Let's talk about the basics of stock options. Few people trade them and fewer know what they are. An option is the act of buying time - time to do something. If I buy an option, I have finished the first part of the agreement I have with the other party. However, I am no obligation to actually buy the commodity or the underlying asset. In a sense I can let the option expire and pay nothing but the one who sold the option to me keeps the money I used to buy the option.
First of all Options are derivatives of something. That means an Option gains its value from some underlying instrument that has value. In the case of options trading the underlying instrument are stocks, commodities, futures contracts, foreign currencies, or stock indexes. So the options contracts would base its value on the values of whatever instrument you want to trade.
Now remember all an option is a contract between a buyer and a seller. In a contract both parties have to agree upon certain things. One of the first things that the two parties need to agree upon is the strike price. Simply put the strike price is the price in an options contract at which the underlying instrument is bought of sold if the options is exercised. So the buyer of the options contract reserves the right to purchase or sell the underlying instrument for a specified price or strike price. Think of it as the price you are locking in for a premium. The premium is the amount of money you are going to pay to lock in the strike price of the option. In other words, for a call option, I lock in the option to buy the underlying instrument for a certain strike price by a certain date. You will receive a premium for holding that stock for me until the option expires or ends.
Take for example I believe the value of your house is going to increase from its' current value of $100,000 to $200,000 because there is a new sub-division coming in that you might not know about. I am going to pay you $10,000 right now for you to hold the house for me for three more months. By the end of three months, if I choose to, I will pay you $150,000 for your house. You just bought the house for $75,000, so hey you are getting to double the amount of money, so for this example you agree. Now remember no matter what you get to keep the $10,000 premium. So even if I decide not to buy your house for $150,000 you keep the $10,000. If I find someone willing to pay $200,000 for the house I will exercise my rights to purchase the house from you for $150,000. You would have made a profit of $85,000 from when you bought the house and my investment of $10,000 would gain me $40,000.
An important consideration though is that there are tax implications when it comes to stock options. If you hold on to your shares for a set period then there is normally no tax to pay on any profit made from the stock, although this does vary from country to country. So for a simple method to understand stock options just think of it as a chance to get some money based on how successful your company is doing.
First of all Options are derivatives of something. That means an Option gains its value from some underlying instrument that has value. In the case of options trading the underlying instrument are stocks, commodities, futures contracts, foreign currencies, or stock indexes. So the options contracts would base its value on the values of whatever instrument you want to trade.
Now remember all an option is a contract between a buyer and a seller. In a contract both parties have to agree upon certain things. One of the first things that the two parties need to agree upon is the strike price. Simply put the strike price is the price in an options contract at which the underlying instrument is bought of sold if the options is exercised. So the buyer of the options contract reserves the right to purchase or sell the underlying instrument for a specified price or strike price. Think of it as the price you are locking in for a premium. The premium is the amount of money you are going to pay to lock in the strike price of the option. In other words, for a call option, I lock in the option to buy the underlying instrument for a certain strike price by a certain date. You will receive a premium for holding that stock for me until the option expires or ends.
Take for example I believe the value of your house is going to increase from its' current value of $100,000 to $200,000 because there is a new sub-division coming in that you might not know about. I am going to pay you $10,000 right now for you to hold the house for me for three more months. By the end of three months, if I choose to, I will pay you $150,000 for your house. You just bought the house for $75,000, so hey you are getting to double the amount of money, so for this example you agree. Now remember no matter what you get to keep the $10,000 premium. So even if I decide not to buy your house for $150,000 you keep the $10,000. If I find someone willing to pay $200,000 for the house I will exercise my rights to purchase the house from you for $150,000. You would have made a profit of $85,000 from when you bought the house and my investment of $10,000 would gain me $40,000.
An important consideration though is that there are tax implications when it comes to stock options. If you hold on to your shares for a set period then there is normally no tax to pay on any profit made from the stock, although this does vary from country to country. So for a simple method to understand stock options just think of it as a chance to get some money based on how successful your company is doing.
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It is always advisable to understand the fundamentals of stock options before you start trading for real. Stock Options Definition Traditionally stock options were only ever an incentive to the higher echelons of management. There a ton of material you can go through to understanding options trading.
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