Covered calls – a strategy used for generating income from already owned shares.

Hello and welcome back to options learning series. We have gone through some of the basics of the options trading and the terminology in the previous posts. I would now like to take you to the next level of complexity involved in options trading. Let us start with what is known as covered call strategy or writing covered calls against stock owned.

This is most exciting strategy and is used by many experienced traders and traders that are new to options alike. This strategy simply means you sell calls on a certain stock that you own in equivalent number of contracts. You can also sell calls at the same time of purchasing the stock and is referred to as “buy-write”. We already know from our previous posts that call options render a right to the buyer and an obligation to the seller. Here, by selling the calls we are obligated to deliver the stock in the event it is exercised. That is where we are using our already purchased or freshly bought shares as collateral and in the process we are “covered” against the obligation arising from the sale of calls. This strategy is the most basic and widely used tool in options world that combines the flexibility of listed options against a security with stock ownership.

Let us look into a hypothetical example of selling a call option by using a real stock and its option. For example, consider a company called Las Vegas Sands Inc (LVS). This company owns and operates casinos in USA and China and is starting new ventures in Singapore and Bethlehem. LVS trades on New York Stock Exchange (NYSE) with a closing price of $32.01 as of 9-17-2010. It has options listed with one dollar incremental strike prices. Which means one can buy or sell calls and puts for various strike prices. This stock has just doubled in the past six-and-half months. It may continue its run and might reach new highs in the next several months. But, if you think this might take a breather and stay around that price for a while or could even drop a little and pullback, then it is a good idea to sell covered calls.

The sale of covered calls lets you keep the premium received in return for the obligation that you sell the shares to the call buyer at the agreed price before a certain date. The $34.00 October 2010 expiration calls have closed at $0.74 which means you will receive $74.00 for every 100 LVS shares you owned by selling Oct. 2010 $34 call.

Say that you own 500 shares of LVS with a purchase price of $32.00 and decided to sell covered call (at times it is referred to as writing covered calls. Don’t get confused writing just means selling, there is no literary skill involved here).

You can sell 5 calls. If you can recall that options have a time value and the premium decays with time and more so in the last few weeks even at a higher pace. This means whenever you want to sell calls go with the closest available expiration calls which would be the Oct. expiration in our example. Sell out-of-the money calls to maximize the returns. That would be $34.00 strike price.

As an owner of 500 LVS shares with an initial investment of 32 x 500 = $16000.00 you are entering into an option contract obligation by receiving 5 x100 x 0.74 = $370.00 to sell the stock at $34.00 before third Friday of October.

Now, what are the different outcomes possible by the third Friday of October?

Stock closes below $34.00 – you get to keep the shares and the $370.00 (a profit of little over 2.3% on the $16000.00 initial investment). You may sell covered calls again for the November expiration this time around generate the income again. Rinse and repeat.

Stock closes above $34.00 – you are obligated to sell the shares at $34.00 limiting your profit to ($34.00 - $32.00 + $0.74) x 100 x 5 = $1370.00 (a return of 8.5%).

Stock closes below your original buy price of $32.00 – you get to keep the shares and the $370.00 premium – gives a protection of $0.74 on each share and leaving you at a breakeven price of $31.26.
The chart below explains the scenarios discussed above.

Current  price : $32.01
Price		Profit / loss
24.01		($3,636.25)
27.56		($1,851.72)
31.26		$0.00
31.29		$16.21
34.00		$1,370.00
35.03		$1,370.00
38.76		$1,370.00
42.5		$1,370.00

Please be aware that the potential risk of selling calls without owning the underlying stock is unlimited as you are obligated to sell the stock at agreed price once you sell the calls and in theory the price of the stock can go up infinitely.

One more thing to keep in mind when you are selling covered calls is be ready to part with the shares if the price of the stock goes above the strike price. Under that circumstances if you still want to keep the stock wither you can buy back the sold calls and keep the shares or buy back the shares again in the open market and potentially initiate another covered call.

That’s in detail what covered calls are about. If you have any questions about this strategy do email me or leave a comment and I will be happy to answer. Don’t forget to
bookmark this page, and comeback again to learn more strategies about options trading.

Happy learning and Good trading.

