Call and Put Options Explained

An option contract is an agreement wherein the owner has the right to buy or sell a security or an asset at a particular price on a fixed date in the future. It is called an option because the owner of the contract is not committed to carry out the obligation of the contract if he or she feels that it is disadvantageous.

There are two types of options contracts: call options and put options.

Call Options
In simple terms, call options give the owner the right to buy the underlying asset in the contract. Again, it is not an obligation.

For example, John and Tom agreed on a call options contract wherein John will buy from Tom, 100 shares (equivalent to one option) of Company A at $20 (strike price) what will expire on the third Friday of April. The current price of the share is $20.

At the expiry date (also called maturity date), the share price of Company A remains at $25. John can then exercise his right to buy the share for $20 and thus, yielding $5. Meanwhile, if the share price goes down to $22, John can still earn $2 by simply exercising his rights as stated in the contract. In whichever way, any amount higher than the strike price at the end of the contract will become the profit of the owner. But before it can happen, the owner who decides to pursue his right has to have his money ready to pay for the amount.

However, if the share price goes down below $20, say $18, on the maturity date, it will be too expensive for John so he can just ignore the contract since he is not obliged to carry it out. He will only lose the amount he paid for the contract called the Option Premium. Tom, on the other hand will keep the asset and the premium, which in a sense, is his profit.

Put Options
In put options, the buyer has the right to sell an asset to the writer (the seller). Just like the call asset, it is bounded by a contract which states that the underlying asset will be sold at a particular price and a particular date. But the similarity ends there. In put options, the writer has to buy the underlying asset at the strike price if the buyer exercises this option.

Let us continue with John and Tom. John bought call options from Tom. But he could also buy put options from Tom. If John buys put options, it means that he buys the right to sell Company A’s shares at $20 on April 1. If the price of shares goes down below $20 on the expiry date, John can exercise his right and can still sell it at $20, thus making a profit.

Buying put option allows investors to earn when price of shares drops at the end of the contract.

Profit potentials are unlimited for the buyers of put options, especially if the market begins to sell off. On the other hand, risks are limited if the market goes against them.

Important note:

In reality, trading of options or transactions does not happen between two persons. Buying or selling can happen without knowing the identity of the other party.

Options are only sold in 100 share lots. So if the share price is $20, you will have to pay $2,000 for each option contract plus the Option Premium.

January 30th, 2010 | Tags: , , , | No Comments »

The Many Different Kinds of Investments

Overall, there are three different kinds of investments. These include stocks, bonds, and cash. Sounds simple, right? Well, unfortunately, it gets very complicated from there. You see, each type of investment has numerous types of investments that fall under it.

There is quite a bit to learn about each different investment type. The stock market can be a big scary place for those who know little or nothing about investing. Fortunately, the amount of information that you need to learn has a direct relation to the type of investor that you are. There are also three types of investors: conservative, moderate, and aggressive. The different types of investments also cater to the two levels of risk tolerance: high risk and low risk.

Conservative investors often invest in cash. This means that they put their money in interest bearing savings accounts, money market accounts, mutual funds, US Treasury bills, and Certificates of Deposit. These are very safe investments that grow over a long period of time. These are also low risk investments.

Moderate investors often invest in cash and bonds, and may dabble in the stock market. Moderate investing may be low or moderate risks. Moderate investors often also invest in real estate, providing that it is low risk real estate.

Aggressive investors commonly do most of their investing in the stock market, which is higher risk. They also tend to invest in business ventures as well as higher risk real estate. For instance, if an aggressive investor puts his or her money into an older apartment building, then invests more money renovating the property, they are running a risk. They expect to be able to rent the apartments out for more money than the apartments are currently worth ñ or to sell the entire property for a profit on their initial investments. In some cases, this works out just fine, and in other cases, it doesnít. Itís a risk.

Before you start investing, it is very important that you learn about the different types of investments, and what those investments can do for you. Understand the risks involved, and pay attention to past trends as well. History does indeed repeat itself, and investors know this first hand!

October 17th, 2009 | Tags: , , , , , | No Comments »

The Assortment of Different Bonds that Are Available

Investing in bonds is very safe, and the returns are usually very good. There are four basic types of bonds available and they are sold through the Government, through corporations, state and local governments, and foreign governments.

The greatest thing about bonds is that you will get your initial investment back. This makes bonds the perfect investment vehicle for those who are new to investing, or for those who have a low risk tolerance.

The United States Government sells Treasury Bonds through the Treasury Department. You can purchase Treasury Bonds with maturity dates ranging from three months to thirty years.

Treasury bonds include Treasury Notes (T-Notes), Treasury Bills (T-Bills), and Treasury Bonds. All Treasury bonds are backed by the United States Government, and tax is only charged on the interest that the bonds earn.

Corporate bonds are sold through public securities markets. A corporate bond is essentially a company selling its debt. Corporate bonds usually have high interest rates, but they are a bit risky. If the company goes belly-up, the bond is worthless.

State and local Governments also sell bonds. Unlike bonds issued by the federal government, these bonds usually have higher interest rates. This is because State and Local Governments can indeed go bankrupt ñ unlike the federal government.

State and Local Government bonds are free from income taxes ñ even on the interest. State and local taxes may also be waived. Tax-free Municipal Bonds are common State and Local Government Bonds.

Purchasing foreign bonds is actually very difficult, and is often done as part of a mutual fund. It is often very risky to invest in foreign countries. The safest type of bond to buy is one that is issued by the US Government.

The interest may be a bit lower, but again, there is little or no risk involved. For best results, when a bond reaches maturity, reinvest it into another bond.

October 17th, 2009 | Tags: , , , , | No Comments »