An at-the-money option is described as an option whose exercise
or strike price is approximately equal to the present price of
the underlying stock.

For instance, if Microsoft (MSFT) was trading at $65.00, then
the January $65.00 call would an example of an at-the-money call
option. Similarly, the January $65.00 put would be an example of
an at-the-money put option.

An in-the-money call option is described as a call whose strike
(exercise) price is lower than the present price of the
underlying. An in-the-money put is a put whose strike (exercise)
price is higher than the present price of the underlying, i.e.
an option which could be exercised immediately for a cash credit
should the option buyer wish to exercise the option.

In our Microsoft example above, an in-the-money call option
would be any listed call option with a strike price below $65.00
(the price of the stock). So, the MSFT January 60 call option
would be an example of an in-the-money call.

The reason is that at any time prior to the expiration date, you
could exercise the option and profit from the difference in
value: in this case $5.00 ($65.00 stock price – $60.00 call
option strike price = $5.00 of intrinsic value). In other words,
the option is $5.00 “in-the-money.”

Using our Microsoft example, an in-the-money put option would be
any listed put option with a strike price above $65.00 (the
price of the stock). The MSFT January 70 put option would be an
example of an in-the-money put.

It is in-the-money because at any time prior to the expiration
date, you could exercise the option and profit from the
difference in value: in this case $5.00 ($70.00 put option
strike price – $65.00 stock price = $5.00 of intrinsic value. In
other words, the option is $5.00 “in-the-money.”

An out-of-the-money call is described as a call whose exercise
price (strike price) is higher than the present price of the
underlying. Thus, an out-of-the-money call option’s entire
premium consists of only extrinsic value.

There is no intrinsic value in an out-of-the-money call because
the option’s strike price is higher than the current stock
price. For example, if you chose to exercise the MSFT January 70
call while the stock was trading at $65.00, you would
essentially be choosing to buy the stock for $70.00 when the
stock is trading at $65.00 in the open market. This action would
result in a $5.00 loss. Obviously, you wouldn’t do that.

An out-of-the-money put has an exercise price that is lower than
the present price of the underlying. Thus, an out-of-the-money
put option’s entire premium consists of only extrinsic value.

There is no intrinsic value in an out-of-the-money put because
the option’s strike price is lower than the current stock price.
For example, if you chose to exercise the MSFT January 60 put
while the stock was trading at$65.00, you would be choosing to
sell the stock at $60.00 when the stock is trading at $65.00 in
the open market. This action would result in a $5.00 loss.
Obviously, you would not want to do that.

A put option gives the buyer the right but not the obligation to
sell a specific security at a specific price by a specific date.
It’s a way of “locking in” the sales price of a stock for a
period of time.

The specific date is known as the contract’s expiration date. On
or prior to the expiration date the holder of the option
contract has the right to “exercise” the option.

The term exercise means the process by which the buyer of an
option converts the option into a long stock position in the
case of a call or a short stock position in the case of a put.

The term assign or assignment means the process by which the
seller of an option is notified of the buyer’s intention to
exercise.

Buyers of options exercise. Sellers of options are assigned.

The strike price or exercise price is defined as the price at
which the holder has the right to buy (for a call) or sell (for
a put), the underlying security. Strike prices are quoted in
dollars, i.e. May 50 calls means May $50.00 strike calls.

There are several other important terms in an option contract:

A long position is defined as any position which will
theoretically increase in value should the price of the
underlying security increase. Vice versa, the position will
theoretically decrease in value should the underlying security
decrease.

The buying of stock, the buying of a call, or the sale of a put
all constitute a long position.

A short position is defined as any position which will
theoretically increase in value should the price of the
underlying security decrease. Vice versa, the position will
theoretically decrease in value should the underlying security
increase.

The selling of stock, the selling of a call, or the buying of a
put all constitute short positions.

The “option class” identifies the specific underlying security
the option is written on. The “option series” describes the
expiration month and strike price. As an example, let’s use the
Microsoft (MSFT) May 65 calls.

MSFT is the option class. May 65 call is the option series. May
is the expiration month and 65 is the strike price.

Let’s try one more. How about the Home Depot January 35 puts?
Home Depot (HD) is the option class. January is the expiration
month and 35 the strike price.

All stocks and options are identified by symbol. We have
discussed how the stock itself has a symbol (stock symbol HD =
Home Depot, while MSFT = Microsoft.)

Options have symbols too. These symbols are standardized for all
exchange traded (listed) options. A different letter identifies
each specific month’s call or put. The chart below shows which
letters coincide with which month’s calls and which month’s
puts.

