Stock Option 101 Vincent Tzeng March 25, 2011

What is “stock option”? A contract or right to buy or sell a stock at a certain price before a certain date A contract or right to buy or sell a stock at a certain price before a certain date

Key Variables Type of options = Call or Put Contract price = Striking price End of contract date = Expiration Date 1 Option Contact is based on 100 shares of the underlying stock Price of an option changes all the time Type of options = Call or Put Contract price = Striking price End of contract date = Expiration Date 1 Option Contact is based on 100 shares of the underlying stock Price of an option changes all the time

What are “CALLs” & “PUTs” options? Call = contract to BUY a stock Put = contract to SELL a stock There are agreed price, specific time, and an underlying stock involved in all contracts.

Option Contract Buyer & Seller Buyer pays a settled price($) to Seller Buyer gets the RIGHT to buy (call) or sell (put) the stock anytime before the expiration date (Exercise an option) All options END on the Expiration Date Seller can end an option by buying back

Why buy a Call Option?  Buyer bets the stock will GO UP substantially before the expiration date.  Buyer hopes to buy the stock at lower than the market price.  Buyers usually are aggressors & big risk takers, looking for “quick $ gain”.  Buyers take risk, and lose “most of the times”

It is better to SELL call options Seller receives instant cash Seller can reduce cost base Seller continues to collect dividend It is like selling “time” for cash! Sellers win “almost all the times!”

Go Higher Go Lower Stay the same Go Higher Stock Price may go in 3 Ways selling call option reduces your cost base

Starting stock price Striking price Stock$ + option$ received (1)final stock price on expiration, stock will be called (2) final price, stock will be called (3b) final price, still own the stock (3a) final price, still own the stock Seller’s profit Selling covered CALL options (own stock)

Why Buy a PUT Option?  Buyer bets stock price to go lower  Buyer hopes to SELL the stock at a higher than the market price before the expiration date.  Buyer can reduce down side risk of a stock

Starting stock price Striking price Option$ received (1)final stock price on expiration, you have to buy the stock at striking price. (2) final price, you have to buy (3b) final price on expiration date, as if nothing happened (3a) final price, as if nothing happened Seller’s profit Selling PUT options

Let’s look at some examples, NVDA, GOOG

Example : NVDA

NVDA options w striking price at $20

NVDA options w expiration date in September

NVDA options w expiration date in January 2012

GOOGLE options w expiration date in January 2012

APPLE options w expiration date in January 2012

Account Requirement to Trade Options  Need a Margin Account, and brokerage firm’s approval for trading options  Own stock (>100 shs) to sell covered option  IRA or ROTH requires enough cash reserve to sell put options  You can always risk to buy any options  1 contract is based on 100 shares of stock

SummarySummary  Stock option can be a good investment tool.  Conservatively, can add to your asset gain.  Get instant cash while holding on your stock  ROTH is TAX-FREE on option gains.  Do options ONLY on “good” stocks.  Understand consequences before trading.  Do SELLING (covered only), not BUYING!

Summary (negatives) May limit your overall gain Relatively short term (market timing?) Tie up your stock under option contract Tie up your cash from selling PUT Tax issues on regular stock accounts More complicated trading than stock “Naked Writing” can lose your shirts!

WARNING!WARNING! SeriousSerious ** Option Trading ** may NOT be for Everyone!!!

ReferencesReferences Stock_Options_Explained.htm

一寸光陰一寸金， 為何不來賣光陰？ On selling stock options - Vincent Tzeng