New to options ==> Looking for confirmation

[gogi]

I've tried to understand options in the past, they all seemed so complex that I gave up a couple of times.

Recently I read an explanation of the most basic, buying and selling options. The explanation seemed simple enough, but I can't believe what I'm reading - it just seems too good to be true.

Please let me explain my understanding of selling a call, and help me understand where the negative aspect is... as it just seems to good to be true.

If I own 100 shares of ABC Company, currently trading at $10.00. I look at
the options currently selling for ABC Company, there is an option with an
expiration WAY into the future (Jan 2011), a strike price of $12.50. The call
is selling for $3.10.

Ok, so I decide I want to sell a single contract of ABC Company, I own the stock so it is not a naked trade. The following statements are all true?

- I collect $310 when I sell the option.
- If the stock reaches $12.50 I may be forced to sell the stock, I would get $12.50 for every share PLUS I keep the initial $310.
- If the stock drops back down to $8.00 and never reaches the strike price before expiration I still own my 100 shares and I keep the $310.
- The closer to the expiration date, the less the option is worth - unless the stock prices goes above the strike price, at which point it is 'in the money'.


Anyone see a problem with my understanding so far?


Gogi

[mrmarket]

nope...everything you state is correct. The part you left out is that if the stock goes to $300 per share, you need to sell it at $12.50.

[gogi]

Thanks for the reply Mr. Market.

I'm OK if the stock goes upto 300, I would rather take my known profit.

BUT, if as in my example I sell the covered call with an expiration of Jan 2011. Odds are good that at some point between now and Jan 2011 the stock which is at $10.00 WILL go over $12.50.

I suspect that if the stock went above $15.50 that the option holder would quite likely not exercise the option (they would just sell the option). I would end up holding my 100 shares that I am using to cover the sold call option until Jan 2011.

Ideally if the stock hit the strike price people would exercise the option, and I take my known profit and am happy. I suspect in reality, I'm going to be backing that covered option for a very long time even if the strike price is reached quickly, which blocks up my cash and prevents me from doing any trading with those funds.

I think that is the negative point I have been missing.

I don't care if the stock goes to $300, if I've sold my stock and taken the premium... but after thinking about the option holder has the OPTION but they probably will not actually execute the option, it will just keep getting sold over and over on the market. Then I'm sorta locked in for two years.

Is my thinking still on track?


Gogi

[New-born baby]

Thanks for the reply Mr. Market.

I'm OK if the stock goes upto 300, I would rather take my known profit.

BUT, if as in my example I sell the covered call with an expiration of Jan 2011. Odds are good that at some point between now and Jan 2011 the stock which is at $10.00 WILL go over $12.50.

I suspect that if the stock went above $15.50 that the option holder would quite likely not exercise the option (they would just sell the option). I would end up holding my 100 shares that I am using to cover the sold call option until Jan 2011.

Ideally if the stock hit the strike price people would exercise the option, and I take my known profit and am happy. I suspect in reality, I'm going to be backing that covered option for a very long time even if the strike price is reached quickly, which blocks up my cash and prevents me from doing any trading with those funds.

I think that is the negative point I have been missing.

I don't care if the stock goes to $300, if I've sold my stock and taken the premium... but after thinking about the option holder has the OPTION but they probably will not actually execute the option, it will just keep getting sold over and over on the market. Then I'm sorta locked in for two years.

Is my thinking still on track?


Gogi

Gogi,
First, if the stock went to $15.50 at expiry, no doubt they'd take your stock. There is absolutely no question about it. The broker is going to take it away.

Now consider this:
Would you care if you sold an option for $3.10 if the stock went to $2? Jan 2011 is a long time from Dec 2008. You are not getting a lot of dough to hold that stock for two years, imho. Does it pay a dividend? What you are risking is hold a dog while it dies on you. For instance GM: a year ago, it was a $30 stock. IF you sold a Jan 2010 option for $3.10, would you feel good about that trade today? Just something to think about.

Now if your stock paid a 15% divy and you sold a Jan 2011 call, I might be more inclined to take the risk. Remember this market has not yet bottomed. Yes, we've found a temporary bottom here at an 8000 DOW, but the chart insists the bottom is 6000. I figure the Jan earnings reports may precipitate another decline.