How to open an option trading account

Many individual investors are fearful of trading options and if you add the negative campaign coming from the traditional brokers the fear only gets bigger. But, the number of options contracts traded has been tremendously increasing year over year. And options are becoming increasingly essential to succeed in a highly volatile stock market like the one we are experiencing now. This brings us to the point of how to open an options account.
Learning to use options effectively takes some time - particularly if you are set in your ways - but market conditions have changed so much in such a short time that you have to make the effort if you expect to both maximize profits and guard against major reversals.

Because of the dramatic changes in the markets, it's no longer enough to merely look for good stocks, buy and hold, hoping for a profit. It is similar to asking for different result from applying same old techniques.
Today’s markets’ success and sustainability depends on your ability to buy quality shares at bargain prices, generate added income while you hold them, hedge against volatile short-term moves and sell your stocks at a premium when the time is right.

Options enable you to do all those things - and more - with many of the techniques I will be detailing on the future articles of our ongoing options learning series.

For maximum efficiency and optimum results, you need a designated options account - preferably one you can access online to get real-time quotes and instant entry of both your orders to the electronic trading systems offering the best prices at any given time.

Many of the full-service and discount stockbrokers have options-trading capability but remain far behind the curve when it comes to options in terms of effective order execution, margin requirements, commission rates and they're often reluctant to grant options-trading approval to anyone who isn't a highly experienced investor.

What to look for?
So, how do you go about finding the right options specialist and opening your own trading account?
You want to look for the following things when you start shopping for an options broker.

Experience requirements
Account minimums
Designated Trade Levels
Commission rates, other fees
Research and analytical tools.

Most importantly, compare the clarity and ease of use of their order-entry platforms - especially with regard to the specific strategies you want to use. For example, if you plan to use a lot of spreads, make sure you can place actual "spread orders" - buying and selling the options in combination, rather than having to price and order them individually.

Trading platform
Some of the online brokers specializing in options trading are providing websites and trading platforms with a variety of instructional articles, strategy tutorials and analytical tools like stock screeners, price charts, volatility ratings and valuation calculators (plus many more). That's on top of the basic quote-retrieval mechanisms for stocks, indexes, some futures and the links to "option chains" - a listing of all currently traded options on a given stock. Some are even offering individual coaching and strategy suggestions based on your existing holdings.

As you learn the ropes and improve your skills, you'll eventually use most of these tools and services, so make sure your broker offers them before you open the account.

Offering of option trading level

Paper trade

Please consider “paper trading” also called as “virtual trading” or “practice trading” before you start your real trading.

Get the experience

Paper trading, paper trading, paper trading - that's the key to learning how option strategies work and how to use them most effectively.

How many strategies?

There are thousands of possible trade combinations using options and various underlying assets, meaning your trading program can be as simple or as complicated as you want to make i

Online brokers specializing in options fully recognize both their potential and their risks. For that reason, these they want to ensure that you have a reasonable degree of investing experience in stocks and other assets - enough so that you understand both the nature of risk and the impact of taking the inevitable loss.
If you are a beginner with minimal investment experience and haven't traded options before, chances are you will be limited to simple buy and sell calls and puts level of trading. Once you familiarize about the markets, various options strategies, the basics of trading "on margin" and the forces that typically drive stock price movements and dictate “option premiums” the higher option trading levels which allow more complex strategies like spreads, straddles, strangles, etc., may be assigned (More about these strategies in the later posts). Typically there are four to six trading levels.

Requirements
Almost all online options brokers will let you open an account with a minimum deposit of $5,000, and some will let you in for as little as $2,000. However, with accounts of that size, the types of trades you can do will be limited - usually restricted to the buying of stock, outright purchases of plain-vanilla "call" or "put" options, the sale of "covered calls" or the positioning of basic bullish or bearish "option spreads."

You may have to put up at least $10,000 if you want employ more advanced strategies and higher-risk-involving trades. (If you want to become a specialist option trader engaging in such sophisticated options strategies, look for the broker that offers strong educational and analytical support.)

Finally, if you intend to engage in really high-risk strategies - such as the sale of "naked" calls on stocks or the writing of index options - you may be looking at an initial outlay of $50,000 or more.

