THE MATHEMATICS OF OPTIONS TRADING :
Let’s first consider a scenario where a single share of stock valued at $100.00 is purchased and subsequently sold at some later date. If this single share of stock increases in value by $6.00, a 6% profit will have been made if the stock is sold for $106.00, neglecting transaction fees and other things as explained below. If this same share of stock fell to $90.00 per share, an investor could simply hold it for an indeterminate amount of time with the hope that it will regain its value. Additionally, if there is reason to believe the stock will increase in value once again, an investor may consider buying an additional share at this cheaper price ( buying the dip ).
Now, what is an ” options contract “? Let’s first consider a ” call option “. A call option gives us the right ( but not the obligation ) to buy 100 shares of a stock at a predetermined price called the ” strike price “. If a stock in question rises above the strike price, we have a choice of exercising the option ( buying 100 shares at the strike price, regardless of how much higher the stock price has risen above the strike price ), or we can sell the option ( and the rights that come with it ) on the open market. Most options that are ” in the money ” are indeed sold. Options contracts will net the same amount of money per share over the strike price that we’d earn if we sold the stock outright. Options contracts are cheaper than shares of stock, so the percent profit earned from selling options is much greater than the profit earned by selling the monetary equivalent amount of stock. THERE IS A CAVEAT, HOWEVER! Options contracts have expiration dates. If a call option doesn’t rise above the strike price before the expiration date, the contract will expire worthless.
Buying a stock valued at $100.00 would take $100.00, and buying 100 shares of a $100.00 stock would cost $10,000.00; however, THE OPTION ( legally binding contract ) TO PURCHASE 100 SHARES OF A $100.00 stock during some finite time frame may cost as little as $5.00 per contract ( $500.00 ). Once again, purchasing the right to buy 100 shares of a stock is different than purchasing the stock outright. A direct purchase is direct ; an option, for a fee, represents a transaction that can and may occur. WHEN AN OPTION IS PURCHASED, A LEGAL RIGHT IS BEING PURCHASED.
A group of 100 options contracts ( at $5.00 per contract ) cost $500.00 Thus, a $100.00 profit will be made for every $1.00 that the stock price rises above the strike price ( If it does so before the expiration date ).
NOTE: For further reference, check out this excellent article titled ” The 4 Advantages of Options “.
https://www.investopedia.com/…/06/options4advantages.asp
It is noted in the above article that, ” Options have great leveraging power. As such, an investor can obtain an option position similar to a stock position, but at huge cost savings. For example, to purchase 200 shares of an $80 stock, an investor must pay out $16,000. However, if the investor were to purchase two $20 calls (with each contract representing 100 shares), the total outlay would be only $4,000 (2 contracts x 100 shares/contract x $20 market price). The investor would then have an additional $12,000 to use at his or her discretion. “
RENAISSANCE PHYSICS 