Special Edition How Options Work. 2

What is a Put? A put is the right but not the obligation to sell the underlying instrument. We trade FTSE100, as our instrument, which is valued at £10 a point. So if you buy a 7000 put with FTSE at 7000 it is known intuitively really as being At-the-money. As in the first chapter you buy a put and pay 30, and FTSE drops to 6900 you make 100 minus the 30 you paid, which gives you 70 points at £10 a point= £700.

What is a Call ? A call is the right but not the obligation to buy the underlying instrument. We trade FTSE100, which is valued at £10 a point. So if you buy a call  for 30 with FTSE at 7000 (at-the-money) and the FTSE again goes up to 7100, you make 100-30 points, which again means you make £700.

Options are either in-the-money when their value is greater, or out-of-the-money when they are worth less. You can see this from the options chain, once you figure out the gobbledegook. Calls are always on the left, Puts on the right. Live prices during the trading day are quoted as Bid and Ask. So someone is bidding 28 for the option you want to buy, but the seller is asking 32. The mid price is probably going to trade.  It is a market, like any other market.

Now you can see how someone can make money when the market falls. You buy a put. But…….. you could do the same thing and sell a call.

It Gets Even more Interesting

How can you sell something you don’t own? Example- you go to a car dealer and you order the new Ford Model X for £30,000. You are signing a contract to buy something from a person who does not yet own that thing. She orders it from Ford in the hope that her dealer margin, her profit, is still 10%. Now a contract is binding and maybe overnight the price of that car moves a lot, the dealer is taking that risk. They have sold an option which you bought.

Next we really boggle your mind. What if we could trade a combination of options? What if we could sell an option that expires this month and buy another one in the next month or next year? Even more expansive, what if we could buy or sell calls and puts in-the-money, out-of-the-money, or at-the-money? We can.There are many many strategies to manage risk. That is why options are superior in every way to simply trading a share or a future. And I’ve traded a lot of futures! With options you can be wrong, horribly wrong and still make money. I keep a  ‘comedy portfolio’ of shares I researched well, and they continue to lose money.

Options are traded on pretty well everything- including the volatility of…options! It’s called the VIX, and we use this as a gauge for the overall market. As the saying goes, America sneezes, the rest of the world catches a cold, and VIX is based on the US market (S&P500)

The Familiar and Unfamiliar.

The beginners trade is something called the covered call. This is for those brave souls who own shares. You can trade options on shares, and again the ice.com lists UK share options.Here’s BP  https://www.theice.com/marketdata/reports/265

A covered call means your options are ‘covered’ so if your stock is called away because you agreed to forfeit the rights by selling a call, the owner of the call gets the stock. Example, you bought 1000 shares BP at £5 You then sold a 510 call, for 15, which means your share can be taken away but you would get 510. BP moves up to 510, your stock is taken from you at 510, but….. you also took in 15 from selling the call. You make 25 but no longer have BP shares, which may go to the Moon or take an early bath.  The other side of this trade with the same outcome is selling a put without owning the stock. You get the stock ‘put to you’ at the agreed price, so with BP dropping you take a chance, but if BP stays at £5 or goes up you keep your money.

Some people sell puts to buy a stock cheaply. Example, you sell a 490 put for 15, BP drops to 480  you pay the agreed 490 but you have taken in a credit of 15 from the put you sold. While you have sold the rights and thus have an obligation, you can trade in and out of options any old time you like. 08:00-16:30 Mon-Fri. You are never married to a position, watching your shares wilt in the daylight! Caveat: Shares can go up as well as down.

The esteemed Larry Macmillan has some further thoughts if you are interested and already own shares: https://www.optionstrategist.com/blog/2022/09/some-thoughts-covered-call-writing-1104?utm_source=Email+Updater&utm_campaign=333a39f2da-Weekly_Blog_Roundup10_1_2014&utm_medium=email&utm_term=0_2f928c56ef-333a39f2da-401810697&mc_cid=333a39f2da&mc_eid=5f15d5ff5d

NEXT Installment, the all important Greeks. But for now be aware that options have time decay or ‘theta’ it’ sa bit like buying an ice cube.