Where to start?
I am listing a few of leading online options brokers. These aren't recommendations and I am no way compensated by these firms for listing them here - just a good starting point if you're ready to expand your trading horizons (just click on the firm name and the link will take you to their Web site):
Optionsxpress – offers very good trading platform with virtual trading facility
Optionshouse – competitive commission structure also offers paper trading
Tradeking – favorable option and stock commission rates
Trademonster - offers paperTRADE™, a practice account you can open and use to test strategies and sharpen your trading skills before actually putting your money on the line.

It is fairly easy and simple to open an account - either practice or real. You can complete all of the "paperwork" online, with the firm's Website walking you through the forms step by step. You can even arrange to fund the account with a direct transfer from your bank so you don't have to send in a check and wait for it to clear.

If everything goes well you should able to place your first trade within a week from opening of your account.

Come back again later for another interesting options learning lesson. If you like my blog posts please Subscribe by Email and never miss any future tips about options trading. Also share my blog post using the Social Bookmarking services below.

Recap

Some quick facts about options

Contract

Options are quoted in per share prices, but only sold in 100 share lots. For example, a call option might be quoted at $2, but you would pay $200 because options are always sold in 100-share lots making it one contract.

Strike price

The Strike Price (or Exercise Price) is price the underlying security can be bought or sold for as detailed in the option contract.

How to identify an option

You identify options by the month they expire, whether they are a put or call option, and the strike price. For example, an “XYZ October100 Call” would be a call option on XYZ stock with a strike price of 100 that expires in October.

Expiration Date

The Expiration Date is the month in which the option expires. All options expire on the third Friday of the month unless that Friday is a holiday, then the options expire on Thursday.

Important!!!

This recap of options gives you an idea of what they are all about, but it is the tip of the iceberg. Do not trade options without understanding them completely as you could lose all. Consider a formal training or at least paper trade options before jump in.

This post is a deliberate reiteration of what we learned so far in-order to reinforce the basics of the options trading and make our learning journey begin on stronger foundation. The idea is to make the new comers and those who have been here before but felt it too much to digest the past posts, to feel at home. So, let’s have a recap on the past posts.

Option in stock market is basically a contract between two traders namely buyer and seller. An option gives; buyer a right and seller an obligation to fulfill the agreed contract.

Whenever, an option is traded, it just means that a contract has been made between a buyer and a seller either to buy or sell certain stock on or before a certain time period at an agreed price. The last date of “certain time period” mentioned in the last line is known as expiration date in options trading language.  Likewise, the “agreed price” is called strike price.

If you are a buyer of option you have the right to buy or sell the underlying stock any time before the expiration date. Similarly, if you are a seller of an option, then you have an obligation to sell or buy the underlying stock on or before the expiration date.

An option trade may be initiated for any of the available expiration dates. Usually most of the options will be listed for current month, following month, and couple of more with future expiration dates. In US markets third Friday of every month is the expiration date for that month options. Since, your option expires on the third Friday; you either trade out your option or exercise it.

There are two basic options called call and put which are either bought to: open or close or sold to: open or close resulting in 8 different combination of trades.

1. Buy to open a call
2. Buy to close a call
3. Sell to open a call
4. Sell to close a call
5. Buy to open a put
6. Buy to close a put 
7. Sell to open a put
8. Sell to close a put

Option contract usually means 100 shares. Whenever an option contract is traded it means 100 shares of the underlying stock are agreed to be either bought or sold between the buyer and seller.

Because options have finite life they lose their value quickly towards the fag end of their life or they rapidly lose their time value in the last weeks before their expiration in other words described as time decay.

According to the options industry council only 10% of the options contracts are exercised and 70% are closed out before the expiration and remaining 20% expire worthless.

There is a common saying in markets “I would rather be wrong and make money than right and lose” which is to say that it is more important to make money trading than making the right trades and still lose. But then your trading should not be based on some random thoughts. It is very important to have strict discipline in-order to make money trading and more importantly make money consistently. Consider a formal training or at-least paper trade before you can start real trading.

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Put buying as a trading instrument

We have already learned through the previous posts that put option is the contract that gives a buyer tight but not obligation to sell a stock at an agreed price (strike price) on or before a specified date (expiration).

So, far we have seen what call options are and what would happen to a call option depending on the stock price moves during its life. Let’s see the fate of a put option in action in this post.

