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Options explained. What is it? Let's use an example. Say, you came to the store to buy some vegetables and suddenly saw the audio system of your dreams. Now, in the perfect world you would just take it. But in the real world you a) have no money at the moment and b) have a spouse that must approve first. So you are asking the store owner to hold the audio system and not to sell it to anyone until you go home, resolve the real world problems and return with money. And the store owner says "no". Because from his point of view it is a financial risk you are asking him to take. What if the real world problems will not be resolved? What if you will not come back with money? And then you are bribing him. Here. Take this twenty dollars. If I come back, you count this money as part of the payment. And if you don't? - the store owner still isn't sure that it isn't a trick. - And if not, you keep this money. OK, the store owner says. For this money the audio system will be "on hold" for one day. That's it. For a small (or large) deposit you just bought yourself an option (a right) to buy the audio system. Why do we need options? There are few benefits in using options or similar techniques. The reason described above (I have no money but I expect to have them) is not the most important one. You can use options to guarantee the price of a purchase. Say, you are buying a house. And the price is 100,000 and naturally you don't have them. But you are sure that you can - if you go to your bank and take a loan. But what if the moment you leave, the other guy walks in and offers 120,000? To avoid this situation you can offer the house owner to SELL YOU an option to buy this house within some fixed period of time (day, week, month, 6 month) for some amount of money (one dollar, 200 dollars, 1,000 dollars). You put it in writing and your price is GUARANTEED. And then the real estate market goes down and the house is now $90,000... So you can abandon the option - you don't have to buy anything! Or better - you can make another offer to the same seller! So it is a technique to profit from the price moves with the little risk! Think about the house example above. If you expect that the real estate market is about to go up, you would like to buy a house NOW. But if the market go down instead - you loose a lot of money. However if instead of buying the $100,000 house you buy the $1000 option... You will loose much less and you will win (if price go up) the same. No. Not the same. Say, the house price went up from 100,000 to 120,000 dollars. The profit is 20,000 and it means 20% if you paid 100,000 dollars. OR if you only paid $1000 for the option, then it will be 2,000 percent! Stock market. Of course, the situation with the house that I described above is not very realistic. There are options in real estate, and a lot of them, but they are slightly different and I am only going to talk about stock options here. Because on the stock market options work EXACTLY as I described. It is called a leverage. Once again: for the small downpayment you can buy the right to buy or to sell stocks at the FIXED price. All you need to do is to research the stock and to deside (for yourself) which way will it change. Then you buy or sell options. For stocks the options are going in LOTS, 100 shares in each lot. The right to buy shares of the stock at fixed price within fixed period of time (1, 2, ... months) is called an option to buy. If you want this right, you need to BUY A CALL. If you want to sell shares at the fixed price (you believe they are doing down) then you need to SELL A CALL, which means that you promice to someone (the person who buy it from you) that you will SELL these stocks at a fixed price if he ask (if you GET CALLED). Now, there is a risk - what if you sell a call for one lot (100 shares) at 100 dollars and the stock dropped to $1 per share? To COVER for this risk, you might WRITE A COVERED CALL. It means that you HAVE the stock on your trading account, so that you don't have to buy it for $100 in order to give it away for $1. How can we use this technique (See the Multiple streams of income book for more strategies. It is a trully wonderfull book, that can change your world - financially speaking. Very easy to read, except when you begin, you cannot stop!) to profit from it? Let's say we have a Microsoft shares (MSFT). 100 of them. We believe it will not go up dramatically, but it is not going to fall either. We write a covered call for one month for one lot. It means that we cannot sell the MSFT during one month - they are kind of a security deposit. Now for this action we IMMEDIATELY get some money - the price of an option. This is ours and no one will take them from us. Then month later one of two things will happen - MSFT may grow above the price that you wrote a call for (say you wrote a call for $100 and it is now $103), so you get a call from the other person and your shares are his shares now. You have $100/share that he pays you AND the price of the option that you got at the beginning. Or if the MSFT didn't grow (just as you expected) you keep the shares AND the price you was paid for the call. And you can sell same shares again! And again. Terminology. Let's get clear with the terminology. If you want to have the right to buy - it is called buying a call. If you want to sell the right to buy (from you) to someone else it would be selling a call. Now if you want to have the right to sell, it is buying a PUT, and if you want to give someone the right to sell (to you) - you are selling a put. Risks. The more reward, the more the risk. Options are using large leverages (5-10 times of your money) and the risk is higher. Say, you bought a call for 1 lot for $100. As time goes, the stock price remains at $99.99 - then what exactly will you have at the end of the period (the date an option expires)? Nothing. You will lose all money! On the other side, if you paid $5 for share to buy this option and price went up one dollar, you will get (estimation only) $100 as a profit which is 100 / 500 = 20% profit on 1% price change! How do you trade options? First, you need the "option trading account" with your broker. Then you need to buy and sell options. In most cases (unless you use options to actually ges shares) you don't need to buy and sell underlying securities - you are only trading options. That's it. Books to read. Trere are few books you might want to read BEFORE you go out there. The one I recommend the most is the Robert Allen's Multiple streams of income. Also pick any trading books from the icons I put on the right side of this page - they all are good. Good luck.

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