by Keith55
What is options trading?
There are two choices in options tradings, the puts and the calls.
You buy puts when you think the stock or index is about go go lower quickly in short period of time. As for calls, you buy them when you think a stock or index is about to go higher quickly in a short period of time.

Instead of buying the actual stock, you are actually speculating on the direction of ths stock. This is a significant advantage for investors with limited investment funds and yet can participate in investing based on the growth and fall of ths stocks of companies that interest them.

Call options (puts and calls) are actually contracts with a delivery date (expiry date). Call options are the right but not the obligation to purchase an agreed upon amount of stock at a particular price in the future.

1 call option = the rights to purchase 100 stocks of common stock.

How do you make money with options trading?
For example, you want to capture the rise of the next ten points for Google’s stocks over a period of eg.eight months.
If the price point of eg. Google is $50 today (Feb 07), you would tell the broker that you want to buy October 20 calls

You would say that you want to buy October 50 calls on intel.
The broker would look up his options window and find out the price of calls. For example, the ask price of each call option might be $5. If you buy 1 call option, it would be $5 and it would entity you to the rights to buy 100 shares of google stock at $50 in October.

The amount to pay for 1 call option would be
= (call or put price) x number of shares x number of call options
= $5 x 100 x 1
= $500.

If the price of Googles rise to $60 in October. The option call which you purchase at $50 for google is now worth $60.
Therefore, you would have made.

(Price of google stocks in October - Price of Google stocks in Feb - Call options price)
= ($60 - $50) - $5
= $5 profit per call option

Since 1 call option allows you to purchase 100 shares at $50, you should have made
(Profit per call option x 100 shares)
= $5 x 100 shares
= $500 profit

However, that means if you purchase a call option for Google at $5, prices of Google stock have to rise above $55 in October before you can make a profit.

Advantages of Options Trading vs Common Stock Investing
For example, if you only had $500 to invest and you want to invest in Google Stocks. If the prices of Google stock is $50 in Feb 07, with $500 you can only purchase 10 stock. If the prices rise to $60 in October as what we have illustrated in the earier example, you would have made

(Profit per stock x Number of stock)
= $10 x 10 stock
= $100 profit

With call options, you made $500 and with common stock investing you made $100. See the difference it can make?
Of cos, some of you might argued that you can hold on to the common stock until the prices rise much higher. But how much do you need the price of Google stock to rise to to make $500 profit with common stock investing?

Call options are good if you had a hunch or tipoff that something fantastic is going to happen to stock market or to a particular company’s stock. Its good for speculators. I am not trying to encourage speculation here but some of us speculate from time to time.

If you have other great idea or information that you want to share with me and the other readers, why don’t you drop me an email to keith@bewarrenbuffett.comThis e-mail address is being protected from spam bots, you need JavaScript enabled to view it

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