Put option is purchased in order to profit from a down side move in a stock price. You make money when the stock price goes down when you own a put option on the stock. Another important use of put options are they are popularly used as protective instruments or insurance on a stock already owned. For example let’s say you own 500 shares of Intel Corp. (INTC) with a purchase price of $18.50. You could buy 5 contracts of put options for 4-6 into the future by paying about $100 per contract or $500 total price for $17.50 strike which gives a right to sell INTC at $17.50 no matter how low the stock price goes to before the expiration while still enjoying the gains if the stock continues to climb.

Let us look into a hypothetical example of what would happen to a put option purchase (buy to open) before we sell it (sell to close). This time around let us imagine a trade initiated on Research in Motion Inc. (RIMM) maker of the popular smart phone Black Berry, trades on NASDAQ, and closed at $40.10 as of Sept. 14^th. This stock has strike prices at $2.5 intervals near the closing price. The picture below shows the details of the put options table for Oct. expiration on RIMM stock again October was chosen for the obvious reason of following the paper trade.

Please refer to the previous post for an explanation of what each column represents.

Note that there are put options above the stock price in the picture. They are called out-of-the money options and the options $47.50 strike and above are called in-the-money options.

Our imaginary trade:

As you can see from the picture above that the October $45 puts have a premium (cost) of $2.79 indicating the expiration is the third Friday of October and the strike price is $45. The total price of the contract is $2.79 x 100 = $279 without commissions.

When you buy the above put option you have an option to sell 100 shares of RIMM at $45 on or before October 15^th 2010. The stock price must fall below $42.21 to break even and further below to make money on this trade.

For the purpose of this example, let’s say the stock price moved down to $41.50 by Sept. 27^th. The option contract has increased as the stock price moved down and is now worth only $4.25 x 100 = $425.  That means now you have a profit of ($425 - $279) = $146 on your initial investment of $279. If you decide to ride the trend down as there is more time left before the option expires. Now, by Oct. 8^th the stock price gained and moved to $43. The options contract has lost some of the premium though it is still in the money by $2 so now worth only $2.75 x 100 = $275, and you are barely close to breakeven ($2.79 - $2.75) x 100 = -$4.

By the expiration date, the price drops again to $38.50. Because this is less than our $45 strike price our trade is in the money and we have a right to either exercise the option and sell 100 shares in the open market or sell-to-close the option which would be worth ($45-$38.50) x 100 = $750 and book the profits of $750-$279 = $471 after subtracting your initial investment. Note that there is no premium value left as it is the expiration day.

To summarize, here is what happened to our option investment:

RIMM Oct. 45 put	Sept. 15th	Sept. 27th	Oct. 8th	Oct. 15th Exp.
Stock price	$45.10	$41.50	$43	$38.50
Option Price	$2.79	$4.25	$2.75	$7.50
Option value	$279.00	$425.00	$275.00	$750.00
Profit / Loss	$0	$146	-$4.00	$471.00

Caution: Please do not initiate any trades based on our imaginary examples as this could result in total (100%) and be advised that none of the content in the post is any advice or promotion of any sort and should be completely treated as educational material only.

That’s about the life of a put option. Do you know what happened to the seller of the put option in that example? Think about it.

More options related stuff in the next post. Don’t forget to leave your comments and suggestions and come back again for an exciting learning experience.

Anatomy of an option trade

Let us learn in this post about different outcomes of (anatomy of) an option trade. For example, let us see what would happen to a trade opened on IBM stocks option. IBM stock trades on New York Stock Exchange (NYSE) with a closing price of $129.61 as of 9/13/10. IBM has options listed with $5 incremental strike prices. This can be better understood with picture below. This is a call options table for IBM stock which expires on 15th of October 2010. I have purposely included October expiration table instead of September’s sice they expire in a couple days and it will be easy to follow the details of the post as the stock price moves over the next month and understand the different outcomes explained for Oct. expiration.

