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)}
1 comment:
how do you get the premium amount ??
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