Options are one of the mysteries of the stock market. Many people have heard of them, but few understand how they work. Through this series of lessons, we would like to provide you with a brief overview of what options are and how they work.
When you buy an option on a particular stock, you haven't purchased the actual stock itself, you have simply bought the right to buy or sell the stock under certain predefined conditions.
Depending on these conditions, the purchase of this stock could result in a significant profit for the buyer of the option. This would cause the buyer of the option to move onto the next phase and exercise their option and purchase the stock under these favorable conditions. This purchase of the stock is a separate transaction from the purchase of the option.
However, there is also a second possibility. Because of the favorable conditions attached to this option, others may be interested in purchasing the option you own.
Let's Illustrate
Let's say, you wanted to buy a particular piece of property. For a variety of reasons, you are not ready to purchase it just yet, but you have a hunch that property values are going to go up very quickly. So you ask the owner if you can have an option on the property that gives you the right, but not the obligation, to purchase the real estate for its current fair market value of $200,000, and you buy that option for 5000.00 three months down the road.
Now the sale of the option, legally obligates the owner to keep his property off the market until you make your decision. The owner is limited in what revenues he can earn off this property.
So in the end, he agrees to sell this option to you for $5,000 to make up for lost revenues on this property during the option period. This option price is non-refundable, you are simply compensating the owner for lost revenues during the option period.
If at the end of the three months, you decide to purchase the property, you will end up paying $205,000 -- $200,000 for the purchase of the property and $5,000 for the option.
If, however, you decide that the conditions are no longer favorable for you to purchase the property you can walk away from the deal and only be out the $5,000 option premium.
Now let's take a look at how this option works under different scenarios:
Message Board Post Of The Last Option Trade
Still four options in play, but today we cashed in our TSL calls, for a 73 percent profit from our entry Thurday-to our sale today. In the money almost from the word go, we bought the bottom and top ticked the exit- We'll take it! Our new entry today was into March 71 XLE puts (XBTOS). So, we remain at 4 options-don't worry, more to come soon.
TheSpookyOne (Options Moderator)
Spooky
What you Failed to mention was that we were in the trade actually 5 days (Yes weekends count) which translates into 14.6% per day which is a WHOPPING 5329% annualized gain on this trade alone. Great Job!!!
Grs