Month                 Calls                     Puts
January                 A                         M
February               B                         N
March                    C                         O
April                       D                         P
May                        E                         Q
June                       F                          R
July                        G                         S
August                   H                         T
September             I                         U
October                  J                         V
November             K                         W
December              L                         X

Following the month symbol is the strike price symbol. A letter
represents each different strike price. These strike prices are
also standardized for all listed options, as follows:
A = 5             H = 40             O = 75             V = 12.5
B = 10           I = 45               P = 80             W = 17.5
C = 15           J = 50               Q = 85             X = 22.5
D = 20          K = 55               R = 90             Y = Not Assigned
E = 25           L = 60               S = 95             Z = Not Assigned
F = 30           M = 65              T = 100
G = 35 N = 70 U = 7.5

For example, let’s look at this symbol HD GF:

HD is the stock symbol that represents Home Depot
G signifies the month and type which is July calls
F indicates strike price that is 30

An option is a traded security that is a derivative product.

By derivative product we mean that it is a product whose value
is based upon or derived from the price of something else. Since
we are talking about stocks, a stock option is based upon, among
other things, the price of the underlying stock.

There are also options on other traded securities such as
currencies, indexes and interest rates, but here we will limit
our discussion to stock options, or options based on stocks.

A distinguishing factor of an option is that is a depreciating
asset in the sense that it has a limited life, and has to be
used before the date on which it expires. As time goes by, the
option loses value as it moves closer to its expiration date

When we speak of options in terms of volume, we refer to
contracts. Each stock option contract is equivalent to 100
shares of stock. When we talk about two contracts, we are
talking about 200 shares, 10 contracts; we are talking about
1,000 shares, 75 contracts 7500 shares and so on.

Amount of Shares         Equivalent Amount of Option Contracts
100                                                             1
200                                                             2
1000                                                         10
7500                                                         75
15000                                                     150
50000                                                     500
100000                                                 1000

NOTE: It is important to understand the dollar cost of options
before actually trading them. When an option is quoted at $1.00
per contract, the investor must realize that the $1.00
represents a price of $1.00 per share, not per contract.
Remember that each contract is worth 100 shares. This means that
if you were to buy one option contract at a quoted price of
$1.00, your total cost will be $100.00 (1 contract x $1.00 per
share x 100 shares per contract). If you were to buy 10
contracts for $1.50 per contract, your total cost will be
$1500.00. Use the formula below when calculating total dollar
cost of the option.

Total Dollar Cost of Trade = Number of Contracts x Price per
Contract x 100

Option contracts are literally a sales agreement between two
parties. The two parties are the buyer (or holder) and the
seller (or writer). When you buy an option contract you are
considered to be long the option. When you sell an option
contract, you are considered to be short the option. This, of
course, is assuming you had no previous position in the said
option.

In an option contract, although it seems as though the buyer and
seller must be tied together, they are not. You see, the buyer
doesn’t really buy from the seller and the seller doesn’t really
sell to the buyer.

In reality, an organization called the OCC or Options Clearing
Corporation steps in between the two sides. The OCC buys from
the seller and sells to the buyer. This makes the OCC neutral,
and it allows both the buyer and the seller to trade out of a
position without involving the other party.

The problem is that most individual investors do not have the
knowledge, resources, or time to spend doing their own research,
stock selection, execution, and position management.

The development and expansion of the internet has solved part of
this problem in that the internet now provides timely
information and resources, right at the fingertips of the
individual investor.

Earnings reports, income statements, balance sheets, charts,
graphs, research, chat rooms, and even CEO video conferences are
easy to obtain online. Now, investors have all the tools
necessary to make their own decisions.

However, for many the problem still exists. Why? Because, all
the tools in the world are no good to you, if you don’t know how
and when to use them. The truth of the matter is that most
investors are not qualified or properly trained to interpret the
use of these tools, and are therefore ill equipped to use them
in making their own investment decisions.

So now what should investors do? The answer is to find someone
to help you help yourself. Not to make your decisions for you,
but to assist you in making your investment decisions and to
help educate you as to the `how` and `why. `

You need to become more involved, and the first step in the
involvement process is education.

Education is the key to successful investing for the individual
investor in the market of the future.

All of us who invest in the stock market know that there are
three possible outcomes after we make a stock purchase.

First, the stock can go up and this is generally a good outcome.

Second, the stocks can go down and this is usually a bad
outcome.

Third, the stock can go nowhere – which is also generally a bad
outcome.

It is bad because not only could you have put that money to use
in something with less risk that might have produced a return,
but you also incurred commission costs on the way in and out
which added to your loss.

So, we see that there are three things that can happen when you
take on a new stock position, and two of them are bad.

Now, what if we tell you that by employing a certain strategy
correctly, you can improve your chances dramatically?

Instead of having two of three scenarios possibly go wrong, you
would have two of three scenarios that could go right. And, the
third scenario, the bad one, wouldn’t be nearly as bad.

