From: ask@cbnews.cb.att.com (Arthur S. Kamlet)
Subject: Re: what are stock options?
Reply-To: ask@cblph.att.com
Organization: AT&T Bell Laboratories,  Columbus, Ohio
Distribution: usa
Date: Thu, 27 Aug 1992 23:48:06 GMT

In article <YARRI.92Aug27014733@maumee.ee.eng.ohio-state.edu> yarri@ee.eng.ohio-state.edu (Douglas Yarrington) writes:
>
>Would some one do me the favor of describing the mechanism and methods
>of trading stock options?

This should probably  be a FAQ -- at some point.

First, an option is a contract between buyer and seller.


The option is connected to something, such as a listed stock or an
exchange index or futures contracts or real estate.  For simplicity,
I will discuss only options connected to listed stocks.

The option is designated by:
       - Name of the associated stock
       - "strike price"
       - Expiration Date

       - The option costs a "premium" to buy, plus brokers commission.

The two most popular types of options are Calls and Puts.

    Example:  The Wall Street Journal might list an 
                IBM Oct 90 Call @ $2.00

    Translation:  This is a Call Option

                  The company associated with it is IBM
                    (See also the price of IBM stock on the NYSE)

                  The option expires on the third Saturday
                      following the third Friday of October, 1992.

                  (an option is worthless and useless once it expires)

                  The strike price is $90.00  If you own this option
                  you can buy  IBM @ $90.00  (even if it is then
                  trading on the NYSE @$100.00, I should be so lucky!)

                  If you want to buy the option it will cost you $2.00
                  plus brokers commissions.   If you want to sell
                  the option you will get $2.00 less commissions.


In general, options are written on blocks of 100s of shares.  So
when you buy "1" IBM Oct 90 Call @ $2.00 you actually are buying a
contract to buy 100 shares of IBM @ $90 per share ($9,000) on or
before the expiration date in October.   You will pay $200 plus
commission to buy the call.

If you wish to exercise your option you call your broker and say you
want to exercise your option.  Your broker will arrange for the
person who sold you your option ( a financial fiction:  A computer
matches up buyers with sellers in a magical way) to sell you 100
shares of IBM for $9,000 plus commission.

If you instead wish to sell (sell=write) that option you instruct
your broker that you wish to write 1 Call IBM Oct 90s, and the very
next day your account will be credited with $200 less commission.

If IBM does not reach $90 before the call expires, the option writer
gets to keep that $200 (less commission)   If the stock does reach
above $90,  you will probably be "called."

If you are called you must deliver the stock.  Your broker will sell
your IBM stock for $9000 (and charge commission).  If you owned the
stock, that's OK.  If you did not own the stock your broker will buy
the stock at market price and immediately sell it at $9000.
Commissions each way.

If you write a Call option and own the stock that's called
"Covered Call Writing."  If you don't own the stock it's called
"Naked Call Writing."   It is quite risky to write naked calls,
since the price of the stock could zoom zooom up and you would have
to buy it at the market price.

My personal advice for new options people if to begin by writing
covered call options for stocks currently trading below the
strike price of the option.  (write out-of-the-money covered calls)

When the strike price of a call is above the current market price
of the associated stock, the call is "out of the money" and is "in
the money" when the stock price is below the call's strike price.

-----

Most regular folks like you and me do not exercise our options; we
trade them back, covering our original trade.  Saves commissions and
all that.

=========
The other common option is the PUT.

If you buy a put from me, you gain the right to sell me your stock
at the strike price on or before the expiration date.

Puts are almost the mirror-image of calls. (I ran out of time, so
will post this;  if more questions, please ask.  If there's a demand
to expand the PUT story, I'll be glad to , or let the other options
experts do that.)
-- 
Art Kamlet  a_s_kamlet@att.com  AT&T Bell Laboratories, Columbus
Newsgroups: misc.invest