Numbers in the extreme left column are called strike prices. Next column represents a unique identifier of different options of IBM. Please refer to the earlier post where, I have explained the symbology of options. Last is the price at which the option traded last. Chg Is the change of options price from close of previous day. Note that all the changes are green and up since price of IBM went up and we know that call options gain when a stock price goes up. Bid and ask are the prices what buyer is ready to pay and a seller is ready sell a particular option for. Vol. is the number of options traded for that day. And last column is what is called as open interest which means the trades that are opened and waiting to be closed.

Note that there are call options above the stock price in the picture. They are called in-the-money options and the options $130 strike and above are called out-of-the-money options. Now, imagine if the stock priced closed at any of the strike prices for example at $125 or $130, then that option will be called as at-the-money option.

Don’t worry about any of the parameters that you did not understand as we will revisit them very often.

Initiating a trade:

IBM stock price closed at 129.61 by the close of September 13th, and the premium (cost) is $2.64 for an October 130 Call, which indicates that the expiration is the third Friday of October and the strike price is $130. The total price of the contract is $2.64 x 100 = $264. I did not include the commissions incurred just to make it simple (you'd also have to take commissions into account in real time).

You may recall that a call option contract is the option to buy 100 shares; that's why we multiply the contract by 100 to get the total price. The stock price must rise above $130 before the call option is worth anything since we are buying $130 strike price; furthermore, because the contract is $2.64 per share, your break-even price would be $132.64.

When the stock price is $129.61, it's less than the $130 strike price, so the option is worthless. But don't forget that you've paid $264 for the option, so you are currently down by this amount.

For the purpose of this example, let’s say the stock price moved down to $125 by Sept. 27th. The option contract has decreased along with the stock price and is now worth only $1.10 x 100 = $110.  Subtract what you paid for the contract, and now you have a loss of ($264 - $110) = $164. Where, as the real stock owner would be under water by [(129.61-125) x 100] = $469 on 100 shares. At this point you could decide to take the los and sell your option to close the position also known as “sell to close”. For the sake of this example, let's say we let it ride as there is more time left before the option expires. Now, by Oct. 8th if the stock price gained and moved to $135. The options contract will also increased along with the stock price and is now worth $6.25 x 100 = $625, and your profit is ($6.25 - $2.64) x 100 = $361. That was a wild swing from losing more than 50% in the first 10 days to a gain of over 130% in next ten days. You could sell your options here and take profits - unless, of course, you think the stock price will continue to rise and did not sell.

By the expiration date, the price drops to $128.50. Because this is less than our $130 strike price and there is no time left, the option contract is worthless. We are now down by our initial investment of $264. Well, that’s just a hypothetical analysis and we do not know what is going to happen to IBM stock price by Oct. 15th 2010 but we do know what will happen to our option price what ever the direction stock price moves.

To summarize, here is what happened to our option investment:

IBM Oct. 130 call	Sept. 15th	Sept. 27th	Oct. 8th	Oct. 15th Expiration
Stock price	$129.61	$125	$135	$128.50
Option Price	$2.64	$1.10	$6.25	Worthless
Option value	$264.00	$110	$625	$0
Profit / Loss	$0	-$164	$361	-$264

The price swing during the length of the option from a low to high was $625 which gives over double the initial investment. That is the power of leverage.

We have learned in great detail of life of an option contract in this example. This example only talks about buying a call option but there can be more trades initiated like for example, selling the same call would have given a profit of $264 to the seller.

Let me close here for now and will be back with more options stuff in the next post. Do leave your comments and suggestions and don’t forget to bookmark this blog for an easy return to free options education. 

Why use options?

Hello and welcome back to the blog. I have said in my previous post that we will learn about how to choose a proper option in this post. I realized that it would be way ahead of our learning curve. So let us get more insights into the basics of options by learning why use options in this post.

Two major uses of options are; speculation and hedge.

Speculation:

Option trading is used as a speculation when an investor thinks of benefiting from the movement in the price of a stock. The advantage of using options is you are not limited to making profits only when the stock price moves up. Since, the options are so versatile you can make money when price of a stock goes up, down or even sideways.

You buy a call option on any stock when you think it is going to move up and then profit from the move.

You buy a put option if you think the price of a stock is moving down to profit from the move.

A third way to make money using options by selling options if you think the price of the stock will not go anywhere and stays sideways.

