Bull Market 1

8/8/2019 Bull Market 1

1/19

Copyright, 1996 Dale Carnegie & Associates, Inc.

Stock Options - Basic Strategies

For A Lifetime Of Option

Investing

The

Bull Market

Report

Seminar

Vail 99


2/19

Introduction - The Very Basics

An option is the right, but not the obligation,

to buy or sell a stock for a specified price onor before a specific date. A call is the right

to buy the stock, while a put is the right to

sell the stock.


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Buyer and Writer or Seller

The person who purchases an option,

whether it is a put or a call, is the option

"buyer." Conversely, the person whooriginally sells the put or call is the option

"seller" or "writer."


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Contract -- Premium -- Risk

1 option contract controls 100 shares

The price of the option is referred to as the

"premium

The potential loss to the buyer of an option

can be no greater than the initial premium

paid for the contract.


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Strike Price

Strike price" or "exercise price" - the price

at which the option holder may buy the

underlying stock pursuant to a call option orsell the stock pursuant to a put option.


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Expiration Date

Expiration date" - options expire on the

third Friday of the month


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Call Options vs. Put Options

Call Options - The buyer

of a call option purchases

the right to buy 100 shares

of the underlying stock atthe stated exercise price.

Thus, the buyer of 2 IBM

May 160 call options has

the right to purchase 200shares of IBM at $160 up

until June expiration date.

Put Options - The buyer of

a put option purchases the

right to sell shares of the

underlying stock at thecontracted strike price.

Thus, the buyer of one

IBM May 160 put has the

right to sell 100 shares ofIBM at $160 any time

prior to the expiration

date.


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Strategies - Risks and Rewards

Who Buys Options?

An investor who is very bullish

An investor who would like to take advantageof leverage with a limited dollar risk


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AnE

xample In an example, ZYX is trading at 44 1/4. Instead of spending $22,125 for 500 shares of

ZYX stock, an investor could purchase a six-month call with a 45 strike price for 3 3/8.

By purchasing a six month call with a 45 strike for 3 3/8, the investor is saying that he

anticipates ZYX will rise above the strike of 45 (which is where ZYX can be purchased

no matter how high ZYX has risen) + 3 3/8 (the option premium), or 48 3/8, by

expiration. Each call represents 100 shares of stock, so 5 calls could be bought in place

of 500 shares of stock. The cost of 5 calls at 3 3/8 is $1,687.50 (5 calls x 3 3/8 x $100).

Instead of spending $22,125 on stock, only $1,687.50 is needed for the purchase of the 5

calls. The balance of $20,437.50 could then be invested in short-term instruments. This

investor has unlimited profit potential as ZYX rises above 48 3/8. The risk for the option

buyer is limited to the premium paid, which in this example is $1,687.50. Commissions

and taxes have not been taken into consideration in these examples, although they canhave a significant affect on the investor's returns.

Had the stock been purchased at 44 1/4 (a cost of $22,125), and it rose to 51, it would

now be worth $25,500. This would be a 15.3% increase in value over the original cost of

$22,125. But, the call buyer spent only $1,687.50 and earned 77% on his options.


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Who sells options?

1) Put Sellers

2) Call Sellers


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Put Writer:

An investor who would like to acquire a

position in a particular security, but is willing towait for it to trade at his desired price.

Would you rather buy CSCO today (4/5/99) for

$113 or 2 months from now for $105

(May 115 puts @ $10)


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Writing A Put

Have you ever given your stockbroker an order to buy a security at a specified

price? If you have, you have participated in a waiting game. The stock will not

be purchased until it trades at or below your limit price. Instead of waiting for

that to happen, you could have sold a cash-secured put. A premium (the price

of the option) for selling a put option would be paid to you for accepting theobligation to buy a stock that you want to be a part of your portfolio at the

price you select.

If the stock does not drop below the strike price by expiration, the premium

will be retained by the seller and another put may be sold. By selling the put,

the investor receives the premium while waiting for the stock to decline to thestrike or price at which he is willing to own it.

Therefore, the cash-secured put is a strategy that may help you accumulate

stock at a lower price than where it is currently trading (net cost = strike price -

premium).


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Covered Call Writer:

An investor who is neutral to moderately

bullish.An investor who is willing to limit his upside

for some downside protection.

Cash flow

NOTE: The covered call strategy may be implemented in Keogh and IRA

accounts.


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Covered Call Writing

Covered call writing is either the simultaneous purchase of stock and the sale of a call

option or the sale of a call option against a stock currently held by an investor.

Generally, one call option is sold for every 100 shares of stock. The writer receives cash

for selling the call but will be obligated to sell the stock at the strike price of the call if

the call is assigned to his account. In other words, an investor is "paid" to agree to sell

his holdings at a certain level (the strike price). In exchange for being paid, the investor

gives up any increase in the stock above the strike price.

If an investor is neutral to moderately bullish on a stock currently owned, the covered

call might be a strategy he would consider. Let's say that 100 shares are currently held in

his account. If the investor was to sell one slightly out-of-the-money call, he would be

paid a premium to be obligated to sell the stock at a predetermined price, the strikeprice. In addition to receiving the premium, the investor would also continue to receive

the dividends (if any) as long as he still owns the stock.

The covered call can also be used if the investor is considering buying a stock on which

he is moderately bullish for the near term. A call could be sold at the same time the

stock is purchased. The premium collected reduces the effective cost of the stock and he

will continue to collect dividends (if any) or as long as the stock is held.


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Credit Spreads

Credit: because the option sold is priced

higher than the option bought

Spread: because it's a purchase of oneoption and the sale of a related option on the

same stock at a different strike price


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Credit Spreads

Bearish Credit

Spreads

uses call optionsprofitable if the

stock does not

increase

significantly

Bullish Credit

Spreads

uses put optionsprofitable if the

stock does not

decrease

significantly


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Making It All Work For You!

Covered Calls & Credit Spreads

Time is on your side

Position trades


18/19

Time and Position Trades

It is very difficult for most people over the long-term to make money buying

options on a regular basis. The main reason for this is two-fold. When you buy

an option with a month or two until expiration, you have to be right in the

direction that the stock is going to move AND you have to be right on the timing

of the move...that is, it has to move pretty soon or the time value of the option

will work against you too much.

When you sell options (ie, covered calls and credit spreads), the strategies tend

to be a little more forgiving. This is due greatly to the fact that you will have the

time value working for you.

Another benefit of covered calls and credit spreads is that they are what I referto as "position trades". That is, once you enter the covered call position or the

credit spread, generally, you don't need to watch the screen all day. Such is not

true when you are buying options. Generally, when you buy options, you want to

keep close tabs on it during the day in case it makes a run one way or another

so that you can make a move if needed. Thus, the covered call and credit

spread techniques fit in to many people's lifestyle much better than other stock

option strategies.


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Notes

Certain of of the foregoing text re-printed herein with permission from the C.B.O.E.

Copyright 1998 1999 Chicago Board Options Exchange.

Bull Market 1

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