An Even Trading Field?

August 4, 2009

The Securities and Exchange Commission, better known as the SEC, is considering a ban against so-called “flash orders.” Apparently, buy and sell information can occur in the tiny little milliseconds leading up to when information is made public. During these milliseconds, uber-computers used by certain trading platforms like Direct Edge, Nasdaq OMX and BATS can use the buy and sell information to make better trading decisions.

How does this affect you? Well, it may or may not affect you that much really. If you’re playing the markets for the long term, then it probably doesn’t matter too much. But if you’re playing for short-term gains, like options plays, then milliseconds can make a huge difference.

But isn’t it nice to know how people are trying to scam other people? And that sometimes our publicly funded regulatory bodies do, in fact, pay attention?

-RT


Understanding Options For Newbs: Expiration

May 11, 2009

This is episode 3 of Understanding Options for Newbs, so by now we know what options are and what they mean. This is going to be a short, but important post. Plus, the next one’s going to be a doozy. =)

The next exceedingly important and fundamentally basic thing you need to know is that options contracts expire. Yes, that’s right, at some point every option will be rendered completely worthless regardless of the price it was originally purchased at. So that Under Armour option you just purchased, assuming it was a May option, will be worth exactly $0.00 once that closing bell sounds on Friday, May 15, 2009. What does that mean for you? Apart from the expiration date affecting the price of that option on a daily basis, it means that you had better know if you want to sell, exercise or hold the option (and let it expire) well before the expiration date.

Oftentimes it’s better to hold the option and let it die (if you’ve gotten to that point) than to exercise it. I mention this specifically if you’re the kind of person to convince yourself, “Oh I’m going to throw away all that money I spent on that option if I let it expire, I’ll just exercise it and it will have been partially worth it.” What’s really worse, holding an expiring option and losing $200, or exercising the option and spending $2,000 for one hundred shares of a stock that is probably not even gaining in value (otherwise you should have sold it, hopefully, for a profit!).

Next time we’ll discuss how options are valued. Without understanding why those contracts are valued at what they are, you might wonder why that call option you bought is decreasing in value even though the stock itself hasn’t gone down, or may even went up a little. Stay tuned, same Roaring Time, same Roaring Channel!


Understanding Options For Newbs Part Ia: What is an option?

May 4, 2009

In the last post I discussed what an option is most in terms of money. But you should also know where these options are coming from, because when you buy an option someone else must be selling that option to you. When you hear about CEOs getting millions of dineros in stock options, these are exactly what they sound like. One of those millions of options might just be the one you’re buying!

Basically, when someone owns 100 shares of a stock and wants to sell them, he/she “writes” the option. You can think of it as writing up the contract to purchase shares. That might well be where the terms “options contract” and “writing an option” came from, because no one ever says I want to buy a stock contract. That’s just silly. =P This is the most common way option contracts are created, by having someone who owns hundreds of shares sell off the options to them. We call this a covered call or covered put, depending on the type of option being written.

There exists, also, UNcovered calls/puts. In these cases, people borrow shares from their brokerages to write options. I hope you became wary upon reading the word “borrow” because this is a very dicey game to play. To write an uncovered option you really are borrowing money that you don’t have in your account in the hopes that you turn a profit off these options and can then repay your brokerage. If you don’t turn a profit you still have to pay back the brokerage. And if you bought 100 shares to write an option contract for Under Armour, the example we used last time, then you’ll have borrowed about $2,000 worth of UA shares. That would not be fun to pay back if you didn’t have the money to cover your bets options in the first place!

This just about covers what an option is, in the most technical sense. Please comment and let me know if you have any questions!

Also, a quick note: employee stock options are always call options. It makes sense if you think about it, how could they give you put options? That would mean they give you the right to sell options that aren’t yours… now that doesn’t make much sense, does it?

– RT


Understanding Options For Newbs Part I: What is an option?

