Oddbean new post about login | logout Does anyone understand options and want to explain it to me?
Sure. An option is a contract which gives you the right to buy a fixed amount of an underlying asset at a predetermined price before a certain date. For instance, I could buy a "call" option on Apple which expires on December 15th and has a strike price of $150. This would give me the option, but not the obligation, to buy 100 shares of apple stock on or before that date. If I think that apple will be trading at more than $150 a share, then that contract would be valuable and I would pay some premium for it. If I end up being wrong and Apple is cheaper than $150 a share, my option will expire worthless. The same can go in the other direction, but it works by borrowing and selling shares first, and is called a put option. You can also choose to sell these options if you own the underlying and want to hedge or generate yield, or even sell them naked if you want to go way out on the risk curve. But basically all you need to know is that it is an option to act on an asset at a fixed price before a certain date.
Options contracts involve a buyer and seller, where the buyer pays a premium for the rights granted by the contract. Call options allow the holder to buy the asset at a stated price within a specific time frame. Put options, on the other hand, allow the holder to sell the asset at a stated price within a specific time frame. Each call option has a bullish buyer and a bearish seller while put options have a bearish buyer and a bullish seller. Traders and investors buy and sell options for several reasons. Options speculation allows a trader to hold a leveraged position in an asset at a lower cost than buying shares of the asset. Investors use options to hedge or reduce the risk exposure of their portfolios.
Option - contract to buy or sell something, its called an option because execution of the contract is optional and up to the owner of the contract. The parameters are: asset, amount, price, and expiration date. Call - Option to buy. Example : Asset: BTC, Amount: 1 BTC, Price: $100,000, Expiration: 12/31/2025. The seller of the option (the writer) sells the Call Option (right to buy) to someone (the buyer). The buyer then holds the option. If the price of Bitcoin remains less than $100,000 then the buyer will not execute the option because they can just buy the BTC for less than $100,000 (the option is out of the money, OTM). If the price rises above $100k (maybe it rises to $110k) then the option becomes in the money (ITM). The buyer of the option can then choose to execute the option to buy 1 BTC for only 100k ( a $10k discount) and the writer of the contract is required to sell their coin cheaply. Put - Option to sell. Example : Asset: BTC, Amount: 1 BTC, Price: $75,000, Expiration: 12/31/2025. The seller of the option (the writer) sells the Put Option (right to sell) to someone (the buyer). The buyer then holds the option. If the price of Bitcoin remains above $75,000 then the buyer will not execute the option because they can sell their BTC for more on the open market (the option is out of the money, OTM). If the price falls below $75k (maybe falls to $50k) then the option becomes in the money (ITM). The buyer of the option can then choose to execute the option to sell 1 BTC for $75k ( a $25k premium) and the writer of the contract is required to buy the coin at a premium.
I’ve been using them to invest in stocks where I expect an increase in value to profit without buying the stock. For instance, say a stock trades at 10, to buy 100 shares you need $1000, if the price increases to 14 and you sell, you made 400 (40% return). That same stock may have an option that you can purchase for 4. Each option contract is 100 share lots. So you invest $400. If the stocks moves To 14, your option will increase in value as a multiple. So maybe the option increases 2.50. You close the option and you get 650 when invested 400. So your return is 63% vs buying and vs 40% and you didn’t have as much capital tied up. This is an example and options have funny responses to market changes. I’ve only messed with buying long dated call options. Short dated gets really squirrelly. I’m certainly no expert in this but have had this work in the past. It is my understanding that 80% of calls expire worthless so the idea it is to get in when a stock is depressed and get out when there’s a pop in the stock, not to hold it for the duration.