This topic presents the following content: Definition of a put and a call option, option writer and an option buyer, investor profit profile and how to use, covered call and naked call, derivative security: what it means, in-the-money and out-of-the-money option writing and option premium, bull and a bear spread, calendar spread, butterfly or Bicycle spread. | I. Options 10/26/2012 Professor James Kuhle 2 I. Options A. Definition: The right to buy or sell a specific issue at a specified price (the exercise price) on or before a specified date regardless of what the market price of the security is on the date the option is exercised. B. Call: The right to buy a security (Upside). C. Put: The right to sell a security (Downside). 2 Distinguishing Stock Options From Stock Ownership It is important to understand the distinction between buying stock options and owning the stock. Unlike stocks, options have a limited life. If an expected move does not immediately occur, a stock investor can say, "I’ll give it another week" over and over, ostensibly forever. This is not the case with options trading. Each option has a set expiration date. At expiration, an option is either worth the difference between its strike price and the current stock price, or it is worthless. There is a key concept to keep in mind when dealing with the limited life of . | I. Options 10/26/2012 Professor James Kuhle 2 I. Options A. Definition: The right to buy or sell a specific issue at a specified price (the exercise price) on or before a specified date regardless of what the market price of the security is on the date the option is exercised. B. Call: The right to buy a security (Upside). C. Put: The right to sell a security (Downside). 2 Distinguishing Stock Options From Stock Ownership It is important to understand the distinction between buying stock options and owning the stock. Unlike stocks, options have a limited life. If an expected move does not immediately occur, a stock investor can say, "I’ll give it another week" over and over, ostensibly forever. This is not the case with options trading. Each option has a set expiration date. At expiration, an option is either worth the difference between its strike price and the current stock price, or it is worthless. There is a key concept to keep in mind when dealing with the limited life of options: profiting from an options purchase depends on the ability to correctly predict both the direction and timing of a move in the price of the underlying stock. The first variable, direction, is easily understood. If the expectation is that the underlying stock price will rise but instead it declines, the investor loses money on a call position. (However, a put option investor could earn money if the expectation is that the underlying stock price will fall and the price does fall.) The second key variable in options trading is the timing of the move. For instance, the holder (buyer) of an XYZ May 35 call is guaranteed the right to buy 100 shares of the stock at $35 per share at any time before the option’s May expiration, even if the stock rallies to $40, $50, or even $70 per share or more. However, it costs more for a July 35 call than a May 35 call because of the additional time, and therefore the improved likelihood that the stock will rally above the price of $35 per share. .
