I’m Interested In Learning How To Make $9,900 With 4 Trades. So What Is An Option?
An option is a traded security that is a derivative product.
By derivative product we mean that it is a product whose value is based upon or derived from the price of something else. Since we are referring to stocks, a stock option is centred around a number of factors, not least the price of the underlying stock.
There are also options on other traded securities such as currencies, indexes and interest rates, but here we will limit our discussion to stock options, or options based on stocks.
A differentiating thing about an option is that its a falling asset in the sense that it has a limited life, and has to be used before the date on which it expires. As time goes by, the option loses value as it moves closer to its expiration date
When we speak of options in terms of volume, we refer to contracts. Every stock option contract is the same as 100 shares of stock. When we focus on 2 contracts, we are actually focussing on 200 shares, 10 contracts; and so on. For example focussing on 1,000 shares, 75 contracts 7500 shares and so on.
NOTE: It is important to appreciate the value of options before trading them. When an option is quoted at One Dollar.00 each contract, the speculator must remember that the $1.00 represents a price of $1.00 every share, not every contract. Remember that every contract is worth One Hundred shares. This implies that if you were to get one option contract valued at $1.00, your total cost will be One Hundred Dollars.00 (1contract x$1.00 per share x 100 shares per contract). If you were to get 10 contracts for $1.50 each contract, your whole cost works out at $1500.00. Use the formula below when calculating total dollar cost of the option.
Total Dollar Cost of Trade = Number of Contracts x Price per Contract x 100
Option contracts are literally a sales agreement between two parties. The two parties are the buyer (or holder) and the seller (or writer). When you purchase an option contract you are judged to be long the option. When you sell an option contract, you are assumed to be short the option. This, of course, is assuming you had no previous position in the said option.
In an option contract, although it seems as though the buyer and seller must be tied together, they are not. You see, the owner doesn’t actually buy from the original owner and the original owner doesn’t really sell to the new owner.
In fact, a group called the Options Clearing Corporation (OCC) jumps in the middle of the two sides. The OCC gets it from the seller and gives it to the purchaser. This makes the OCC neutral, and it allows both the buyer and the seller to trade out of a position without involving the other party.
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