Due to this versatility of options investors have a chance to gain as well a big money as they can lose. Speculation is the main reason options are termed very risky investing instruments. This is because when you buy or sell an option not only that you have to be correct on the direction (up or down) of the price move but also on the timing (how soon or late the move will happen) and magnitude (how much the price will move). And of course throw in the factor of commissions, the odds of making money trading options is stacked up against you.

So, why do we speculate trading options, if the odds are so skewed? There comes the factor of leverage. Apart from the versatility, options provide what is known as leverage by way of controlling 100 shares with one contract. So, it helps in making a lot of money even with a small change in the price of a stock.

Hedging:

This is another function of option. Hedging is similar to buying insurance on house or car. When you a particular stock and want to protect your investment from the downside movement on the stock you may want to buy some put options to limit your exposure to the losses occurring from the downside move in the stock, though there is an argument against hedging for the reason you should not invest in a stock you think will move down. But then this is a better strategy if you want to get the full potential of upward gains while limiting your exposure to downside.

Another function of options is known as employee stock options given by some employers in order to keep their smart and talented employees from jumping off the company. This is similar to the regular stock option where the holder has a right but not the obligation to buy the company stock but this contract is between the company and the employee where as a normal option is a contract between two individuals that are completely unrelated to the company.

That’s in a nutshell about the uses of options and when a particular kind of option is used. More about the usefulness of options and the different outcomes of an options purchase in the next post. Mean while you can go to previous posts to learn about basics of options. Don’t forget bookmark this page and comeback for the updates for you options learning experience.

Calls and Puts

If you want to trade options, Call and Put are the two important phrases that you need to get familiarized with. When someone talks about trading options, it has to be either a call or a put. Two more phrases that are good to know are long and short. In general buying something to own is long and selling without owning is short.

Any stock that is trading on stock markets with options will have Calls and Puts listed for different strike prices and that stock is referred as underlying. Note that not all stocks will have options.

Legendary investor Warren Buffet’s Berkshire Hathaway (BRK-A) trades on New York Stock Exchange (NYSE) does not have options. An interesting fact about this company is a single share of BRK-A costs about $123,500.00 as of September 9, 2010 if you don’t know already.

Call
A Call is an options contract that gives the buyer the right to exercise the option and buy the underlying stock at the strike price on or at any time up to the expiration date.

An options trader can be long a Call, in which case they have bought a Call contract, and have the right of exercise described above. Or a trader can be short a Call, in which case they have sold a Call contract, and may be required to sell the underlying commodity if they are chosen by the exchange (or options clearing system) to complete their contract obligations.

For a better understanding, let’s look at Caterpillar Inc.’s shares closed at $70.64 as of September 9, 2010. When a buyer is long 5 contracts of Sept. 70 CAT calls means s/he bought a right to control 500 shares of CAT until the close of third Friday of September (17th) by paying 1.57x5x100 = $285.00 not including the commissions.

An option contract usually represents 100 shares of the underlying. If this buyer has to make money CAT share price should be more than $71.57 (70.00 strike price + 1.57 option price) by Sept. 17th of 2010 though they closed at $70.64 Sept. 9th of 2010. The difference between the closing price of the stock and the option price + strike price is called the premium. In this example it is (70.00+1.57) - 70.64 = 0.93 cents. Buyer is paying this premium for the time value left before the expiration of the option.

All options have a limited life. They are defined by a specific expiration date. The picture below is a snapshot of CAT’s options table for September expiration that can be found on yahoo finance site.

source: yahoo finance

Three different scenarios are expected by the expiration date.

Stock price stays at or below $70.00: call option expires worth less and buyer looses all the money paid for buying those 5 contracts ($285.00). Seller gets to keep that money.

Stock price surges past $70.00 and much more: Buyer can exercise the option and buy 500 shares of CAT for $70.00 a piece either to keep as an investment or sell in the open market the current price and pocket the profit assuming selling over $71.57. The seller has an obligation to sell 500 shares at $70.00 though the shares are trading higher than $71.57.

Third possibility is the call buyer sells those contracts before the expiration either for a profit if the share price goes up and the call option price moves above $1.57 or at a loss if the share price drops.

Most traders do not exercise their options; instead they will close it sometime before it expires. This rarely happens and there is not much benefit to doing this, so don’t get caught up in the formal definition of buying a call option.

