Covered Call

Long the stock, short a call. The term "buy-write" also is used for this strategy. This has essentially the same payoff as a short put

Covered Call = Long Stock + Short Call

This strategy is best implemented in a bullish to neutral market where a slow rise in the market price of the underlying stock is anticipated. This technique allows traders to handle moderate price declines because the call premium reduces the position's breakeven. Since the profit on a covered call is limited to the premium received, the premium needs to be high enough to balance out the trade's risk. This is good for stock that you like to keep it long term and also get some extra propfit (option premium).

EXAMPLE:

If you believe that Microsoft will be up slowly, you can either buy MSFT stock and sell it's call option. Let's see the example of buying MSFT 100 share and sell

1 contracts (100 share) MSFT October 32.5 call.

1. Buy 100 share MSFT

MSFT current price - $ 30

Commission - $ 10

Total cost - $ 3010 (30*100+10)

2. Sell 1 contracts of Oct. MSFT 35 Call

Premium - $ 1.00/contract * 1 (1.00*100) = $ 100

Commission - $ 20

Total cost - $ 80 (100-20)

Max risk - $ 2930 (3010-80)

Breakeven - $ 29.30 (30.1-.8)

Max profit - unlimited to the upside over breakeven

If CSCO price climb up to 34

Option Profit - 80

Stock Profit - 390 {(34-30.10)*100}

Total - 470

After the call option expire worthless (MSFT price less than 35), you can sell a call option over and over again. Or your option is assigned (MSFT price above 35),

you sell your stock to call option buyer. Now, you can buy the same stock or find other target(stock) and repeat this strategy.

Example of Long Call /Short Call/Long Put/Short Put

Long Call (Buying Call)

A trader who believes that a stock's price will increase might buy the right to purchase the stock call option rather than just buy the stock. He would have no obligation to buy the stock, only the right to do so until the expiry date. If the stock price increases over the exercise price by more than the premium paid, he will profit. If the stock price decreases, he will let the call contract expire worthless, and only lose the amount of the premium. A trader might buy the option instead of shares, because for the same amount of money, he can obtain a larger number of options than shares. If the stock rises, he will thus realize a larger gain than if he had purchased shares. This is an example of the principle of leverage.

EXAMPLE:

If you believe that CSCO will be up, you can either buy CSCO stock or buy call option. Let's compare the difference between buy CSCO stock 100 share and buy

5 contracts (500 share) CSCO October 30 call.

1. Buy 5 contracts of Oct. CSCO 30 Call

CSCO current price - $ 28

Premium - $ 1.70/contract * 5 (1.7*500) = $ 850

Commission - $ 20

Total cost - $ 870 (850+20)

Max risk - $ 870 (850+20)

Breakeven - $ 29.74 (28+1.75+20/5)

Max profit - unlimited to the upside over breakeven

Margin - none

If CSCO price climb up to 33

Premium - 3.5/contract

Profit - 860 (3.5*500-870-20)

2. Buy 100 share CSCO

CSCO current price - $ 28

Commission - $ 10

Total cost - $ 2810 (28*100+10)

Max risk - $ 2810

Breakeven - $ 28.10

Max profit - unlimited to the upside over breakeven

If CSCO price climb up to 33

Profit - 480 (3300-2810-10)

Short Call (Naked short call -Sell Call)

A trader who believes that a stock's price will decrease can short sell the stock or instead sell a call. Both tactics are generally considered inappropriate for small investors. The trader selling a call has an obligation to sell the stock to the call buyer at the buyer's option. If the stock price decreases, the short call position will make a profit in the amount of the premium. If the stock price increases over the exercise price by more than the amount of the premium, the short will lose money. Unless a trader already owns the shares which he may be required to provide, the potential loss is unlimited. However, such a trader who sells a call option for those shares he already owns has sold a covered call.

EXAMPLE: (Only for experienced investors who have lots of margin available can take high risk)

If you believe that CSCO will be down, you can either short CSCO stock or sell call option. Let's compare the difference between short CSCO stock 100 share and sell

5 contracts (500 share) CSCO October 30 call.

