ABstocks: Learn Stock Market

- Note: option trading has lower risk than stock trading since you can only lose the premium (initial money you put in to buy the option) in the worse case scenario

- They can be traded like stocks on your brokerage order page. You just have to talk to your discount brokerage to make sure you can buy/sell options in your account. Instead of symbols for stock market (ie “F” for Ford Motor Company), the option symbols you trade are a little longer and for example are something along the line of:

“F Jan 2013 15.000 put”

Which means has “F” for Ford Motor Company, expiry date of “Jan 2013″, “15.000″ strike price, and “put” which means you can short the stock at $15 (the strike price)

- Options (North American options) expire on end of the 3rd week (Friday usually) of the month they are listed

- You can buy 1 contract minimum, which is 100 shares. So the price that is listed is multiplied by 100 * #-of-contracts

- Calls give you the option to buy the underlying stock at the strike price before the expiry date (similar to longing)

- Puts give you the option to sell the underlying stock at the strike price before the expiry date (similar to shorting)

- Note: writing your own options is a completely different topic. It means when you have an underlying stock you can write your own options. It involves more risk and we will cover this in the short future. For a beginner we recommend you avoid this for now.

First thing first, the things you need to remember about options are:

- Give yourself plenty of time and don’t choose an option that is going to expire in the next few months. Unless you are absolutely sure that it will be profitable (put or call doesn’t matter) in that short time. You might be paying higher premiums for longer term options, but at least the value will not go to zero all of sudden when the expiry reaches and it gives you plenty of time to sell it back to the market.

- Choose higher volume options (the ones that are traded more) and avoid the ones that don’t or have very low trading volume. You don’t want to be waiting forever for an order to execute. You can switch back and forth to US or Canadian markets of the same company if one doesn’t have enough volume ie rim in Canadian market and rimm in US market of the same company (Research in Motion). Overall options have a lot less volume than stocks, and US markets have more volume.

- Aim for trading the option or (selling it back) rather than exercising it. You usually get a bigger return this way, unless you want to own the underlying stock with exercising your options.

Lets look at an example:

Ford Motor Company on Google Finance

http://www.google.ca/finance/option_chain?q=NYSE:F

Current price at the time of writing this article and shown in the graph below is $14.02/share closing on the Friday:

You can click on “option chain” on the left hand side of Google finance to get the options available for the stock you are looking for. You can also get these on Yahoo finance or many other website as well as your discount brokerage page.

In case of Ford Motor Company,  the options table is shown below by Google finance. Click on the image to see the bigger picture.

We have chosen Jan 2013 (note: 19th of the month is end of 3rd week when options expire in the month usually). You can see in the picture that which options are in the money, which ones have no volume/low volume/highest volume. When the option strike price is lower than the current strike price it is in the money (for calls) and when the option strike price is higher than the current stock price it is called “in the money” (for puts).

You should select first the put or the call, then the high volume options and something that is near the current stock price and with a few months (at least) time to expire.

After selecting your option you can do a purchase on your discount brokerage interface and you should always look at the ask and bid prices.  The commissions are a little higher usually for options vs stocks but then it depends on your brokerage fee policy. You can start with 1 contract (which is 100 shares) and go up. The price listed on the table above has to bee multiplied by 100 so you can find the price you will be paying for 1 contract when purchasing  that option. ie put of strike $15 for Jan 2013 of Ford is $2.95 and you have to purchase a minimum of 1 contract which will be: 1 contract * 100 * $2.95 = $295.