all. |
| specified price (the strike price) during a specified | | | | An option is the right, but not the obligation, to buy |
| period of time. | | | | something at a specific price for a specific amount of |
| Wow, well that helps a lot. Okay, let’s try to break | | | | time. That “something” is called the underlying. |
| that down into simpler terms. First, let’s take the | | | | Now you might ask yourself, “Why would I want to |
| part about a given stock, commodity, currency, index, | | | | give you the right to buy my car at $500 for the next |
| or debt. Let’s simplify that by saying that we have | | | | two weeks, if someone might come along and offer |
| the ability to buy and sell options for many things. You | | | | me $1000?”. The answer, because I pay you! That |
| can buy an option for a stock such as IBM, a | | | | is why it is called “buying the option”. What I get |
| commodity such as gold, a currency such as the U.S. | | | | out of buying that option is that I control that car for |
| dollar, an index such as the S&P 500, or debt such as | | | | the next two weeks! I can find a buyer for $1000, buy |
| a bond. So for the purpose of finishing our description | | | | it from you for $500, and sell it for a profit immediately. |