April 27, 2009

This is the first post in a series where I’ll be explaining stock Options: what they are, how they work, and how to understand them well enough so you can try your hand at buying and selling them. And hopefully turning a profit. ;)

An option contract, better known colloquially as just “an option,” is technically just the right to purchase or sell shares of a stock at a given price – the option’s strike price, which I’ll elaborate on further down. But here’s an example: Let’s say you want to buy a call option for, say, Under Armour, Inc. (yeah, the sports clothing company, did you know they were publicly traded? Don’t lie!), which is priced at $21.39 per share as I write this (closing price on April 23, 2009). The call option gives you the owner the right to purchase shares at the option’s strike price. If you buy that call with a strike price of 20.00, which is valued at $2.00 right now, what you’ve effectively done is buy the rights to purchase 100 shares at $20.00 per share. So the strike price is the price that you can actually buy/sell shares at.

Here’s what an options chart looks like (I know, it can be damn intimidating at first, but take a breath and chill out for a second. I’m going to walk you through this over the course of this Options Series):

In this chart, the “Strike” column shows each option’s strike price. The actual value of the option is the “Last” column, which is the price that that stock option was last traded at. The “Chg” column is how much the value of the option has changed that day, by percentage. Don’t worry about the rest of the columns for now, we’ll get there in a future installment.

By now you might be asking yourself, “Where the hell did these 100 shares come from!? I just wanted to buy ONE option!” Here’s the deal: each option contract is actually a contract to purchase 100 options. In other words, you’re purchasing the ability to have 100 options of buying shares of a stock at that strike price, but you don’t have to buy those shares. It’s an option, not an obligation. If you do buy those shares, that’s called “exercising an option.”

This 100-shares-per-contract concept is the hardest thing to wrap your head around at first, in my experience. In the options chart you just see the regular strike price. Brokerages advertise their commission fees as $7-12 per single transaction PLUS $0.70-1.25 per one contract. They never talk about these things in plural, but that option that costs $2.00 (remember, this is not the strike price) is actually costing you $200! That’s $2×100 for you math whizzes out there. ;)

Oh by the way, options are always traded by the hundreds, so you can’t decide to buy one share and have 99 options left. It just doesn’t work that way.

On the other side of the ticker, a put option is one in which the strike price is the price at which you have the right to sell 100 shares. So if you buy the Under Armour put option with the strike price at 20.00, and then the actual stock price dips to $19.00/share, then that put is very valuable. The option owner can theoretically buy 100 shares at $19 each and then turn around and sell them at $20 each for a profit of 100 big smackers! Of course, there are quite a few details I’m leaving out here that make exercising your option potentially unprofitable (or less profitable than just selling the option).

In fact, only about 30% of options get exercised before their expiration dates. Oh right, those options you just sank $200 into will be rendered worthless in a few short weeks. This is reflected in the above options chart in the upper right hand corner where it says, “Expire at close.” This will also be covered in a future installment. Did I mention stock options are quite complex? I mean, you have to sign extra forms just to be able to trade them(!) because you can lose a lot of money very quickly if you don’t know understand what’s going on.

If the market were cut and dry then any time you could turn a profit by exercising your options you would invariably do just that, right? But the market is more like a crazy twelve-headed beast of Greek mythical proportions that you have to figure out, disfigured face by disfigured face, until you think you’re ready to tackle the she-witch.

So what have we learned today? Well, we learned that an option contract translates to the ability to purchase 100 shares of a stock at the option’s strike price. A call option gives you the ability to purchase 100 shares at the option’s strike price, and a put option lets you sell 100 shares at that option’s strike price. Dems da basics! Please make sure you understand this well because everything that comes after this is based on the fundamental understanding of what an options contract is. If you’ve got questions, I’ll see ya in the comments section.

*If you’re curious, Under Armour’s stock symbol is UA. Creative huh? Personally, I was surprised that that wasn’t already taken by a huge company like United Airlines or something.