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About Options

Constant Value Investing

Getting Started with Options Trading

How does the Stock Market Work?

How to Invest in Stocks

Investing in Stocks: Turn $5,000 into $1,000,000

Investing in the Stock Market

Stock Market Quotes

Stock Splits

Types of Stock Orders

Why do Stock Prices go Up and Down?

About Stock Options

Puts and Calls

A call option is the right (but not obligation) to buy a stock at a predetermined price until a certain date in the future. A put option is the right (but not obligation) to sell a stock at a predetermined price until a certain date in the future. The advantage of options is that they cost a fraction of what it would cost to purchase the stock itself and they normally increase in price at about the same rate as the stock itself does. The disadvantage is that they have an expiration date at which time they become worthless. Another disadvantage is that you may lose all the money you invest in options (although you will rarely lose more that you would have lost had you bought the stock because you didn’t pay as much to start with).

Maturity Dates

Options are available in several different maturity dates as well as prices (called strike prices). The maturity dates are normally staggered several months apart. This is the date that the option will expire.  They will normally be two or three months apart with the longest period being about nine months. An exception is a long-term option referred to as a leap that may not mature for one or two years. Here is an example of what might be available in options.

Options Chart

These are options for Renal Care Group (symbol RCI). Notice that the stock is currently trading at 47.10. We see on the left portion of this example all call options available for May 06. The strike prices are 40, 45, and 50. The 40 and 45 is referred to as “in the money” since it will give the owner of the option the right to buy the stock at 40 or 45 and then sell it on the open market at 47.10. The other option is referred to as “out of the money”.  The 50 option gives you the right to buy the stock at 50 when you could simply buy it on the open market right now at 47.10. The difference is that this option will give you the “option” to buy it at 50 until it expires in May 06 no matter what the stock does in the meantime. If the stock goes to 53 you can still exercise your option to buy it at 50 and then sell it on the open market at 53. This is the attraction of options. You do not have to actually exercise an option and be involved in the buying (and the necessary funds to do so as well as commissions) and selling of the stock. As the price of the stock changes the price of the option will change as well. You will simply sell your option at a profit.

In the example above the recommended option is the May 06 50 call. May 06 because it affords us the greatest amount of time before expiration and 50 because that is the first option that is “out of the money”.

Options do not exist for some stocks. Also some types of brokerage accounts such as IRA accounts are not eligible to trade options.

This has been a very brief discussion of options. Your broker has publications that will go into more detail. Your broker will also require you to sign an options agreement before you may trade options. Options can give you a great deal more leverage with your money than buying the stock itself; however, options are considered very speculative and therefore risky investments. Make sure you have a firm understanding of options before attempting to buy and sell them.

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Copyright © 2004 - 2005 Harry E. Hooper of M&H Consulting Services LLC - All Rights Reserved. To request permission to reprint this article, please contact: [email protected]