Questions and Answers about Options InvestingOptions investing is fun to learn. One way to really keep up on the learning curve is to look at questions others have asked and have been answered by safe-options-trading income. The following is a sampling of some options investing questions and answers, provided to you because you may have the self-same or very similar queries. Some of these have been answered on Yahoo! Answers, where they have recieved "Best Answer" award.
Answer: By "Payoff" I assume you mean "results from the trade". You can make money or lose money every time you buy or sell an option, whether it be a call or a put. Lets take buying calls first: The downside risk is the price you pay for the calls. If they expire worthless, you lose what you paid for them. Your upside potential is theoretically unlimited because they will rise in value as the underlying rises. You must sell them for a profit before they expire though. Lets look at selling calls: Your maximum payoff is the premium you receive for selling the call. Your downside risk is theoretically unlimited (unless you are trading a covered call) if the underlying rises to heights unforeseen. Similarly with buying and selling puts.
Question: I've got a few questions related to options trading: 1. Who is usually the writer? 2. As a buyer of call/put options contract, if we choose to sell it for profits, do we have to wait till 1 month before expiration before selling and is there any implication if somebody exercise it after I sold that contract? It kinds of bothers me as I can't seem to find the answers... Answer: The writer or seller is an anonymous individual or institution looking to make income by collecting the premium you paid to buy the option. You do not have to wait one month, you can close out your position at any time the options market is open. Once you are out of the contract, you release yourself from any further implications (except tax that you may have to pay on your proceeds). You need to round out your knowledge about options. They can be very profitable when used wisely, but you can get burned.
Question: I make a significant potion of my yearly income from options trading. I've always wondered if it is possible to avoid or defer the costly short term capital gains taxes. The advice I've received so far does not seem to apply to gains made from options investing. Answer: You are out of luck. You must pay capital gains tax on option gains, at least in the US. You might be able to defer some of these gains to the next year in a few special circumstances: for example if you sold a call or put in year one and bought it back or it expired in year two. Also, if you have less than $3000 in capital gains and greater capital losses than gains you can avoid paying capital gains tax on your winners.
Question:_______________ is(are) the right to buy a certain number shares of a company's stock at a? a. Stock options b. Cash compensation c. Stock-based compensation d. Perquisites Answer: Stock options is only partly correct. There are put stock options and call stock options. It is the call stock option that grants the owner the right to buy stock at a specified price.
Question: How do you value an options contract ? Answer: The value of an option is a function of several factors including the volatility of the underlying security, the time remaining in the option's life, and the relative position of the strike price of the option to the price of the underlying security. The theoretical value of an option is calculated by mathematical models. The parameters in these models are named afer Greek letters, hence the term Options Greeks. In practice, the value of any given option changes tick by tick as the market is open. You can look up the end-of-day value of any listed option in the business sections of most good newspapers. During the day you can get the value of any given option by going online to sites like Yahoo Finance.
Question: In a stock collar, can the income earned when the call option is sold be offset by the cost of the put option? Answer: There will be income from the call sold, and a debit for the put bought. Ideally, the cost of the put will be less than the premium received for the call, resulting in a net credit at the outset of the trade. If called out you get the capital gain to add into you profit. If the stock drops below the put strike price, exercise that put and keep your call premium. The collar gives a valuable measure of safety to the covered call.
Question: With reference to "option trading", is a "put" the right to be able to sell a stock at the strike price? If the strike price of a certain put is "in the money" on expiration day, does that mean that I can sell that stock at that price? So if I have regular stocks and the stock price goes down later on expiration day, does that mean that I can now sell my original regular stocks at my put strike price? Answer: A put is a contract between the put buyer and the put seller. The put owner buys the right to sell (or "put") shares to the put seller at the strike price of the put at any time until the option expires. A put is "in the money" anytime the stock price is lower than the strike price of the put. Buyers of puts are often doing so to insure the value of their portfolio against losses.
Question: What actually does a Short Position in a call option mean? Answer: You can be either long or short and options position. To be long means you are the buyer of the option. To be short means you are the seller of an option. Since a call option is a binding contract, having a short call position places you in the position of having to deliver 100 shares of the stock at the strike price of the option to the call buyer should she exercise her call. Obviously, this can place you in a risky position, especially if the stock price should decrease. To partly compensate you for this risk you will receive a premium (dollars into your account) for entering the short call position. Keep on mind that you can mitigate the risk of entering a short call by already owning the underlying shares; this is called a covered call and is used all the time by conservative investors.
