I first got involved with stock options back in the 1990s the way a lot of people do.
I was given some by my company as a perk called an ISO, an “Incentive Stock Option.” What I didn’t know then was that anyone could buy and sell these types of options on the exchange without being a key employee of a company.
And this is the first piece of education you should be getting when it comes to options:
Once you get comfortable with the basics, the opportunities to make money become endless.
Options are one of the most versatile, if not the most versatile, trading instrument ever invented. Since options cost less than stock, they provide a high leverage approach to trading that can significantly limit the overall risk of a trade or provide additional income.
To me an option is like renting a stock, with the intent to turn around and “Sell the Rental” to someone else when the stock moves in the direction you want.
I love buying options under the right conditions. Call option buyers have the right, but not the obligation, to buy the underlying stock at a specified price until a specified time (its expiration).
It is essential to become familiar with the inner workings of calls before moving on to other strategies. Every strategy you learn from this point on depends on your thorough understanding of this basic call strategy.
There are no margin requirements if you want to purchase a call option because your risk is limited to the price of the option. In contrast, option sellers receive a credit in their account for selling an option, and get to keep this amount if the option expires worthless.
Buying a call option requires the cash for the purchase. If XYZ Corporation is trading at $100 a share, it would cost $10,000 to purchase 100 shares of stock. However, if the XYZ Corporation 100 calls are trading for 2 points ($2), you would need only $200 to purchase these options and “Rent the Stock.”
Here are some key terms you’ll need to know as you start your stock “rental” program:
STRIKE PRICE – The price at which an underlying stock can be purchased or sold if the option is exercised is called the strike price. Options are available in several strike prices above and below the current price of the underlying asset. Strike prices below the stock’s price will be more expensive because they are worth more, while strikes above the stock price are cheaper because the stock has to climb to offer real value.
EXPIRATION – The date the option expires is referred to as the expiration date. Most stock options expire on the third Friday of every month, but about 250 or so have expirations that are every week. All listed options have options available for the current month and the next month, as well as specific future months.
PREMIUM – The price of an option is called the premium. An option’s premium is determined by a number of factors, including the type of option, the current price of the underlying asset, the strike price of the option, the time remaining until expiration, and volatility.
An option premium is priced on a per share basis. So that means if XYZ Corporation option is priced at $2, the total premium for that option would be $200 (2 x 100 = $200).
Let’s summarize with some key bullet points:
- Call options give you the right to buy the underlying instrument, but you’re not required to.
- Call options are good for a specified period of time, after which they expire. Most traders close their option positions out before then.
- Call options, when bought, are done so at a debit to the buyer.
- Call options, when sold, are done so by giving a credit to the seller.
- Call options are available in several strike prices corresponding to the price of the underlying instrument.
- The cost of a call option is referred to as the option premium. The premium fluctuates just like a stock does at the market.
- Options are not available on every stock. There are over 25,000 listed stocks, but only about 3,000 or so trade options.
I hope you can now see why I would rather “Rent to Own” than just own. There are many advantages… with the biggest ones being lower cost and risk.
In my next issue I’ll show you how our “Rental” strategy turned a small investment into a 100% return.
Until next time…
America’s #1 Trader