Options
Posted by ferenc on June 22nd, 2007 filed in UncategorizedComment now »
Double your investment in one year by professional trading.
Certainly you earn 100% profit twice on your asset. First, the value of the investment doubles. Second, the value of your own shares increase by 100% percent. Save your present value of your money for the future. Cash on hand the most powerful tool to make your wealth. It is a dream and the lack of knowledge that you can make substantial profit without any risk
Some type of investment are widely recognized and understood by most people. This is because there is a general acceptance or sense of legitimacy about them. The American stock market and real estate, for example, are well understood by just about every one in the USA Even to a point that very real risks might be ignored or overlooked in some instances. Or, if these forms of investing are not truly familiar, there may at least be a belief that they are known, and that risks are small. Understanding makes it much easier for new investors to enter specific markets. Real estate is known for its historical appreciation and safety. And the stock market is the most popular way to invest, either through direct ownership of shares or through purchases of shares in mutual funds. However bear equity and real estate markets disappoint the public because they have suffered major losses. Nevertheless there are major signals for the beginning of a bear or bull markets. When option traders perceived these signals then was said to be big many ahead. The lack of understanding about the option markets creates fear. Options may be highly speculative or highly conservative and moderately aggressive. Having combined techniques applied, giving the advantage to secure substantial profit. This is such an investment in which the net profit could continuously exceed the annual rate of return of one hundred percent. Competitive Advantage Options are derivative instruments. This means that an option’s value and its trading characteristics are tied to the asset that underlies the option. It is this essential defining characteristic that makes options valuable to the knowledgeable investor. A major advantage of options is their versatility. They can be used in accordance with a wide variety of investment strategies. As a result, any investor who understands when and how to use options in pursuit of his or her individual financial objectives can enjoy a clear advantage over other investors. The investor will have an effective means of managing the risk inherent in any investment program. In most investment situations, understanding options gives the investor a wider range of investment choices.The asset on which the option is traded might be stock, an equity index, a future contract, a Treasury security, or another type of security.
Types of Stocks
Stock -Common Stock -preferred Stock -Outstanding stock –Treasury stock
Trading theories
Dow Theory – Elliot Wave Theory – Fundamental analysis – Technical analysis Mark Twain effect – January effect – Efficient market hypothesis
Stock pricing
Dividend yields – Gordon model – Income per share – Book value – Financial ratio
P/CF ratio – PE ratio – PEG ratio – Price/sales ratio – P/B ratio – Earning yield – Beta coefficient
Stock related terms
Dividend – Stock split – Growth stock – Undervalued stock - Investment – Speculation – Trade – Day Trading
MARKET
The American style stock option market opportunity exists on the NASDAQ, New York, Pacific, American, Philadelphia and Chicago Stock Exchanges. By the advancement of electronic trading its market is extremely liquid and has high turnover of capital. Competitors for the stock option markets are the buyers and sellers that is due time and to the unequal number of contracts and in the constantly changing strategies in long and short positions. Being more precise the trader compete against time and his/her own knowledge. The U.S capital markets’ market capitalization is the largest in the world hereby there aren’t any institutional investor who could control the security markets. Unlike other business sectors in which have big market players with major market shares.
The U.S. capital market is such where the results can be obtained out of the economic and financial regularities. These factors are essential to function the capital and money markets. The consequences of these concepts is that there is always a room to succeed for a small investor or small investment (and start-up) companies. The premium (price) of a stock option contract has a wide variety of ranges, anywhere from 1/64×100=$1.5625 up to 50×100=$5000. Without the knowledge of option theories and experience, it is impossible to be successful.
Standardization of Option Contracts
The proposal that created the CBOE also contained a suggestion for creating an intermediary organization to standardize and clear option contracts. This organization is known as the Options Clearing Corporation (OCC). The OCC is a corporation owned by the exchanges that trade listed stock options; it guarantees all option contracts. Also, option contracts now have standardized terms so investors can trade them in the market.
The call option
A call is the right to buy 100 shares of stock at a fixed price per share and within a limited period of time. As a call buyer , you acquire that right, and as a call seller, you grant the right to someone else.
The put option
A put is the opposite of a call. It is the right to sell 100 shares of stock at a fixed price per share and within a limited period of time. As a put buyer, you acquire that right, and as a seller, you grant the right to someone else.