1. Buy 5 contracts of Oct. CSCO 30 call

CSCO current price - $ 28

Premium - $ 1.50/contract * 5 (1.5*500) = $ 750

Commission - $ 20

Total cost - $ 770 (750+20)

Max risk - unlimited to the upside over breakeven

Breakeven - $ 29.46 (28+1.50-20/5)

Max profit - $ 730 (750-20)

Margin - yes with high margin available

If CSCO price stay below 30

Profit - 730 (750-20)

If CSCO price climb up to 31

Loss - 770 {(31-29.46)*500 +20}

2. Short 100 share CSCO

CSCO current price - $ 28

Commission - $ 10

Total cost - $ 2810

Max risk - unlimited to the upside over breakeven

Breakeven - $ 27.90

Max profit - $ 2780 (2790-10)

Long Put (Buying Put)

A trader who believes that a stock's price will decrease can buy the right to sell the stock at a fixed price. He will be under no obligation to sell the stock, but has the right to do so until the expiry date. If the stock price decreases below the exercise price by more than the premium paid, he will profit. If the stock price increases, he will just let the put contract expire worthless and only lose his premium paid.

EXAMPLE:

If you believe that CSCO will be down, you can either short CSCO stock or buy put option. Let's compare the difference between short CSCO stock 100 share and buy

5 contracts (500 share) CSCO October 25 put.

1. Buy 5 contracts of Oct. CSCO 25 put

CSCO current price - $ 28

Premium - $ 1.50/contract * 5 (1.5*500) = $ 750

Commission - $ 20

Total cost - $ 770 (750+20)

Max risk - $ 770 (750+20)

Breakeven - $ 26.46 (28-1.50-20/5)

Max profit - $ 13230 (26.46*500-20) if CSCO bankrupcy

Margin - none

If CSCO price tumble to 23

Premium - 3.0/contract

Profit - 710 (3.0*500-770-20)

2. Short 100 share CSCO

CSCO current price - $ 28

Commission - $ 10

Total cost - $ 2810

Max risk - unlimited to the upside over breakeven

Breakeven - $ 27.90

Max profit - $ 2780 (2790-10)

If CSCO price tumble to 23

Profit - 480 (2790-2300-10)

Short Put (Naked put - Sell Put)

A trader who believes that a stock's price will increase can sell the right to sell the stock at a fixed price. The trader now has the obligation to purchase the stock at a fixed price. In some exchanges the option contracts are cash settled as well. The trader has sold insurance to the buyer of the put requiring the trader to insure the stockholder below the fixed price. This trade is generally considered inappropriate for a small investor. If the stock price increases, the short put position will make a profit in the amount of the premium. If the stock price decreases below the exercise price by more than the premium, the short position will lose money.

EXAMPLE:

If you believe that CSCO will be up, you can either buy CSCO stock or sell put option. Let's compare the difference between buy CSCO stock 100 share and sell

5 contracts (500 share) CSCO October 30 call.

1. Sell 5 contracts of Oct. CSCO 25 Put

CSCO current price - $ 28

Premium - $ 1.30/contract * 5 (1.3*500) = $ 650

Commission - $ 20

Total cost - $ 20

Max risk - $ 11830 (23.66*500) if CSCO become $ 0 (it's almost impossible)

Breakeven - $ 23.66 (25-1.30-20/5)

Max profit - $ 630 (650-20)

Margin - yes

If CSCO price stay above $ 25

Premium - 1.3/contract

Profit - 630 (1.3*500-20)

If CSCO price tumble to $ 22

Loss - 850 {(23.66-22)*500-20)}

but you can buy 500 share CSCO at $ 25 if you believe it is worthy to keep the stock

2. Buy 100 share CSCO

CSCO current price - $ 28

Commission - $ 10

Total cost - $ 2810 (28*100+10)

Max risk - $ 2810

Breakeven - $ 28.10

Max profit - unlimited to the upside over breakeven

If CSCO price climb up to 33

Profit - 480 (3300-2810-10)

If CSCO price tumble to $ 22

Loss - 610 {(28-22)*100-10)}

Option

Long Call

A trader who believes that a stock's price will increase might buy the right to purchase the stock call option rather than just buy the stock. He would have no obligation to buy the stock, only the right to do so until the expiry date. If the stock price increases over the exercise price by more than the premium paid, he will profit. If the stock price decreases, he will let the call contract expire worthless, and only lose the amount of the premium. A trader might buy the option instead of shares, because for the same amount of money, he can obtain a larger number of options than shares. If the stock rises, he will thus realize a larger gain than if he had purchased shares. This is an example of the principle of leverage.

Short Call (Naked short call)

A trader who believes that a stock's price will decrease can short sell the stock or instead sell a call. Both tactics are generally considered inappropriate for small investors. The trader selling a call has an obligation to sell the stock to the call buyer at the buyer's option. If the stock price decreases, the short call position will make a profit in the amount of the premium. If the stock price increases over the exercise price by more than the amount of the premium, the short will lose money. Unless a trader already owns the shares which he may be required to provide, the potential loss is unlimited. However, such a trader who sells a call option for those shares he already owns has sold a covered call.