I could be wrong.

[gogi]

Gogi,
First, if the stock went to $15.50 at expiry, no doubt they'd take your stock. There is absolutely no question about it. The broker is going to take it away.

Now consider this:
Would you care if you sold an option for $3.10 if the stock went to $2? Jan 2011 is a long time from Dec 2008. You are not getting a lot of dough to hold that stock for two years, imho. Does it pay a dividend? What you are risking is hold a dog while it dies on you. For instance GM: a year ago, it was a $30 stock. IF you sold a Jan 2010 option for $3.10, would you feel good about that trade today? Just something to think about.

If the stock goes to $15.50 they can have it, I would be happy to give it to them. I would be pocketing an excellent return, I say this assuming they would take ownership of the stock when it hits $15.50.

But how often do people exercise the option prior to expiry? If I sold the option now while the stock is at $10.00, strike $12.50 (expiry still Jan 2011) but it hits $15.50 in March 2009 will they take the stock at that time? One can't tell right?

If I sell the 2 year option today, and it hits the strike price in only a couple of months I would be glad to hand over the stock. If it hits the strike price in a couple of months, but they don't exercise the option for two years that would suck.

Basically I'm trying to figure out how to use the option to generate a bit more income from owning the stock. Glad to sell if it goes up, glad to sell the option if it does not hit the strike also of course...

Selling the call on GM would of course not been a good thing, BUT at least you have the premium. Had you held the stock, it crashed and you had not sold the option you would have even less right?


Gogi

[skiracer]

its a foolish position. what did you pay initially for the stock and why would you want to tie your money up for approx. two years to make $310. you could take that same money and in the course of two years make 30 or 40 trades and possibly make alot more money or possibly lose alot more money. my bet would be on the latter. sounds to me like you dont know much about the inner workings of options or the numerous factors that effect their movement. newborn has probably forgotten more about options than you know at the present. it would do you well to listen to what he has to say but i think your mind is already made up. read a few books or take a couple of webinars and learn alot more about them. you havent scratched the surface with what you know about them.

[skiracer]

you're talking about a long term option, a LEAP, which trades much differently than regular options, and when trying to exit is much harder that one would assume if not educated or experienced in trading them previous to this specific trade. the position doesnt make much sense to me. you're tying up the cost of the 100 shares of stock, which you never stated what you entered the position at, and that $310 which you got from selling the call will get spent before it is really earned and in the course of approx two years that stock may go up and down between the strike and who knows which could trigger your exiting for a few reasons. most not in your control. in the course of that time you could possibly do 30 - 40 trades with that capital and depending on how active you become either make more money and experience trading than the $310 or go broke. options are so much more involved and intricate than you could imagine at this point in your trading career that you should take the time to study them and how they work before ever investing in them. newborn may have forgotten more than you may ever learn about them and has traded some exotic combinations of puts and calls with success. his observations should be taken as such and considered.
there are a number of great sites that are devoted almost entirely to options. www.cboe.com will provide more than enough seminars and webinars to bring you up to speed on all the facets of trading them. www.optionsexpress.com is good for anything regarding options. it sounds like you have already made your mind up or are in both positions with the trade. good luck with it but take some time to consider all the so called "options" and what to do with the money.

[ninner]

Gogi,
First, if the stock went to $15.50 at expiry, no doubt they'd take your stock. There is absolutely no question about it. The broker is going to take it away.

Now consider this:
Would you care if you sold an option for $3.10 if the stock went to $2? Jan 2011 is a long time from Dec 2008. You are not getting a lot of dough to hold that stock for two years, imho. Does it pay a dividend? What you are risking is hold a dog while it dies on you. For instance GM: a year ago, it was a $30 stock. IF you sold a Jan 2010 option for $3.10, would you feel good about that trade today? Just something to think about.

Now if your stock paid a 15% divy and you sold a Jan 2011 call, I might be more inclined to take the risk. Remember this market has not yet bottomed. Yes, we've found a temporary bottom here at an 8000 DOW, but the chart insists the bottom is 6000. I figure the Jan earnings reports may precipitate another decline.

