Option Strategies II

I Request you to read all the posts from the begining :)

Trading Options :-


In All the above posts we have learnt about buying the the options, exercise the options, or letting the option to expire.

When u go and buy an options that means your opening a position. Following are the ways to close an option :-

1) Exercise the option
2) Let the option expire

We have already learnt about these two in previous posts. The last one is ( most popular )

3) Sell the option.

Buying and selling option is same as buying and selling stocks. You Buy the options in the market where other poeple will also buy and sell options. So there will be Bid and ask prices as there are in Stocks. When u buy any stock option that means you have an OPEN POSITION ( remember this term ) in the stock. When u sell your option that means you have CLOSED your POSITION in the option. Another important term is OPEN INTEREST.

OPEN INTEREST :-

This simply means the no of OPEN positions for the option in the market.

Lets take an example here :-

You buy an option on the 1st of August for the HINDALCO when the stock was trading at Rs 160.00. We buy the August option with a strike price of Rs170.00, at a premium of Rs 0.75 You now have an Open Position on the Hindalco Rs170 August Call option.

Let's assume that a week later, on the 8th of August, the price for the Hindalco stock has gone up to Rs 180.00. That means your option is now In-The-Money by Rs10, since your strike price is Rs 170 and the current value is Rs180, allowing you to theoretically exercise the option and buy the stock at Rs 170, and immediately sell it at Rs170 for a Rs10 profit. (Remember that since you are trading American Options, you can exercise anytime before expiration day.)

However, a more convenient method (and cheaper too, since you don't have to spend the $20 to buy the stock), would be to sell the option to someone else. Since the option is now In-The-Money, its premium would have risen quite a bit too, say to RS4.50. That is the price you can sell the option at. You don't have to worry about finding someone to buy the option from you . The American options market ( Remember that American Options have nothing to do with America its just an type of option which was discussed earlier ) has Market Makers who will maintain market liquidity, i.e. they will make sure all buyers will find corresponding sellers, and vice versa.

So you will sell the Call Option at Rs4.50. Since you initially paid RS0.75 for the option premium, you have just made a profit of Rs4.50 - RS0.75 = RS3.75. In case you were wondering, that's a 400% profit on our Rs0.75 investment !!!

But be aware of the fact that you could have lost your entire Rs 0.75 if the stock price of Hindalco would have gone below 160!!!

Leave comments... or mail me at optrading@rediffmail.com

There is more to come this is just a start so stay tuned..