Option Strategy Examples: Protective Put. Covered Call. Collars. Example.  Essentials of investments
Channel: Farhat Lectures. The # 1 CPA & Accounting Courses
Date: 2020-09-09

In this video, I discuss option strategy examples.  Option strategy examples
 will include protective put, covered call and collars.  The option strategy is covered in an essentials of investments. 
✔️Accounting students and CPA Exam candidates, check my website for additional resources:  https://farhatlectures.com/
📧Connect with me on social media: https://linktr.ee/farhatlectures
#CPAEXAM #essentailsofinvestments #stockoptions

Options are conditional derivative contracts that allow buyers of the contracts (option holders) to buy or sell a security at a chosen price. Option buyers are charged an amount called a "premium" by the sellers for such a right. Should market prices be unfavorable for option holders, they will let the option expire worthless, thus ensuring the losses are not higher than the premium. In contrast, option sellers (option writers) assume greater risk than the option buyers, which is why they demand this premium.


Options are divided into "call" and "put" options. With a call option, the buyer of the contract purchases the right to buy the underlying asset in the future at a predetermined price, called exercise price or strike price. With a put option, the buyer acquires the right to sell the underlying asset in the future at the predetermined price. 


Why Trade Options Rather Than a Direct Asset?
There are some advantages to trading options. The Chicago Board of Options Exchange (CBOE) is the largest such exchange in the world, offering options on a wide variety of single stocks, ETFs and indexes.1 Traders can construct option strategies ranging from buying or selling a single option to very complex ones that involve multiple simultaneous option positions.


The following are basic option strategies for beginners. 

Buying Calls (Long Call)
This is the preferred strategy for traders who:

Are "bullish" or confident on a particular stock, ETF or index and want to limit risk
Want to utilize leverage to take advantage of rising prices

Options are leveraged instruments, i.e., they allow traders to amplify the benefit by risking smaller amounts than would otherwise be required if trading the underlying asset itself. A standard option contract on a stock controls 100 shares of the underlying security.

Suppose a trader wants to invest $5,000 in Apple (AAPL), trading around $165 per share. With this amount, he or she can purchase 30 shares for $4,950. Suppose then that the price of the stock increases by 10% to $181.50 over the next month. Ignoring any brokerage, commission or transaction fees, the trader’s portfolio will rise to $5,445, leaving the trader with a net dollar return of $495, or 10% on the capital invested.

Now, let's say a call option on the stock with a strike price of $165 that expires about a month from now costs $5.50 per share or $550 per contract. Given the trader's available investment budget, he or she can buy nine options for a cost of $4,950. Because the option contract controls 100 shares, the trader is effectively making a deal on 900 shares. If the stock price increases 10% to $181.50 at expiration, the option will expire in the money and be worth $16.50 per share ($181.50-$165 strike), or $14,850 on 900 shares. That's a net dollar return of $9,990, or 200% on the capital invested, a much larger return compared to trading the underlying asset directly. (For related reading, see "Should an Investor Hold or Exercise an Option?")

Risk/Reward: The trader's potential loss from a long call is limited to the premium paid. Potential profit is unlimited, as the option payoff will increase along with the underlying asset price until expiration, and there is theoretically no limit to how high it can go.