Options for everybody. Stefan Deutschmann
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money, buy the material cheaper and just hire the people to build the house for less than the agreed price that has already been agreed. So if you manage to finish the house for 80,000 USD for example, you still sell it for the agreed 100,000 USD, the difference is therefore your profit. I'm sure this example sounds logical, but if you can't quite convert it to put contracts yet, then that's no big deal. We will often come into contact with this principle, so that you don't have to understand everything at the first attempt.
So, again, just this time without houses. You sell a stock at a certain price in the future and hope that you can buy the stock at a lower price in the future. This means that the value of the stock decreases and therefore your profit increases incrementally. So a classic short sale.
Let's give another example with numbers. Let's say that a stock is quoted at 50 USD and we want to buy a put "out of the money". Let's take the strike at 40 USD (the more bearish you are, the further down you would go). This means that if the underlying falls below 40 USD, we are in the profitable zone. As with long call options, you also have an integrated loss limit. Your loss only amounts to the premium paid, which was fixed at the beginning of the contract. For example, 200 USD.
However, unlike the example with our house building project, you are not obliged to buy the stock if it exceeds 40 USD. Remember, as an option buyer, you own rights, not obligations. There is no reason for you to buy the stock at 50 USD if you have speculated on falling prices.
Here, too, increased volatility has a positive effect on the strategy, just as we have seen with long call options. If the volatility increases and the market is more volatile, which means that the price could range from 40 to 30, up to 50 and back to 30, there is a greater chance that the option will continue to be profitable. Volatility, the vega, makes the option price more expensive when it rises - exactly what you want.
Well, as with call options, time (theta) also affects a long put option. With long options, both put and call, the decline in theta has a negative effect on the option price. We remember that options are finite. They have a final date on which they expire. So as time goes by, the value of those options goes down because the stocks have less time to get into the potential profit zone. So as option buyers, we always play against time, which can be very negative, especially in combination with low volatility.
Before we close this chapter, we need to look again at the breakeven of long puts, the point at which you start to be profitable. Let's stick to the above example where you bought a long put at a strike of 40 USD for 2 USD premium. Your break even is reached at 40 USD – 2 USD = 38 USD. The further the stock falls below this price, the more you will earn. However, the theoretical profit potential is limited here, as a stock could in principle also fall to 0. On the other hand, your biggest possible loss is 200 USD.
Remember:
For options, you have the choice of a strike price, you are not tied to the share price.
With long calls/puts you pay a premium that is your maximum loss at the same time, your profit is (theoretically) unlimited
Options are influenced by various factors (the "Greeks").
2.3 Buying or selling Options?
You have already gained a first insight into the world of options, the first types of contracts and what they contain. Now it's time to increase the speed a bit and deal with the really serious topics. Don't worry, everything will be explained to you in detail again and if you don't understand it on the first try, go back and take the time to go through the lines again. Remember: option trading is a marathon, not a sprint.
You have already learned that you can act as an option buyer. Logically, however, there must also be an opposing side, which you can of course take too. Let's start with a small table - this will make it clearer and easier to understand which rights and obligations we need to know as traders when it comes to buying or selling calls and puts. Remember that every trade has two sides. So you always have an opponent with whom you have to agree to trade. There are four basic options we can get involved with. We can buy calls and puts or sell calls and puts.
Figure 3 : Rights and obligations for buyers and sellers
In this case, the buyer of a call option has the right to buy the share at a certain price in the future. If you are now an option buyer, you pay money in the form of a premium. So if you pay for something, in return you get a right to make a decision in the future, to wanting to exercise an option or not. On the other hand, a put option buyer has the right to sell shares at a certain price in the future. In both cases, you pay money to the option seller so that you acquire a right and at the same time commit the counterparty.
On the other side of the table we have the option sellers. As option sellers, we have obligations because we have sold our rights for a fixed premium. As a seller you are obliged to sell or purchase shares at a certain price in the future. However, this only applies if the other party makes use of its right and you have to fulfil your obligation. In this case one speaks of being "assigned". But what is my advantage in selling rights if I can be assigned at any time during the contract term? We will discuss this in detail and at the end you will notice that the option seller's side is much more profitable and comfortable than the buyer's side.
For example, you have the option to conclude the option contract at any time, which will liquidate your obligation. I'll be a little ahead of you here. Let's say you're a seller, your option has already made 50% profit, so you buy back your own contract, which is worth much less than it used to be, of course. You keep the 50% of the premium and at the same time your obligation is released. Basically you have a lot of possibilities to manage your contracts in order not to be committed. You will get to know them all in the course of the book.
The obligation to buy/sell shares is only given if they expire or if they are assigned early. However, early assignment of your position only works for American-style options. In contrast, there are still so-called European options, which cannot be managed/closed or assigned during the contract period. With this type of option, the entire term is binding for both parties to the contract. However, these are of no interest to us and are therefore ignored. But now we want to take away your fear of being assigned. You don't have to panic to owe your counterpart 100 shares once. Assignments usually happen within the last week or the last few days of a contract term. However, we have sufficient possibilities to manage our contracts in advance so as not to let it get that far in the first place - you are going to learn these mechanics later.
Let's get back to the basics. As a seller, you now have an obligation. In the case of a put option, you have the obligation to buy shares from the option buyer, who will sell them to you at a predetermined price (strike). So if the put option buyer says that he will sell a stock to you at USD 50, you must buy the stock for USD 50 if the price has fallen to that price. If the stock continues to fall, you still have to pay the counterparty the agreed price (strike), even if the stocks are actually only worth USD 30, for example. Your intention as an option seller is, of course, that the stock remains worth more and does not fall to this level. In this case, the seller now receives money from the option buyer in the form of a premium. Do you remember? As a buyer you always had to pay this premium, as a seller you collect it immediately at the beginning of the contract.
Let's repeat what we've said. If you are a call option buyer, you hope in this case that the stock price will rise. This is your hope. You buy a call option in the expectation that the stock price will rise in the future. If you are a put option buyer, you hope the stock price will fall below your strike. When buying a call or put option, remember that you pay a premium to get a right. You are dependent on the stock not only moving, but also on your preferred bill. Otherwise you not only lose the premium, you also make no profit. By claiming this premium as a seller, you give yourself the rights to commit yourself. However, you don't care what the share does. It can rise, fall or simply not move