Question: How does a stock option work? Answer: A stock option is a contract between an option buyer and an option seller. There are two types of stock options: puts and calls. Regarding puts: The put buyer has the right to sell (that is to "put") 100 shares per contract of the specific stock to the put seller at the strike price of the put at any time until the put expires. The put seller is obligated to take ownership of these shares should the put buyer exercise his right, regardless of the actual price of the stock. The put seller is compensated for the risk having the stock "put" to him by receiving a premium. The put buyer is generally trying to insure his stock holdings against a downturn in stock price. The put seller is trying to capture income. Regarding calls: The call buyer has the right to buy (that is to "call") 100 shares per contract of the specific stock from the call seller at the strike price of the call option at any time until the call expires. The call seller is obligated to provide these shares if the call owner exercises his right, regardless of the then current price of the stock. As you can imagine, the call seller takes on a real risk and he is compensated for that risk by being paid a premium.
Question: Can you suggest a useful method to profit from options near their expiration? Answer: Try selling out-of-the-money options just before expiration to gain incremental income. You'll recall the beauty of options decay: at the very end of their life, options waste away the fastest. By selling out-of-the-money options a few days ahead of expiration you can maximize this decay effect to your advantage. You won't make a killing, but you can construct some high win percentages on a monthly basis.
Question: What are some ways to shelter my stock option earnings from being taxed so heavily?
Answer: You can consider making the trades in an IRA or other tax-sheltered account.
Question: What are the advantages and disadvantages of covered-call trading?
Answer: Covered calls can be a good way to make profits in the stock market. Like anything in the stock market, there are risks associated with the potential rewards. The principle advantage of the technique is that it brings immediate cash into your account when you sell the call, providing you with an immediate positive return and lowering the basis of your stock investment. Over time, a covered-call program can bring in a considerable sum to your account. The main disadvantage is that the technique does not work well in a sharply declining market, (but neither does simple stock ownership without covered calls!).
Question: I have heard some people say that options can have unlimited losses? How is this possible?
Answer: When speaking about unlimited losses, most people would be referring to selling a naked call. Buying a put, buying a call, and selling a put would not result in potentially unlimited losses (although they may be large). The reason why selling a naked call can result in an unlimited loss is because theoretically a stock can rise in price to infinity. Since the seller of the call must provide shares to the call owner if called, the naked seller runs the risk of having to purchase shares at very lofty levels if the underling suddenly "shoots up to the moon" Of course, one safe way to make money selling calls is by selling covered calls, where you already own the stock, and if called out, you are covered.
Question: Can Iron Condors be used as a conservative options-selling technique? Answer: Iron condors can be made into a conservative options strategy especially when the following three caveats are kept in mind: 1. Make sure the sold call on both sides of the condor are quite far out of the money, 2. Find a range-bound stock or ETF without too much volatility, and 3. Keep your commissions rock-bottom low. Subscribe to Barron's Magazine today and get 52 weeks for $149 Plus 4 FREE WEEKS Question: What is the "Delta" of an options and where do I find it? Answer: The Delta of a stock option is a very useful number to know. Delta measures the change of an option’s price relative to the change in price of the underlying security. Calls with Deltas that are approaching 100 (and corresponding puts with Deltas approaching -100) move in close lockstep with the underlying. Deep-in-the money options have high Delta values. Conversely, options with Delta values nearer to zero move much less relative to price moves in the underlying security. Far out-of-the money options have Deltas nearer to zero. You can find the Delta for any given option in many places. Good, option-friendly, online brokerages such as OptionsXpress or Fidelity provide Delta for any listed option.
Question: What does it mean to sell an option and then buy it back? Answer: If you are new to option selling, the concept of “sell before you buy” may be difficult to grasp at first. In the world of stocks, options and futures you can sell an instrument before you own it. This is called "sell to open" a trade. If you want to close the trade, you offset the sold instrument by "buying it back" or "buy to close". This will rid your account of the sold position. You may have a gain or a loss.
Question: What is the difference between buying a call option on XYZ stock and buying shares of XYZ stock? Answer: A call is a contract that provides the buyer of the call with the right (but not the obligation) to buy 100 shares of the underlying stock at the strike price. The price of the call is substantially cheaper than the price of the full 100 shares of the underlying stock. Calls rise in value when the price of the underlying stock goes up. Calls decrease in value when the price of the underlying stock goes down. Many people who buy calls are speculating that the price of the underlying will go up so they can sell the call for a higher price than they paid for it. You need to be careful with this technique because options have a limited lifespan and they can expire valueless, meaning you can easily lose your entire investment.
Question: Please explain the "bid-ask spread" when buying or selling options. Answer: When you see priced quoted for any option (or stock for that matter), there are two prices shown: (1) the price at which the option is offered for sale, known as the ask; and (2) the highest price someone wants to pay for the option, known as the bid. The bid-ask spread can be very narrow or quite wide, depending on the liquidity of the option. Some options on thinly traded stocks have very wide bid-ask speads, which can reult in quite a bit of slippage when entering a trade on these.
|