It can happen by using just one of the many strategies involving
teaming stocks with options.

Sound interesting?

Great, but let’s start at the beginning and build a solid
foundation first.

How many think the market is performing poorly?

And how many feel the markets performance is neutral?

Actually none of these answers is correct. You see, the market
does not perform, you do. You perform!

Sometimes you perform well, and other times you do not perform
so well. The market doesn’t perform, it moves. It moves up, it
moves down and it moves sideways.

It moves along like anything else that travels in a business
cycle. If the market did perform, then you would only be able to
make money in an up market.

As you know, it is possible to make money in a down market, and
even in a stagnant market. Thus it stands to reason that the
market simply moves and you react to it. So, let’s talk about
your performance. You have two ways that you can perform,
directly and indirectly.

Directly, you pick your own stocks. Indirectly, someone else
picks your stocks for you, whether it is your broker or a fund
manager.

In the latter case, the fact that you chose someone else to pick
the actual stock does not mean that the responsibility of a loss
is theirs. After all, it was you who chose them.

In the end, it is you and you alone who are responsible for your
performance. Consequently, it is your responsibility to become
an educated investor.

Years ago, individual investors didn’t have to worry about who
was managing their money. Now, things have changed as poor
returns from money managers and investment firm scandals have
shaken our confidence in these ‘professionals.’

To get a better look at what lies ahead, you have to go back and
look at what transpired to get you to where you are now. From
there, maybe a clearer path into the future will become visible.

During the Great Bull Market of the 1990’s, many investors, like
you, entered the market and reaped the returns of the largest
bull market in history.

Everyone, it seemed, made incredibly high rates of return. The
market’s incredible, unprecedented move appeared to make
geniuses of us all – but in actuality, it masked some major
flaws with many industry professionals. It also created a
misconception in the general public that all market
professionals were experts.

Suddenly, the bubble burst and those flaws were exposed.

Not only did we find out that most of those experts possessed
more luck than skill, but we also discovered that some had been
cheating us out of our hard earned savings.

Many investors were discouraged with these market developments,
and to make matters worse, many had lost significant amounts of
money. Not to mention, the prospect of regaining these losses
seemed slim to uncertain, at best.

Furthermore, the very people we normally looked to for help in
retrieving these losses either lacked the talent to recover them
or had lost enough of our trust and confidence that we wouldn’t
even entertain the thought of letting them try.

We appreciate your help and support and look forward to continuously serving you better.

John W. Roney III

Traders Edge Online

Is this nothing but a “the sky is falling” negative pessimism? Is this an unfounded and uneducated assumption about something they don’t understand? Or is there some degree of risk inherent in all types of investment?

It’s certainly true that there is risk in all forms of investments. Even holding money in your wallet (if in US dollars) is risky, if the US economy collapses. Since this situation is not very likely, we consider holding our currency (again if you’re in the states) to be a safe investment—our greatest fear at times is simply inflation.

Are Options Risky or Not?

Some people, when you mention options, think of speculation or gambling or sorts, while others see the opposite—they see options as a hedge against potential loss. In truth, options are both, depending on how they are used. Like any other tool, options can be used effectively for good, or can turn around and bite you if you use them incorrectly. A hammer seems like a good tool until you nail your finger one or two times trying to get at the nail.

It should be noted also that there are varying degrees of risk that operate within individual options strategies. There are strategies designed for aggressive returned and other strategies more well-suited to the conservative, avoid risk at all costs, type investor. There are also options strategies well suited for different trading personality types—some traders finding they prefer to hold options over many days or even many weeks, while others will be more comfortable (or find greater excitement) in entering and exiting trades within a few hours time.

Finding Your Formula

Every great baseball hitter that ever stepped up to the bat has his own swing—a swing that had been perfected over thousands of at-bats and countless hours in a batting cage. But when they found their swing they could use it time and time again.

This is true of traders as well. A good trader will have several strategies mastered that he or she can apply as different circumstances and opportunities arise in the markets (and on the charts). These strategies become like a collection of arrows in a quiver that the experienced trader draws from when the right profit opportunities present themselves.

These strategies take time to refine. Successful trading is about mastery—mastery of the market moves and the proper adaptive responses. Correct responses to market changes produce profit. Incorrect responses, not properly managed, lead to failed trades and lost capital and a generally unhappy and unsuccessful trader.

-John W. Roney III

Traders Edge Online

John W. Roney III, founder and executive publisher of Traders Edge Online, The Online Traders Information Resource Partner, works with the best and brightest in the trading business. John is committed to delivering relevant, straight-to-the-point, no B.S. options trading information & resources. “Trade better by trading with the best,” as John says. Traders Edge Online regularly holds free classes for traders committed to refining their skills and achieving trading mastery.