Investors can either buy or sell a Call or Put option.
One can use options for speculation, like short term trading, to take advantage of anticipated swings or sudden movements in a single stock or index, to hedge one’s portfolio or the generate income by selling options and receiving the premium. (Premium is the price of the option).
In The Money (ITM) options and Out The Money (OTM) Options
Options can be classified as being in the money (ITM) – for example the stock price is R90 and you buy a call option with a strike price of R85, in this case the option will be in the money – or out the money (OTM) where you could buy a option with a strike price of R95. Strike price just mean it is the agreed upon price at which you will receive / deliver stock (if you own the option and it expires ITM) or will have to deliver stock if you sold a call option and you own the stock and it expires ITM.
A common use of options is where you own stocks, say you own 1000 Sasol and the price is at R290, you can sell a call option that expires in 60 days with a strike of say R320 for R15-00 per share receiving R15 000 in option premium. This means if Sasol end above R320 after 60 days you will be forced to sell your Sasol at R320, if Sasol ends below R320 you will be entitled to keep the R15-00 per share (or R15-00x 1000 shares = R15 000) premium you received when you sold your Call options. This is called “Covered Call Writing” and is classified as an income strategy!
If however you feel that the price of Sasol could fall (because of very bad results maybe) but you are not sure and you do not want to sell your shares, you can buy a Put option with a strike of say R270-00 for example R18 with an expiry date of 60 days. This means that you now pay R18 000 as “insurance” but should your Sasol shares fall to R180-00, you know your maximum loss will only be a fall down to R270 (plus the premium that you paid), from there onwards you would be fully protected. If you keep you options for the full 60 days, you will lose all the premium you paid for it. You can always buy the options back and recover some of the premium before the expiry date.
There is a LOT to learn when one start using options, but it need not be complicated. We will talk a lot about different strategies in our upcoming newsletters as well as dissect our trades that we do for our model portfolio and why, what the thinking is and why we chose the options and criteria we did. So be sure to hit that subscribe button to our newsletters.
In time we will build this educational forum and add more information to this page, lets call it our “Option University”. So please check back regularly!