Contract
A single option, including the attributes of that option: identification of the stock on which it is written, the cost of the option, date the option will expire, and the fixed price (strike price) at which the stock will be bought or sold if the option is exercised.
Premium: the current price of an option, which buyers pay and sellers receive at the time of the transaction.
At the money: a condition in which the market value of the underlying security is identical to the striking price of the option.
In the money: a condition in which the market value of the underlying stock is higher than the call’s striking price or lower than the put`s striking price.
Out of the money; the opposite of “in the money” a condition in which the market value of the underlying stock is lower than the call’s striking price or higher than the put`s striking price.
Intrinsic value: the amount the option is in the money (An at-the-money or out -of-the-money option has no intrinsic value)
Time value: the option’s premium above any intrinsic value
Leverage: the use of limited amount of money to control greater values (for example, a call buyer who spends $300 to control $5000 to buy 100 shares.)
Exercise: the act of buying or selling stock at the striking price
Expiration rules: Listed stock options in the United States technically expire on the Saturday following the third Friday of the expiration month. Customers of brokerage firms must concern themselves with two procedures in regard to expiration. First, brokerage firm customers must be aware of their firm’s specific rules regarding the deadlines for notification for exercise. Second, brokerage firm customers must be aware of the rules for automatic exercise. (when the option is at or in the money) Role of the
U.S. Stock and Derivative Market in Building Capital
Capital can be increased in many ways. For example, you can use capital to start up a business or buying one (physical asset markets). The risks are extremely high because there is always competition in any industry. It is more safe to invest into the real estate market however profit margin is very limited comparing to the stock market.In the U.S economy most companies are publicly traded whether they are on Stock Exchanges or Over -the-Counter-Market. Stocks and derivatives are one of the best methods of creating capital gains. They are liquid and under normal circumstances, buying and selling them takes only a few minutes, on via personal computer. Time is money! Therefore the length of time, liquidity and experience results in compounded capital gain.
Principles Followed by Successful Investors
Many naïve investors believe they are going to make a killing in the stock market because they have brilliant idea that is in theory. One of the first rule to learn as a stock and derivative investor is to avoid becoming a casualty. Presently and in the past as well we have to consider the international market’s indexes escecially in Asia as the Chinese capital market is growing with fast space. Their activity has to be translated for the USA capital market. The American capital market is still largest in the world and primarily its economy and financial regularities has to be considered.
Principle of Diversification
This is one of my golden rule to reduce exposure to risk. The other one is to utilize combination techniques. The third one is to know whether from what market direction the capital is flowing in and out. Nevertheless without stock analysis stock option trading becomes a lottery.
Competitive Analysis Summary of Major Market Instruments,
Market Participants and Security Characteristics
Quoted interest rate = k = k* + IP + DRP+ LP + MRPK = the quoted, or nominal, rate of interest on a given security.
There are many different securities, hence many different quoted interest rates K* = the real risk-free rate of interest (k* is pronounced “k star) IP = inflation premium DRP = default free premium LP = liquidity, or marketability , premium MRP = maturity risk premium
Instrument -Market -Maturity-interest rate
—————————————————————————————–
U.S. Treasury Money 91 days to 1yr. 6.4% bills
Banker’s Money Up to 180 days 6.3% acceptance
Commercial Money Up to 270 days 6.2% paper
Negotiable Money Up to 1 yr. 6.5% certificates of deposit (CDs)
Money market Money No specific 5.5%
mutual funds
Eurodollar market Money Up to 1 yr. 6 .3%
time deposit
Consumer credit Money Variable 10-15%
U.S. Treasury Capital 1-30 years 7.8%
notes and bonds
Mortgages Capital Up to 30 yr. 9.1%
State and Capital Up to 30 yr. 6.6%
local government
bonds
Corporate Capital Up to 40 years 8.5%
bonds
Leases Capital 3 to 20years Similar to
bond yields
Preferred Capital Unlimited 3-5%
stocks
Common Capital Unlimited 2.5-6%
stocks and capital gain
Stock option Capital Limited and See note
unlimited
Notes It is surprising to many option traders, is that rising interest rates cause call prices to rise and put prices to decline. A call option buyer is entitled to dividends Common Stocks are expected to provide a profit in the form of dividends and capital gains rather than interest.
