Options Trading Rundown

The following info was gathered from E*TRADE’s Options Trading for Beginners Series.

Call

This is a strategy to use if you expect the price to go up.

Buying a call is like buying a coupon. Maybe I don’t want to buy pizza today even though it’s only $8, but I think the price is going up so I can buy a coupon for $10 to use if/when the price goes above $10 (factoring in the cost I paid for the coupon). Same with stocks – I buy the choice, “option”, to buy it at a certain price even if the price goes above that. If it doesn’t hit that certain price I do not have to buy it. This is great if I can use a $10 coupon on a $20 pizza!

You earn/save money if the price goes up beyond the value of the coupon plus what you paid for that coupon. If you pay $1 for the option to buy at $10, you won’t make a profit selling the stock until the price is at least $11+.

You lose money with this strategy if you’ve paid for a coupon, “option”, that you never get to use when the price doesn’t go up as expected. i.e. You paid $1 for the option to buy at $10, but the price doesn’t rise beyond $10 before the option expires.

Put

This is a strategy to use if you expect the price to drop.

Buying a put is like buying insurance. I already own my car, but I expect the value to drop. Buying a put allows me to sell my $8000 car (or stock) for $7000 even if the actual value drops below that.

You earn/save money if the value drops below the value of the option. If I buy a stock for $10 but I’m worried the price will fall, I can buy a put for $9 and if the price drops to $5, I can still sell for $9. If I paid $1 for the option to do this, I essentially get rid of this stock for $8 instead of only $5. So this is a strategy to use if you expect the price to drop.

You lose the amount you paid for the option if the stock doesn’t drop.

Covered Call

This is a strategy to use if you expect the price to drop.

This is when I’m on the other side of a call, selling someone else a coupon for a stock I own. If I’m willing to sell a stock I paid $10 for once it reaches $12, I make not only the $2 profit, but the amount I was paid to sell it (which I get up front).

You earn money if the stock doesn’t go up and the “coupon” is never used.

You lose money if the stock rises more than anticipated and you have to sell your stock that’s worth $20 for only $12.

Cash Secured Put

This is a strategy to use if you expect the price to go up.

This is when I’m selling someone else insurance (agreeing to buy their stock if it drops). If a stock costs more than I’m willing to pay for it, someone pays me to buy it from them if/when it drops. I get the premium even if it doesn’t drop, but if it does drop I get the stock at the price I wanted it for.

You gain money if the stock doesn’t drop (because you keep the premium) or if it drops to the price you’ve agreed to buy it for, but not lower.

You lose money if the stock drops below what you’ve agreed to pay for it. i.e. A stock is currently worth $100, I agree to buy if/when it drops to $95, but it drops all the way to $90.

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