There is an infinite number of strategies that can be used with the aid of options that cannot be done with simply owning or shorting the stock. Note: this is a very simplified example to explain the concepts. Although in reality the differences are not quite as marked options provide a way to very easily leverage your positions and gain much more exposure than you would be able to just buying stocks. If we just owned the stock we would sell it for $101 and make $1. Either way the profit will $1 times times 100 = $100 With the options I can sell my options for $2 or exercise them and sell them. Now let’s say the price of AAPL rises to $101 and we sell our positions. With the same amount of money I can buy 1 share of AAPL at $100. Let’s say I buy a call option for AAPL that costs $1 with a strike price of $100 (hence because it is for 100 shares it will cost $100 as well) If we look at a very simple example we can see how we can greatly increase our profit/loss with options. This means you can greatly increase how much you make (lose) with the amount of money you have. Option’s provide you with being able to greatly leverage your positions since each option contract is for 100 shares. There are two major reasons leverage and strategies. Why use options?Īt it’s core options simply track the underlying asset’s price and so why would we buy an option instead of the underlying asset? Hence in the example above you would just obtain $10,000 instead of needing the $200,000 cash to have to purchase the stocks in the interim. If AAPL is at $105 you would then earn $10,000 profit on this trade.īrokers will often times allow you to simply take the profit as well just like you would at expiry by immediately selling the shares. This also means you have to have the money to be able to buy 2000 shares at $100 = $200,000.
We would let our broker know and he would then “use up” your option contract (hence it no longer has any value) and buy 20 * 100 (each option contract is for 100 shares) 2000 shares of AAPL at a price of $100. Let’s say we wish to exercise 20 AAPL October 20th call options which have a strike price of $100. In simpler terms, an option allows you to pay a certain amount of money (the option price) to allow you to buy or sell a stock at the price (strike price) you decided on when buying the option.Ī call gives you the ability to buy at a specified price, whereas a put gives you the ability to sell at a specified price. Exercising the option is using that right to to buy or sell the underlying instrument. (this is different for European options as they can only be exercised at the end date). An option gives the owner the right, but not the obligation, to buy or sell the underlying instrument(we assume stocks here) at a specified price(strike price) on or before a specified date(exercise date) in the future.
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