Wednesday, August 10, 2005

Why Options?

 
So why trade options?

Well, one good advanatge of options is its high leverage power. For example you think IBM shares would go up. As of 9 Aug, 2005, it costs $83.50 per share. If you want to buy 100 shares, that would cost you $8,350. If in a week's time, IBM rise to $90, you would gain $650 for a nice 7.8% profit. You would need to pay out-right $8,350 to earn $650, unless your brokerage account has margin facility where you foot only a certain % of $8,350 to buy 100 IBM shares.

When you buy options, similarly if you think IBM shares would rise, you would buy a call option (you buy a put when you anticipate the share to drop - think of 911 when airline stocks plunge). Let's say you buy a IBM Sep 85 Call contract when the share price is at $83.50, you would pay only about $116 ($1.16 x 100) per contract. Options are sold at 100 shares per contract. In the same scenario, if IBM rise to $90, your call option would now inherit a intrinsic value of at least $5 (ie. $90 - $85 Strike Price). Since it's a September call option contract and it won't expire til the 3rd Friday in September 2005 (I assume I bought the call contract on 9 Aug, 2005), the call would now worth about $650 ($6.50 x 100) !!! when IBM rise to $90. So, let's see, you sold your call at $650 and yield a profit of $534 (ie. $650 - $116). Wow !! that's a whopping 400% profit !!! And that's what I meant by the high leverage power of options.

The other advantage when buying options is if let's say you bought the same IBM shares and due to unforseen circumstances, the share plunge to $75. If you're holding the shares, you would lose $850 straight away. But if you have bought call option contracts instead, the very most you would lose is the value of the call option ie. $116.

But options do have their downside. They are depreciating assets, meaning if you expect the shares to move in a certain direction and bought a call or put option in the hope the incident would trigger the stock price in your pre-determined direction in a pre-determined period but the event did not happen, your call or put option would lose value as the expiration period of the contract draws near and you would lose money either selling the depreciating option contract at a loss or if you let the option contract expire worthless you would loss the entire value you pay for the options.To have a better understanding of how options work and the terms associated with options trading, you can go to this web-site to get a free CD-ROM which will give you an idea how options work.

http://www.optionsoftware.net/

I would next share some of the mistakes I made while trading options so as to let you avoid these same costly mistakes.

4 comments:

Rick J said...

I have been following a site now for almost 2 years and I have found it to be both reliable and profitable. They post daily and their stock trades have been beating
the indexes easily.

Take a look at Wallstreetwinnersonline.com

RickJ

Rick J said...

I have been following a site now for almost 2 years and I have found it to be both reliable and profitable. They post daily and their stock trades have been beating
the indexes easily.

Take a look at Wallstreetwinnersonline.com

RickJ

Wan said...

Hi Tony, I am new to options trading.

I am in Singapore. There are so many brokerage house in Singapore and which one are you using please? PhilipCapital (POEM), optionsXpress, etc. etc.?

Please advise. Thanks in advance.

Regards, Wan

Tony Chai said...

Hi Wan :

Sorry for the late reply.

I used mainly optionsxpress & interactivebrokers.

Regards,

Tony Chai