1. Options
Cliff Trent
September 17, 2010

2. Options
An option is a contract or “Right” between a buyer and seller for a stock at a predetermined price by a certain date.
Options are Securities.
Options carry risk (sometime significant risk) and should not be used without the proper knowledge.
The following is a brief overview on Options and should not be taken as advice to use options or as a replacement for formal training on options.
Options in some opinions can be compared to gambling. You have no idea what your odds of success are and the chances for LARGE losses can be high.

3. Basic Definitions Buyer = Long or owner Seller = Short or writer
Put = Gives buyer right to sell
Call = Gives buyer the right to buy
Strike price = Price written in the option
Exercise = The execution of an option at the strike price
Covered = You own the stock for which you are writing the option
Uncovered = You don’t own the stock you are writing the option for; HIGH RISK!
Premium = Cost of option paid by buyer.

4. Reasons to use Options
They can be used as a hedge against a portion of your portfolio.
They can also provide extra income.

5. The 4 kinds of Options Buying a Call = Bullish on the market
Right to buy shares at a set price
Also known as Long a Call
Selling a Put = Bullish on the market
Obligated to buy if the option is exercised.
Also known as Short a Put

6. The 4 kinds of Options Selling a Call = Bearish on the market
Obligated to sell if the option is exercised
Also known as Short a Call
Buying a Put = Bearish on the market
Right to sell shares at a set price.
Also known as Long a Put

7. Simple memory aid Selling a Put Bullish Expect price of stk to rise
Buying a Call Buy a stock
Buy a Put Bearish Expect price of stk to fall
Selling a Call Sell a stock

8. The 4 kinds of Options Buying a Call = Right to buy shares
Leverage profit – maximize return
Ex: Buy 1 GE 5 Call
Investor only had to put out $500 instead of $5000 and waits on price to rise. (Break even = $55/share)
Delayed buying of shares – wait and see how a company performs
Short protection – Locks in a purchase price and takes away unlimited risk.
Selling a Put = Obligated to buy
Premium Income – Make a profit without selling a security
Purchase the stock at a set price

9. The 4 kinds of Options Selling a Call = Obligated to sell
Greater Return – To gain premiums by the sale and hopefully unexercised writings of calls
Choose a sale price – You get to chose the sale price for the stock. Could be above or below the current mkt value.
Partial downside protection – Writing a “Covered” call by using the premium received to offset the loss on the stock.
Buying a Put = Right to sell to the writer.
Gain on market decline = Looking for stock to decline in price and sell either stock or option
Protecting a Long Position = Locks in a sale position should prices decline.

10. Rules to remember Buy Calls Maximum Gain = Unlimited
Maximum Loss = Premium paid
Sell Calls
Maximum Gain = Premium paid
Maximum Loss = Unlimited*
*note – if you own the stock then it is different between price paid per share and mkt value at time of exercise of option.
Buy Puts
Maximum Gain = Strike price - premium
Sell Puts
Maximum Loss = Strike price – premium
Calls
Break Even on option = Premium + strike price
Puts
Break Even on option = Premium - strike price

11. How an option appears in the paper
Call Put Option/Strike Exp. Vol Last Vol Last Merck 70 Apr Apr May MerrLyn 13 Jul May
Call buyer would pay a premium of 5.40 per share for: Buy 1 Merck Apr 70 Call

12. Last date of when option can be exercised
Example of an option
Name of
stock
Strike
price
Type
Type
Sell 1 XYZ Dec 80 Call 12
Premium
Number Of
Shares
Last date of when option can be exercised
Note: Number of Shares and Cost of Option are always multiples of 100 ie. 1 = 100 and 12 = 1200

13. Expiration of Options Sell 1 XYZ Dec 80 Call 12
This option expires on the 3rd Friday of the month of December.
Options are generally set up to expire on the 3rd Friday of the month listed.

14. How to read an option Sell 1 XYZ Dec 80 Call 5 Math:
Maximum gain = premium received of $500 or 5
Maximum loss = unlimited due to the price per share can rise to infinity.
Break Even = price per share of $80 + (premium of $500/100 shares = $5 per share) = $85
Maximum Gain: $500
Maximum Loss: Unlimited
Share price Break Even point: 85 per share
If you own 100 shares of XYZ.
Maximum Gain: $500
Maximum Loss: Difference between option price and mkt value when option is exercised
Share price Break Even point: 85 per share

15. How to read an option Buy 1 XYZ Dec 80 Call 5 Math:
Maximum loss = premium received of $500 or 5
Maximum gain = unlimited due to the price per share can rise to infinity.
Break Even = price per share of $80 + (premium of $500/100 shares = $5 per share) = $85
Maximum Gain: Unlimited
Maximum Loss: $500
Share price Break Even point: 85 per share
If you own 100 shares of XYZ.
Maximum Gain: $500
Maximum Loss: Difference between option price and mkt value when option is exercised
Share price Break Even point: 85 per share

16. Taxes Options contracts are only good for a year or less.
So all returns on Options are considered to be short term gains.
You should consult with your Tax Professional before buying or selling options to discuss your tax ramifications.