It is essential to compare different financial markets and financial instruments by their track records since they exists. Risk and Rates of Returns1994 and 2002 were the years most investors wish could erase. The performances of the major stock markets could only be classified as abysmal-stocks traded on the New York Stock Exchange (NYSE), on the American Stock Exchange (AMEX), and over the counter (OTC). In 1994 USAir stock, which trades on the NYSE, lost nearly two thirds of its value because the company had difficulty handling its high operating costs and the costs of air mishaps in the highly competitive airline industry. There were many stock option traders whom bought puts and made a killing on the declining stock price. The reason for that is the put option got deep in the money. There are always such stocks on the market which are going in and out of favor. Other stocks provided very handsome, if not unbelievable, gains. United Inns, a hotel company traded on the NYSE, more than tripled its stock price in 1994; EXX, the toy manufacturer that holds the rights to the Mighty Morphin Power Ranger toys, saw the value of its stock increase by nearly 1,300 percent, from $1.63 to $22.25 on the AMEX. And the stock of Micro Touch Systems, which is an OTC company that manufactures screen for computers, jumped from $6.88 to $37.63, an increase of almost 450 percent. There were many stock option traders whom bought calls and made a killing on the incresing stock price From 1990 a new phenomena rose the beginning life of Internet companies where 1000 percent gains weren’t rare. In 1993, a record number of companies used the Initial Public Offering (IPO) market to “the public” - 707 IPOs raised more than $41 billion. The second and third most active years were 1994 and 1992, respectively. More than 600 IPOs worth nearly $29 billion were issued in 1994, while about $24 billion was raised through 517 IPOs in 1992. The IPO market slowed somewhat at the begging of 1995 than rose until 2000.It is indispensable to use stock analysis software’s and on-line stock quotes, CNBC for quick decision making. Combination Techniques for reducing risk and to increase profit potential Spread: the simultaneous purchase and sale of options on the same underlying stock with different striking prices or expiration datesThere are vertical, diagonal, horizontal, bull, bear, box, calendar and butterfly spreadsStraddle: is the simultaneous purchase and sale of the same number of calls and puts with identical striking prices and expiration datesThere are long, short straddles Hedge: a strategy in which one position protects the other. There are long, short, reverse and variable hedges.Risk Management The listed options business has evolved since it starts in April 1973. The collapse of the equity markets in October 1987 and 1989 and the shock waves sent through the currency markets with the ERM realignment in 1992 are dramatic examples of price risk that is ever present in the security business. In recent years, every major market has experienced similar volatility. From crude oil to Treasury bonds, and from agriculture commodities to currencies, every market in the world has attracted headlines to one time or another when price movements spell panic. The lesson for any participant is that risk management is crucial, and all investors and traders must be flexible enough to change with the evolving environment.In addition to improve risk management, some challenges markets will face are the development of new trading techniques, applications of technology, trading structures, and extended trading hours.
DELTA OF CALL OPTION
$50 Call Option Volatility: 35% Days to expiration: 90days
Theoretical Value Delta
Stock price
$56 $7 1/4 0.78
$55 $6 1/2 0,75
$54 $5 3/4 0.71
$53 $5 1/8 0.68
$52 $4 ½ 0.64
$51 $3 7/8 0.60
$50 $3 ¼ 0.54
$49 $2 ¾ 0.50
$48 $2 3/8 0.46
$47 $2 3/16 0.41
$46 $1 7/8 0.36
$45 $1 7/16 0.32
$44 $1 3/16 0.27
Delta the relationship of change in an option’s premium to changes in the price of the underlying stock (when the two move the same number of points, the delta is 1.00; a higher or lower delta can act as a signal to take advantage of adjustments in time value)
Beta a measurement of the relative volatility of a stock, made by comparing the degree of price movement to movement in an overall index. (For example; NASDAQ, AMEX, New York Stock Exchange Composite Index )
Pricing of option contracts Black-Scholes Option-Pricing Model
Present value of call option = P N (d1) - Exe -rft N (d2)
where; P = price of stock now N(d) = cumulative normal probability density function EX= exercise price of option t = time to exercise date rf = ( continuously compounded)
risk-free rate of interest e = 2.71828[FDH1]