Investing: how does an option?

Miscellaneous SpookyAlfred August 8, 2016 0 0
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Options are very interesting investment instruments. By investing in options you can obviously make a profit when prices rise, but with the right strategy, you can also make a profit if prices remain stable or even fall. With options you can achieve spectacular gains, but you can also suffer huge losses. So it's good to know where you're getting before you trade options.

What are options?

An option gives you the right but not the obligation, to buy or sell the underlying instrument at a pre-agreed price.
It is better to explain to the means of an example:
Suppose that at some point the share price Heineken is 70 euros. At the same time, the option to buy Heineken's share for 70 euros 2 euros. For 2 euros you can buy over the right to buy a share of Heineken for 70 euros. Why would you do this and not just buy the share itself? Suppose the share price drops to 65 euros. Then you can choose not to exercise the option. Then you lose only 2 euros a share, instead of 5 euros. The opposite can also happen: the price of the share rises to 75 euros. Then you can exercise the option and buy the shares for 70 euros and sell back for 75 euros. Your profit is less than 5 euros the 2 euro cost option, so three euros. Options contracts always go 100 pieces. So have you made a profit of 300 euros with a deposit of 200 euros. And while at that price initially not even three shares of Heineken could buy. This is called leverage of shares.

The exercise price

An important feature of an option's exercise price, 70 euros in the above example of Heineken. There are options of different strike prices available. The further the exercise price is below the current price, the more expensive option, because it is likely that the share may be sold for profit. Vice versa is also true that the price of the option is lower, as the exercise price further above the current share price. The rate should finally first increase significantly before this option can make a profit on.

The expiry date

Unlike a stock, an option has an expiration date, the expiration date. After this date, the option can not be exercised. This is a very important property of an option. Has the option reached by this date still not the rate that was necessary to make a profit, you're so lost your investment. In the above example of Heineken shows that the share price must be at least above 72 euros to make a profit. If the price on the expiry date is still 70 euros, you have made two euro loss. This clearly indicates the risk of options. You only have limited time to achieve your profit, and otherwise it is automatically lost.

Call or put?

The example of Heineken that is given above is an example of a call option: the right to buy the share for pre-arranged strike price. But the reverse is also possible: an option that gives you the right to sell the share for pre-arranged strike price. This is called a put option. When a put option do precisely profit when the price falls. Finally, you buy the right to sell a share at a predetermined price. If the price drops to 65 euros and you have a put option with a strike price of 70 euros, you can sell the shares for 70 euros, you can buy yourself at that point for 65 euros. Of course you also pay another price for the option.

Purchase or write an option

Above describes how it works if you buy an option. You can also write an option. The writing of an option is also called sales. But unlike some sales suggests an option does not have to be in your possession to write him. When you write an option, you stand as it were on the other side of the transaction. When someone buys a call option, he buys the right to purchase a share at the exercise price. When somebody same call option writing, he is obliged to deliver the shares to the agreed price, if the buyer of the option exercises its option. In return you'll get a premium.
To get to the Heineken example again:
When the call option Heineken buys you pay 2 per option with an exercise price of 70 euros. These two euros will go to the person who wrote the option. If you write the option, so you get money initially. This is called the premium. As long as the buyer does not exercise the option, so you earn money. However, writing an option is very risky, because the potential loss is unlimited! If the price rises to 75 euros and the buyer exercises the option, then you are obligated to provide the option for 70 euros, which you pay yourself at that moment 75 euros. The profit made by the buyer, so does the writer today. And there's no limit to how far may increase the price of a stock! Writing an option is the only way to make a profit at a constant share price. As long as the exchange rate rises less than the original premium you received make profit. Despite a decline in exercise price, you will also profit. The profit is limited to the premium you received, because the buyer of the option will never exercise it when they are loss making even greater than the initial investment.
Also a put option, you can write. Again, you get what the buyer pays for the option premium. When a put option writing do precisely profit when the share price rises. If the share price falls make up your loss. This loss is not unlimited, as in writing a call option because the share price can not be lower than 0 euros. But when the share price falls, the loss still his gigantic considerably. Writing a put option is also very risky.

Options trading

Options are also listed instruments. The rates are for example found on websites such as finance.yahoo.com and. You do not have to exercise the option to make a profit, but you may be an option again sell at a profit when the price of the option rises. Or you can sell an option to limit your losses. The price of the option depends on a number of different things, such as the price of the underlying value at that time and the time until the expiration date, but also of the market sentiment. The bulk of the gains and losses on options are achieved through trade. Only a small part of the options is exercised effectively.
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