Options Trading For Beginners: Complete Guide with Examples

"so let's say that you buy Intel at 32 and I give you an offer so I Brian want the option to buy Intel from you at $34 within the next two months so if you're going to give me that option if you're going to give me that option then you're not going to give me that option for free so you're going to tell me okay Brian if you want that option then it's going to cost you a $150 and I tell you that okay you got yourself a deal let's do it so I pay you $150 to have that option to buy Intel from you at $34 within the next two months so in other words you sold me a $34 call option that expires in two months for $150"

"so scenario number one the share price of Intel goes down so you bought Intel at $32 a share and let's say that in two months Intel Falls in price by $2 it goes from $32 to30 so in this scenario I'm not going to use the call option that you sold me because why would I buy Intel from you at $34 four when I could just buy it on the open market for 30 so in this scenario you sold me a contract that turned out to be worthless for me okay so for you Intel Falls from 32 to 30 you lose $2 on the stock right but you made $150 by selling me the call option so you hedged and you're only down 50 instead of $2 so it's a good thing that well in this scenario that you sold me the call option"

"scenario number two the share price of Intel does nothing so you bought Intel at 32 after 2 months it's the same nothing happened it's still at 32 in this scenario you didn't make money you didn't lose money on the stock the price stayed the same but you sold me the call option to buy Intel from you at 34 and I paid you $150 to have that option but I'm not going to exercise that option because I'm not going to buy Intel from you at 34 because I could just buy it on the open market for 32 so in this scenario congratulations to you your stock did nothing and you made $150 and let me tell you making a $150 in this type of transaction in two months is not bad because a150 divided by 32 which is what you paid for Intel that's a gain of 4.6% so you made a gain of 4.6% in 2 months so if you annualize that that's a rate of return of 28%"

"scenario number three Intel goes up by a little so you bought Intel at 32 let's say that Intel goes up from 32 to $33 in this scenario you made money on the stock because Intel went up from 32 to 33 Additionally you sold me the call option to buy Intel from you at 34 but the share price of Intel is at 33 so I'm not going to exercise my option because even though the stock price went up I would rather buy Intel in the open market for 33 rather than buy it from you for 34 so this is an awesome scenario for you because you made $150 by selling me the call option and your stock went up by a dollar so you're up $2.50 in 2 months that's a 7.8% gain in 2 months annual realiz that's a rate of return of 46.8%"

"scenario number four the price of Intel shoots up so you bought Intel at 32 Intel shoots up let's just say from 32 to 40 so you have to remember that you sold me the option to buy Intel from you at 34 within the next 2 months and it shot up to 40 so you know what I'm going to do you know what I'm going to do with the call option that you sold me I'm going to use it I'm going to exercise it I'm going to buy Intel from you at 34 and I'm going to sell it on the open market for 40 so even though the price of Intel shot up to 40 you are forced to sell it to me for 34 so that was the contract that was the deal I paid you $150 for that option so you bought Intel at 32 you sell it to me for 34 so you make $2 of gain on the stock and I paid you $150 to buy that call option from you so you make a $150 there you walk away with a gain of 350 in total that's an 11% gain in 2 months annualized that's a rate of return of 66%"

"so let's look at the call options on Intel 6 months out instead of 2 months and here are the prices for the call options 6 months out as you can see the $34 call option 6 months out is selling for $261"

"so you can sell the $34 call option 2 months out and make a150 or we can change the strike price to 38 and sell that option for 50"

"Sirius is currently at $4.89 a share and let's say that you think that it's a good buy at $489 a share so you can buy the stock at $4.89 and just hope that it goes up so that's one way to make money but another option is that you can do a cash secured put so here's what happens essentially you sell a put option by doing so you lock yourself into an agreement as follows Sirius is at $489 a share within one month if Sirius Falls to 450 or below you will buy Sirius for $450 and it doesn't matter if Sirius goes to $450 $449 $4 or $3 if Sirius Falls to $450 or below you will buy Sirius for $450 but within one month if Sirius does not fall to 450 or below then you will not buy it however regardless of which scenario occurs you will be paid 32 cents for agreeing to this"

"so take a look at the 450 put option those are selling for 32"

"scenario number one Siri stock stays above 450... Regardless in any of these events the price remains above 450 therefore in this scenario you do not end up buying Siri stock but you still get paid 32 cents... so if you think about it you did really well nothing happens you didn't end up buying anything or doing anything and you made 32 cents but what was the risk here the risk was that you could end up buying Siri for $450 and what was the reward 32 cents so if you make 32 cents by risking $450 that is a return on investment of 7.1% in one month that is an annualized rate of return of 85%"

"scenario number two Sirus stock Falls to 450 or below so let's say that after 1 month Sirius Falls to $440 in this situation you are obligated to buy Siri for $450 and because you buy Siri for 450 and it's Fallen to 440 you are down 10 cents However you have to remember that you were paid 32 cents to take on this deal so in reality you bought Siri for $450 but if you factor in the 32 cents that you were paid then you really bought Siri for $418 and if the price of Siri is at440 then you're actually at a profit of 22 but I want you to put this into perspective because remember when you saw Siri at489 you like the stock and you thought that it was a good buy at $4.89 but by going with a cash secured put you bought Siri for $418 so you got a much better deal on the stock you got in at a 15% discount"

"here's scenario number three Siri stock plummets so Siri at 489 and remember the deal if Siri Falls to 450 or below you are forced to buy it at $450 in one month if Siri plummets to $1 you will be forced to buy Siri for $450 50 so yes you did get paid 32 for making this deal so your true purchase price is $418 but still the stock fell to $1 this means that you are down $318 which means that you're down 76%"

"so we're using Sirius S II which is at $4.89 a share here's the options chain for serious and we're going to use the options that are expiring in less than one month it's in 22 days but we'll just call it one month to keep it simple and here are the prices on those one month options contracts so take a look at the 450 put option those are selling for 32"