You can also sell (or write) call options. This process exposes the option writer to virtually unlimited risk. You are essentially taking the other side of the trade that a buyer of a call option makes. Most traders buy call options because they believe the price of a stock is going to move higher and they want to profit from that move. You can also exit the option before it expires – during market hours, of course.

Put
A Put is an options contract that gives the buyer the right to sell the underlying stock at the strike price on or at any time up to the expiration date. Again don't get caught up in the formal definition.

An options trader can be long a Put, in which case they have bought a Put contract, and have the right of exercise described above. Or a trader can be short a Put, in which case they have sold a Put contract, and may be required to buy the underlying if they are chosen by the exchange (or options clearing system) to complete their contract obligations.

Mostly, a put option yields an opposite result to that of a call option. In other words a call option buyer makes a profit when the stock price moves up within the expiration date and a put buyer makes when the stock loses its price value.

A put option buyer is betting on the stock’s price moving lower before the expiration.

Apart from the fact that options are a best instruments of leverage as each contract controls 100 shares of underlying traders use options in many different ways and combinations to benefit from the stock price movements.

So, now we are at a point how to choose a proper option to buy? We will see that in the next post. Do come back for more lessons on options.

A Brief History of Options

It has been close to thirty seven years stock options have been trading on organized exchanges.

In 1973, Chicago board of trade (CBOT) founded Chicago board of options exchange (CBOE) and call options on 16 securities started trading. In 1977, put options began trading.  A decade later, index options appeared on the scene.

In 1975, the Securities and Exchange Commission (SEC) approved the Options Clearing Corporation (OCC), which is still the clearing agent for all US-based options exchanges.  As clearing agent, the OCC facilitates the execution of options trades by transferring funds, assigning deliveries, and guaranteeing the performance of all obligations.

The early 1970s also witnessed other important events related to options trading.  For instance, in 1973, Fischer Black and Myron Scholes prepared a research paper that outlined an analytic model that would determine the fair market value of call options.  Their findings were published in the Journal of Political Economy and the model became known as the Black and Scholes Options-Pricing Model.  It is still the most widely used options-pricing model used by traders today. 

Today almost seven different exchanges provide trading these investment vehicles including, Philadelphia Stock Exchange (PHLX), American Stock Exchange (AMEX), Pacific Stock Exchange (PCX), Boston Stock Exchange (BOX) and others.

In 1983, the exchange began trading options on the S&P 100 Index ($OEX).  The OEX was the first index to have listed options.  The CBOE Volatility Index ($VIX) became the market’s first real-time volatility index in 1986.  VIX was, and still is, based on the option prices of the OEX.   

In 1990, Long-term Anticipation Securities (LEAPS) were introduced.  The OCC and the options exchanges created the Options Industry Council (OIC) in 1992.  The OIC is a non-profit association created to educate the investing public and brokers about the benefits and risks of exchange-traded options.   In 1998, the options industry celebrated its 25th anniversary.  In 1999, the AMEX began trading options on the Nasdaq 100 QQQ (QQQ)—an exchange traded fund that is among the most actively traded in the marketplace today. 

On May 26, 2000, the International Securities Exchange (ISE) opened.  It was the first new US exchange in 27 years.  In addition, ISE became the first all-electronic US options exchange. In 2001, the options exchanges converted prices from fractions to decimals.  Additionally, two new implied volatility indices were launched in 2001.  While the Chicago Board Options Exchange created the Nasdaq 100 Volatility Index ($VXN), the American Stock Exchange (AMEX) launched the Nasdaq 100 QQQ Volatility Index ($QQV).  Both were designed to provide option traders with real-time information regarding implied volatility in the technology sector.  October 24, 2008 - The CBOE Volatility Index (VIX) reaches an intra-day all-time high of 89.53. 1.2 billion contracts during 2008, the busiest year in the Exchange's 35 year history.

In 2010 options symbology or the way they are named was changed from its older coding of simple four- or five-character letter codes that have been in use since the Chicago Board Options Exchange (CBOE) first started trading standardized listed options back in 1973. They now use more-definitive codes containing a combination of up to 22 letters and numbers.

That was a short history of options, with an introduction to the options symbology. More about Calls and Puts I will write in the next posts.