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Stock Options and How They Trade

Posted by Compound Stock Earnings in Dallas-Fort Worth-Arlington, TX on Apr 21, 2008

Covered Calls is a conservative investment strategy that involves selling an option against an existing stock position. Compound Stock Earnings’ covered call methods allow investors to earn 3 - 6% per month regardless of the market direct. In the book “Covered Calls and LEAPS: A Wealth Option”, written by Joseph Hooper and Aaron Zalewski, they describe what options are and how they trade.

An option is a financial instrument and contract. An option gives the holder the right, but not the obligation, to buy or sell a financial asset at a certain price up to a certain date. An important distinction is “the right, but not the obligation.” The holder of the option does not have to exercise the right under the contract if it is not in his or her favor to do so.

Options (like futures) are know as derivative securities simply because their value is derived from the value of other more basic variables. For example, an IBM stock option is a derivative security because its value depends on the price of IBM stock. The derivative asset is also referred to as the underlying asset. In this case, the underlying asset is IBM stock.

Options are available on many financial assets including stocks, futures, and commodities. Most options are exchange traded, meaning they are traded on public markets, just like stocks are traded on stock exchanges.

There are two basic stock options:
1.    A call option gives the holder the right, but not the obligation, to buy a stock at a certain price up to a certain date. Call options are used by speculators who expect an increase in the price of the underlying asset.
2.    A put option gives the holder the right, but not the obligation, to sell a stock at a certain price up to a certain date. Put options are used by speculators who expect a decrease in the price of the underlying asset.

The covered calls technique involves the use of call options only.

Options trade the same way that stocks do. There are investors who want to buy options and there are investors who want to sell, or write, options. When these two investors reach an agreement on price, the contract trades.

All exchange-traded options have certain standard characteristics.
Take this description of a contract as an example:

General Electric September 2008 $30.00 Call Option

Company Name- All exchange-traded options relate to a specific publicly listed company (or financial asset.) In the above example the contract relates to stock in General Electric (GE).

Expiration date- All options have an expiration date. In this case the option expires in September 2008.

Strike or exercise sale- All options have a specific strike or exercise price.    These two terms are used interchangeably. If you own this contact you have the right to buy GE stock at a price of $30.00.

Type- All options are either a call option or a put option. A call option provides the right to buy the stock. A put option provides the right to sell the stock. This contract is a call option.

If you owned the GE September 2008 $30.00 call option, you would have the
right but not the obligation, to buy GE stock at $30.00 per share up to the
expiration date of September 2005.

Unlike stocks, options are referred to as contracts. In the United States, a
standard contract relates to 100 shares in the underlying stock- this number
changes depending on which country the option is listed in. Thus, if you buy four
GE September 2008 $30 calls, you own four contracts. Each contract relates to
100 shares, so in this instance, you own the right to buy 400 shares.

For more information visit www.compoundstockearnings.com.

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