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Non-Tech : Banks--- Betting on the recovery -- Ignore unavailable to you. Want to Upgrade?

To: tejek who wrote (44)	2/23/2009 7:30:15 AM
From: RockyBalboa	Respond to of 1428

This strategy is called "covered call"; a short position on call options covered by having the underlying stock. Are you talking here about the person selling, not buying, the calls? Correct. A person having a position, or buying common stock, sells calls which he doesn´t own, to another one (for example via the CBOE, ISE exchange). He then has a short position in calls. How do you know what the call price is on a given stock? I assume that the greater the likelihood that the stock will run to $25 the more expensive the call. Is that correct? -Option prices for listed options are readily available on a realtime basis, changing every second with the underlying prices and other market perceptions. Most online brokers provide option quotes. An option chain looks like this (SPX Index Options): bigcharts.marketwatch.com listing all puts and calls per month over the available strike prices. -Correct. The call price is clearly dependent on the likelyhood the stock swings, aptly named "Volatility". The price of the call, or put implies a certain volatility, called "IMPLIED Volatility" which itself is prone to large changes. There is no explicit market for volatility meaning that it has to be inferred from option prices. The higher the volatility, the higher is the likelihood that the stock swings into either direction in the near future; the higher is the Option price (or the integral value of the right hand side of the stock price distribution in a distribution function (Spot or Forward price - Strike price) for a call option ) This seems considerably more difficult and risky than simply buying a stock. Am I right? It is very risky, no question. As an option buyer you will regularly lose all the premium except for real outliers. Gains can be outsized but so is the inverse of the probability. Most of the options expire worthless, "out of the money". For example, you could have bought S&P 500 Put options with strike prices of 1100 or 1000 for 3 or 4 years, month after month and losing the options premium every month. The big payout would only come in October 2008 and thereafter. What are the odds that one really picks just this month as the crash month and not one else? (the option has to be good until October and not expire in September). Lower risk (and yield enhanching) strategies involve selling short calls with the underlying stock available. But it is never without risk as the downside still exists; the earned premium only mitigates risk to some extent. ---------------------- Puts work pretty similar, like a mirror of calls. A put gives you the right to sell a stock at one predetermined level (strike price, like $10 until a certain time, like March) in that example. This right to sell has itself a value, which is if the stock trades below the $10, mostly consisting of "time" value or volatility value. There is also a little bit of intrinsic value right now ($10 - $9.19) At expiration in March, the right to sell the stock at $10 is worth the intrinsic value provided that the stock trades where it is today. E.g. ($10 - $9.19 = $0.81) Assuming the strike price is $10, what is the likely price of the stock when you bought the put today? In that example this right (the put option) would trade at around $3.20. A buyer puts down $3.20 to have the right, but not the obligation to sell (or sell short) stock at $10 until the expiry on March 20th. If the stock goes to zero he gains $6.80 ($10-$3.20). If the stock runs to $25 (or any price over $10) he would lose the $3.20$ he paid for the put. ----------------------------------------------------------