To The Moon

Options is one sword that can take your portfolio to great heights or tear it down to nothing.

•What is an option?

An option is a contract that gives the buyer the right (but not the obligation) to buy or sell an underlying asset at an agreed-upon price on or before an agreed-upon date.

Call options allow buyers to profit if the price of a stock or index increases, while put options allow the buyer to profit if the price of the stock or index declines. Investors can also short an option by selling them to other investors. In that case, shorting a call option would allow the seller to profit if the underlying price declines while selling a put option would allow the seller to profit if the price increases.

Options can be complex and are traded for a variety of reasons. Option traders can use options in multiple ways to carry out a speculative, hedging or income investment objective. In each example below we show some of the many ways that each of these strategies could be carried out.

•Speculation

Traders can take both sides of the market, trading on both the upward or downward movement of a stock or index.

•Hedging their Investments

Investors can hedge their holdings by using options to protect against directional risk.

•Generating Income

Investors can sell options against shares they own, giving up upside gains in favor of generating income.

•Things to consider

Options trading is not for everyone and it is important to understand the risks involved — especially since options are a decaying asset. There are varying degrees of risks involved with options that are dependent upon the strategy.

Although options may not be appropriate for all investors, they're among the most flexible of investment choices. Options can be used to apply a bullish, bearish or neutral strategy and utilized for generating income, hedging or speculation.

•Leverage & Risk

Options can provide leverage. This means an option buyer can pay a relatively small premium for market exposure in relation to the contract value (usually 100 shares of the underlying stock). An investor can see large percentage gains from comparatively small, favorable percentage moves in the underlying product.

Leverage also has downside implications. If the underlying stock price does not rise or fall as anticipated during the lifetime of the option, leverage could magnify the investment's percentage loss. Options offer their owners a predetermined, set risk. However, if the owner's options expire with no value, this loss can be the entire amount of the premium paid for the option. An uncovered call option Select to open or close help pop-up writer may face unlimited risk.

•Time Decay

The longer the time remaining until an option's expiration, the higher its premium will be. This is because the longer an option's lifetime, the greater the possibility that the underlying share price might move the option in-the-money. Even if all other factors affecting an option's price remain the same, the time value portion of an option's premium will decrease (or decay) with the passage of time.

•Expiration Day

The expiration date is the last day an option exists. For listed stock options, this is usually on the third Friday of the month. This is the deadline that brokerage firms must submit exercise or do not exercise notices to the Options Clearing Corp (OCC). However, the exchanges and brokerage firms have regulations and deadlines for an option holder to notify the brokerage firm of his intent to exercise. This deadline, or expiration cut off time, is generally the third Friday of the month at some time after the close of the market.

The last day expiring equity options trade is also on the third Friday of the month. If that Friday is an exchange holiday, the last trading day will be one day earlier.

• Long - The Clairvoyant Way To Be Millionaire

With respect to this section's usage of the word, long describes a position (in stock and/or options) in which you have purchased and own that security in your brokerage account.

For example, if you have purchased the right to buy 100 shares of a stock and are holding that right in your account, you are long a call contract. If you have purchased the right to sell 100 shares of a stock and are holding that right in your brokerage account, you are long a put contract. If you have purchased 1,000 shares of stock and are holding that stock in your brokerage account or elsewhere, you are long 1,000 shares of stock.

When you are long an equity option contract:

You have the right to exercise that option at any time prior to expiration.

Your potential loss is limited to the amount you paid for the option contract.

• Short - The Ultimate Portfolio Destroyer

Shorting a high price is an idiot proof opportunity but it comes with unlimited risk. One mistake is all it takes to destroy your portfolio. Especially with margin, this is one way to take your portfolio to hell.

With respect to this section's usage of the word, short describes a position in options in which you have written a contract (sold a contract that you did not own). As a result, you now have obligations from terms of that option contract. If the owner exercises the option, you must meet those obligations.

If you have sold the right to buy 100 shares of a stock, you are short a call contract. If you have sold the right to sell 100 shares of a stock, you are short a put contract.

When you write an option contract, you are creating it. The writer of an option collects and keeps the premium received from its initial sale. When you are short (write) an equity option contract:

You can be assigned an exercise notice at any time during the life of the option contract. You should be aware that assignment prior to expiration is a distinct possibility.

Your potential loss on a short call is theoretically unlimited. For a put, the fact that the stock cannot fall below $0 in price limits the risk of loss. This potential loss could still be quite large if the underlying stock declines significantly in price.

•Open

An opening transaction is one that adds to or creates a new trading position. It can be either a purchase or a sale. With respect to an option transaction, consider both:

Buy to open: An opening purchase is a transaction in which the purchaser's intention is to create or increase a long position in a given series of options.

Sell to open: An opening sale is a transaction in which the seller's intention is to create or increase a short position in a given series of options.

•Close

Buy to close: A closing purchase is a transaction in which the purchaser's intent is to reduce or eliminate a short position in a given series of options. This transaction is frequently referred to as covering a short position.

Sell to close: A closing sale is a transaction in which the seller's intent is to reduce or eliminate a long position in a given series of options.

Note:

An investor does not close out a long call position by purchasing a put or vice versa. A closing transaction for an option involves the purchase or sale of an option contract with the same terms on any exchange where the option may be traded. An investor intending to close out an option position must do so by the end of trading hours on the option's last trading day.

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