Long Put

A trader who believes that a stock's price will decrease can buy the right to sell the stock at a fixed price. He will be under no obligation to sell the stock, but has the right to do so until the expiry date. If the stock price decreases below the exercise price by more than the premium paid, he will profit. If the stock price increases, he will just let the put contract expire worthless and only lose his premium paid.

Short Put (Naked put)

A trader who believes that a stock's price will increase can sell the right to sell the stock at a fixed price. The trader now has the obligation to purchase the stock at a fixed price. In some exchanges the option contracts are cash settled as well. The trader has sold insurance to the buyer of the put requiring the trader to insure the stockholder below the fixed price. This trade is generally considered inappropriate for a small investor. If the stock price increases, the short put position will make a profit in the amount of the premium. If the stock price decreases below the exercise price by more than the premium, the short position will lose money.

Option Basic-Short Call

Long Call

A trader who believes that a stock's price will increase might buy the right to purchase the stock call option rather than just buy the stock. He would have no obligation to buy the stock, only the right to do so until the expiry date. If the stock price increases over the exercise price by more than the premium paid, he will profit. If the stock price decreases, he will let the call contract expire worthless, and only lose the amount of the premium. A trader might buy the option instead of shares, because for the same amount of money, he can obtain a larger number of options than shares. If the stock rises, he will thus realize a larger gain than if he had purchased shares. This is an example of the principle of leverage.

Short Call (Naked short call)

A trader who believes that a stock's price will decrease can short sell the stock or instead sell a call. Both tactics are generally considered inappropriate for small investors. The trader selling a call has an obligation to sell the stock to the call buyer at the buyer's option. If the stock price decreases, the short call position will make a profit in the amount of the premium. If the stock price increases over the exercise price by more than the amount of the premium, the short will lose money. Unless a trader already owns the shares which he may be required to provide, the potential loss is unlimited. However, such a trader who sells a call option for those shares he already owns has sold a covered call.

Long Put

A trader who believes that a stock's price will decrease can buy the right to sell the stock at a fixed price. He will be under no obligation to sell the stock, but has the right to do so until the expiry date. If the stock price decreases below the exercise price by more than the premium paid, he will profit. If the stock price increases, he will just let the put contract expire worthless and only lose his premium paid.

Short Put (Naked put)

A trader who believes that a stock's price will increase can sell the right to sell the stock at a fixed price. The trader now has the obligation to purchase the stock at a fixed price. In some exchanges the option contracts are cash settled as well. The trader has sold insurance to the buyer of the put requiring the trader to insure the stockholder below the fixed price. This trade is generally considered inappropriate for a small investor. If the stock price increases, the short put position will make a profit in the amount of the premium. If the stock price decreases below the exercise price by more than the premium, the short position will lose money.

Option Valuation

The premium for an option contract is ultimately determined by supply and demand, but is influenced by five principal factors:

• The price of the underlying security in relation to.
  
• The strike price. Options will be in-the-money when there is a positive intrinsic value; when the strike price is above/below (put/call) the security's current price. They will be at-the-money when the strike price equals the security's current price. They will be out-of-the-money when the strike price is below/above (put/call) the security's current price. Options at-the-money or out-of-the-money have an intrinsic value of zero.
  
• The cumulative cost required to hold a position in the security (including interest + dividends).
  
• The time to expiration. The time value decreases to zero at its expiration date. The option style determines when the buyer may exercise the option. Generally the contract will either be
  
  
  
  • American style — which allows exercise up to the expiration date — or
    
  • European style — where exercise is only allowed on the expiration date — or
    
  • Bermudan style — where exercise is allowed on several, specific dates up to the expiration date.

European contracts are easier to value. Due to the "American" style option having the advantage of an early exercise day (i.e. at any time on or before the options expiry date), they are always at least as valuable as the "European" style option (only exercisable at the expiration date).

• The estimate of the future volatility of the security's price. This is perhaps the least-known input into any pricing model for options, therefore traders often look to the marketplace to see what the implied volatility of an option is — meaning that given the price of an option and all the other inputs except volatility you can solve for that value.

Pricing models include the Binomial options pricing model for American options and the Black-Scholes model for European options. Even though there are pricing models, the value of an option is a personal decision, requiring multiple trade offs and depending on the investment objective.

