Note: I am not an expert. This is information that perhaps should be learned prior to working with an expert.
THE BUYING SIDE OF THE GAME
Let’s say that a call options contract costs $0.40 cents per contract. Since options contracts are sold in groups of 100, the net purchase price of the contract is $40.00. A call options contract gives us the right ( but not the obligation ) to buy 100 shares of stock XYZ at a strike price and expiration date that are each chosen. Stock XYZ is currently trading at $97.00/share, and a strike price of $100.00 is chosen. The purchase of 100 shares of XYZ outright would cost $10,000.00; however, the ability to purchase $10,000.00 worth of XYZ stock at a discount could make the contract itself worth $10,000.00 ( or more ), so it can be sold for $10,000.00 if the purchaser chooses to sell ( which is most of the time ). If the underlying XYZ stock does indeed rise above the $100.00 strike price prior to the expiration date, at what price should it be sold? What is the ” breakeven price ” that the stock must reach in order for the contract to pay for itself?
The options contract cost $40.00 overall. The contract deals with 100 shares of the underlying stock XYZ; therefore, the stock must rise above $100.00 by $0.40 for the contract to be profitable. Remember, a stock or ETF is the underlying asset; the options contract defines what price the underlying asset can be bought ( or sold ) for.
Check: $100.40 x 100 = $10,040.00
Let’s now assume that a put option for a stock ABC has been purchased. A put option gives one the right ( but not the obligation ) to sell 100 shares of a stock at a given strike price. Put options are used for downside protection. Stock ABC is currently trading at $50.00 per share. The right to sell ABC for $49.00 per share costs $12.00. If shares of ABC drop below the $49.00 strike price, at what price should the options contract be sold in order for the buyer to break even?
The options contract has an overall cost of $12.00. Thus, the price of ABC stock would have to fall $0.12 cents below the strike price in order to be profitable for the buyer. For this reason, the put options breakeven price is $49.00 – $0.12 = $48.88. When the stock has fallen to $48.88 per share, the options contract owner would ” break even ” by selling the contract.
Check: $4,900.00 – $4,888.00 = $12.00
THE SELLING SIDE OF THE GAME
Whether selling call options or put options, the worst possible scenario occurs when the price of the stock in question plummets. Let’s consider the sale of a covered call option first.
If we sell a covered call option, we’re selling someone the right to purchase 100 shares of stock at a given price. If we own 100 shares of stock JKL trading at $30.00/share, we may sell a call option with a strike price of $32.00/share. If JKL rises above the $32.00 strike price, it would have been more profitable for the seller to hold the stock. If the option is exercised ( or the expiration date arrives with the option above the strike price ), the option buyer will net $2.00 x 100 = $200.00. The option buyer’s breakeven price would be $34.00. Even though the option seller made additional money, they would’ve made more by simply holding the 100 shares.
Finally, let’s assume a cash secured put option is sold on a stock ZZZ that is trading for $15.00/share. If a strike price of $14.75 is choses, the seller must have $1,475.00 as collateral to enact the trade if necessary. A premium of $8.00 is paid. For this reason, the option seller will potentially be underwater if the ZZZ falls below $14.67/share.
Prior to getting with an expert, learn how option contracts that have been sold can be bought back ( a.k.a. ” rolled ” ) prior to their expiration date in order for losses to be prevented.
RENAISSANCE PHYSICS 