Options

  1. 1) Based on futures contracts
    1. Expiration date occurs approximately two weeks prior to delivery of underlying futures contract
    2. Futures prices are chosen, “strike price”, premiums increase as value of strike price
    3. Cost consists of “time” and “margin” value
      1. Time refers to amount of time until expiration of contract
        1. Decreases as expiration nears
        2. Rarely increases
      2. Margin refers to the gain or loss between the current level of futures and the strike price
    4. No margin calls unless exercised, thus losses can
    5. Initial cost is often referred to as an “insurance”
    6. DEFINITELY SHOULD NOT PURCHASE UNTIL COMPETELY UNDERSTOOD
  2. Buy – risk is limited to cost of option
    1. Calls
      1. “call up”
      2. Increase in value as market rises
    2. Puts
      1. “put down”
      2. Increase in value as market falls
  3. Sell – Unlimited risk, only revenue is cost of option
    1. Calls
      1. Unlimited risk if market rises
      2. Seller receives short position whenever buyer decides to exercise
      3. Seller hopes market will fall
    2. Puts
      1. Unlimited risk if market falls
      2. Seller receives long position whenever buyer decides to exercise
      3. Seller hopes market will rise