Because options are derivatives, they can be combined with different combinations of

• other options
  
• risk-free T-bills
  
• the underlying security, and
  
• futures contracts on that security

to create a risk neutral portfolio (zero risk, zero cost, zero return). In a liquid market, arbitrageurs ensure that the values of all these assets are 'self-leveling', i.e. they incorporate the same assumptions of risk/reward. In theory traders could buy cheap options and sell expensive options (relative to their theoretical prices), in quantities such that the overall delta is zero, and expect to make a profit. Nevertheless, implementing this in practice may be difficult because of "stale" stock prices, large bid/ask spreads, market closures and other symptoms of stock market illiquidity. If stock market prices do not follow a random walk (due, for example, to insider trading) this delta neutral strategy or other model-based strategies may encounter further difficulties. Even for veteran traders using very sophisticated models, option trading is not an easy game to play.

Option

In finance options are types of derivative contracts, including call options and put options, where the future payoffs to the buyer and seller of the contract are determined by the price of another security, such as a common stock. More specifically, a call option is an agreement in which the buyer has the right (but not the obligation) to exercise by buying an asset at a set price strike price on (for a European style option) or not later than (for an American style option) expiration date; and the seller (writer) has the obligation to honor the terms of the contract. A put option is an agreement in which the buyer has the right (but not the obligation) to exercise by selling an asset at the strike price on or before expiration date; and the seller has the obligation to honor the terms of the contract.

Since the option gives the buyer a right and the writer an obligation, the buyer pays the option premium to the writer. The buyer is considered to have a long position, and the seller a short position. For every open contract there is a buyer and a seller. Traders in exchange-traded options do not usually interact directly, but through a clearing house such as, in the U.S., the Options Clearing Corporation (OCC) or in Germany and Luxemburg Clearstream International. The clearing house guarantees that an assigned writer will fulfill his obligation if the option is exercised. Options/Derivatives are not rated and/or are below investment grade; however the OCC's clearing process is considered AAA rated.

The price of an option is called the premium. An option's premium is determined by a few factors including the current price of the underlying asset, the strike price of the option, the time remaining until expiration, and volatility. An option premium is priced on a per share basis. Each option on a stock (1 contract) corresponds to 100 shares. Therefore, if the premium of an option is priced at 1, the total premium for that option would be $100. Buying an option creates a debit in the amount of the premium to the buyer's trading account. Selling an option creates a credit in the amount of the premium to the seller's trading account

A stock option expires by close of business on the 3rd Friday of the expiration month. All listed options have options available for the current month and the next month as well as specific future months. Each stock has a corresponding cycle of months that they offer options in. There are three fixed expiration cycles available. Each cycle has a four-month interval: 1. January, April, July and October; 2. February, May, August and November; 3. March, June, September and December

There are no margin requirements if you want to purchase an option because your risk is limited to the price of the option. In contrast, option sellers receive a credit in their account for selling an option and earn this amount if the option expires worthless. However, option sellers also have an obligation to buy (put) or sell (call) the underlying instrument if their option is exercised by an assigned option holder. Therefore, selling an option requires a healthy margin.

Value Investing

Value investing has proved to be a successful investment strategy. It is a style of investment strategy; from the so-called "Graham & Dodd" School. Followers of this style, known as value investors, generally buy companies whose shares appear underpriced by some forms of fundamental analysis; these may include shares that are trading at, for example, high dividend yields or low price-to-earning or price-to-cash-flow, or price-to-book ratios. Numerous academics have published studies investigating the effects of buying value stocks. These studies have consistently found that value stocks outperform growth stocks and the market as a whole.

Value investing was established by Benjamin Graham and David Dodd, both professors at Columbia University and teachers of many famous investors. In Graham's book The Intelligent Investor, he advocated the important concept of margin of safety. The main proponents of value investing, such as Benjamin Graham and Warren Buffett, have argued that the essence of value investing is buying stocks at less than their intrinsic value. The discount of the market price to the intrinsic value is what Benjamin Graham called the "margin of safety". The intrinsic value is the discounted value of all future distributions.

Benjamin Graham is regarded by many to be the father of value investing. Graham's most famous student, however, was Warren Buffett, who ran successful investing partnerships before closing them in 1969 to focus on running Berkshire Hathaway. Charlie Munger joined Buffett at Berkshire Hathaway in the 1970s and has since worked as Vice Chairman of the company. Buffett has credited Munger with encouraging him to focus on long-term sustainable growth rather than on simply the valuation of current cash flows or assets.

However, the future distributions and the appropriate discount rate can only be assumptions. Warren Buffett has taken the value investing concept even further as his thinking has evolved to where for the last 25 years or so his focus has been on "finding an outstanding company at a sensible price" rather than generic companies at a bargain price.