Undergraduate Investment Society
Undergraduate Investment Society Week 4 - Introduction To Options
Prepared For: UIS memebers Prepared By: Carl Abuan Date: 1/27/11
Table Of Contents Undergraduate Investment Society
What?
Definitions of key terms Different types of options
Why?
Purpose of options Different investment styles Next steps Extra Resources
What? Undergraduate Investment Society
Options
are securities subject to contractual agreements. Options give you the right to buy or sell an underlying security at a certain time or prior to a certain time in the future, usually this is done at a predetermined price. Since this is a right you are not obligated to buy or sell. One Options contract usually represents 100 shares of the security. Options are also considered Derivatives.
A Derivative
is a financial instrument that gets its value from the underlying security and time. For instance if you buy options in Apple, your derivative is directly influenced by the stock price of Apple
Key Terms Undergraduate Investment Society Buyers: Those who purchase options contracts, also called holders Sellers: Those who sell options contracts,
also called writers
Exercise: Buying the commodity at a specific strike price Strike price: The predetermined price at which an option will be delivered. If the contract of the derivative is exercised Spot Price: is the current market price of the derivative contract Expiration: The day in which an options contract expires. All options expire on the third Friday of the expiration month. Contract Premium: the quote price for the options contract. Multiply this number by 100 to get the cost per contract
Types of Options Undergraduate Investment Society The two most common types of options are calls and puts but there are many more such as a protective put, covered calls, straddles and strangles
A call option gives the buyer the right to buy a predetermined amount of a security at a set price
over a given time period. Again, you aren’t obligated to buy the security and if you decide not to you will only lose the money you spent on the options contract. (your betting the asset will rise in price)
The potential for gains is huge and the potential for loss is limited by the premium you pay for the option
A put option
gives you the right to sell a certain amount of a security at a predetermined strike price. Like calls, even if you don’t exercise the option you only lose the premium for the contract. (Your betting the asset will fall in price)
How can it help me? Undergraduate Investment Society Some of the most practical applications for options are to use them for...
Hedging
against risk
Diversification. Providing leverage Speculation(very
for swings in prices
risky) Options is a
zero-sum game.
For every winner there is a loser if you lose money on a trade the seller (or the writer) of the option gains from your loss.
Other Useful Info Undergraduate Investment Society You aren’t buying the security, you are buying the rights to either buy or sell the security Options also have special tax codes associated with them. Depending on whether or not the gains were long or short term. Options are usually much cheaper than their underlying assets. Giving more investment power to people with small amounts of capital (risky).
Make sure your broker is registered with FINRA and the CBOE.
Next Steps Undergraduate Investment Society
1.
Go
2.
Check
3.
Read
4.
Learn
5. Try
to www.ctftc.gov/educationcenter/ for more info
out http://www.investopedia.com/university/options/ to review
an Option quotes board at www.cboe.com
more about Risk and Volatility (more on this to come)
reading
Fundamentals of Options Markets by Michael Williams