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Technology Stocks : AOL, now I get it
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To: Jinping Shi who wrote (410)1/30/1997 9:46:00 AM
From: yard_man   of 496
 
Jinping

Puts and calls are options. One put is an option to sell 100 shares of a stock at a given strike price. These are classically bought to hedge a long position in the stock. Say you have purchased the stock at 40, you buy a put at 35. If the stock falls below 35
your loss is limited by the put. You are out 5 a share, but the intrinsic value of the put has increased by whatever amount below 35 the stock drops. For instance if the stock drops to 32 you have the option to sell (put) the stock to someone at 35. If you excercise that option you are essentially buying 100 shares at 32 and then selling them at 35 for a 300 profit. In practice you don't excercize, but rather sell the put. Also the options are standardized with given levels of strike prices and given expiration dates. With expiration dates closer to the current date the prices of options are closer to their intrinsic value. Options further out in time have more value than intrinsic value -- this is called time value. Calls are an option to buy 100 shrs of a stock. If the stock rises above the strike price here the calls become instrinsically valuable since if you excerisize you can buy the stock at the call price and sell for the higher market price.

This is important: If you hold an option to expiration and there is no intrinsic value at that time you lose the entire price of the option. It becomes worthless

Option speculators don't actually hold any stock they just trade the options. The advantage of option is the high degree of leverage provided with the limited risk (you can only lose the total amount that you've invested, no more). Suppose you own 100 shares of stock XYZ which you bought at 40 buck a share and it moves to 45. Without commissions you have a profit of 500 buck if you sell. Suppose instead you used the 4000 dollars to purchase 10 calls with a strike of 40 (controlling 100 shrs a piece) at 4 a pop. In this instance counting only intrinsic value your calls would be worth 5 x 100 x 10 = 5000 dollars. You see the effect of leverage?
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