I could be wrong.

your not wrong market is going lower but its going to need to build alot more cause to get down there...im speculatiing that we will have a nice rally for the next 2 months or so....starting in january before the market goes lower.....needs more force to go down further......i want to see what the s&p acts when it gets too 1007.51...if we have volume there we are going higher if not and we fail there then we will go back to the bottom of the range again.

[skiracer]

I've tried to understand options in the past, they all seemed so complex that I gave up a couple of times.

Recently I read an explanation of the most basic, buying and selling options. The explanation seemed simple enough, but I can't believe what I'm reading - it just seems too good to be true.

Please let me explain my understanding of selling a call, and help me understand where the negative aspect is... as it just seems to good to be true.

If I own 100 shares of ABC Company, currently trading at $10.00. I look at
the options currently selling for ABC Company, there is an option with an
expiration WAY into the future (Jan 2011), a strike price of $12.50. The call
is selling for $3.10.

Ok, so I decide I want to sell a single contract of ABC Company, I own the stock so it is not a naked trade. The following statements are all true?

- I collect $310 when I sell the option.
- If the stock reaches $12.50 I may be forced to sell the stock, I would get $12.50 for every share PLUS I keep the initial $310.
- If the stock drops back down to $8.00 and never reaches the strike price before expiration I still own my 100 shares and I keep the $310.
- The closer to the expiration date, the less the option is worth - unless the stock prices goes above the strike price, at which point it is 'in the money'.


Anyone see a problem with my understanding so far?


Gogi

cant seem to post to this.

[New-born baby]

But how often do people exercise the option prior to expiry? If I sold the option now while the stock is at $10.00, strike $12.50 (expiry still Jan 2011) but it hits $15.50 in March 2009 will they take the stock at that time? One can't tell right?

You can't tell, but most likely, they won't take it until JAN 2011. However I have had
stocks called away. Usually it happens this way: I sold a call on a stock that was deep in the money to protect myself on a stock that I figured was going to plunge lower. I didn't want to sell for a loss, so I sold the call instead. I have had that happen to me a couple of times.

If I sell the 2 year option today, and it hits the strike price in only a couple of months I would be glad to hand over the stock. If it hits the strike price in a couple of months, but they don't exercise the option for two years that would suck.

And that is probably what would happen, too. Or the broker would exercise the option when he figures the peak had been put in, to maximize his profits. In any case you'd best figure that your money will be tied up for two years.

Basically I'm trying to figure out how to use the option to generate a bit more income from owning the stock. Glad to sell if it goes up, glad to sell the option if it does not hit the strike also of course...

Selling the call on GM would of course not been a good thing, BUT at least you have the premium. Had you held the stock, it crashed and you had not sold the option you would have even less right?

You are on the right track in trying to use the option to generate more cash flow. Why not look at options that expire in one month, or at the most, two months? Believe it or not, you'll generate more cash flow this way, with less risk. You see, it is pretty hard to anticipate what a stock may do in the next two years, but much easier to look just one month away.

Here's a suggestion: post a stock that you believe in, and I'll take a look at it and perhaps a good trade will pop up out of this discussion.

[New-born baby]

A suggested trade

PWE pays a monthly dividend of 2%, about $0.28 per share per month. You can buy the stock at $10.91 today, and sell the FEB 2009 $12.50 strike for $0.25 per share. That comes to $0.25 for the call money + $0.28 divy + $1.59 capital gain for one month IF**IF**PWE makes it to $12.50 on expiry (Feb 20,2009). IF not, it is not likely that PWE will fall much in share price, and you'd still have that $0.53 profit to keep.

[ninner]

swn

hey nb what do u think about SWN i have march 40 calls ....and im losing at the moment lol...im also in TIE and X long both of which i bought last week.

[gustongroves]

Even I’ve confusion with options. But I always feel investing in option is like sailing on an ocean with out a compass. As per my knowledge, in options we have to buy or sell the specific amount of shares at the market rate in the specified time. What if the condition is not going in our way and more over we can’t predict what would be the next thing like raise or fall in the stock market. The newbie’s who would like to know more in regard to options can check this link http://shortcuttoprofits.com