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Options Trading: Concepts, Strategies & Limitations

Explore options trading basics, terminology, strategies, and limitations. Learn about contracts, market makers, exercises, and investment strategies using options.

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Options Trading: Concepts, Strategies & Limitations

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  1. Chapter 23Options-Basic ConceptsAnd Strategies

  2. Limitations Of Option Trading • Lack of Standard Contracts • Lack of Transferability Between Investors • Have to Take Physical Delivery • Risk Associated With Lack of Collateral • Lack of Market Maker

  3. Chicago Board Options Exchange (CBOE) • Began 1973 • Addresses Limitations • Explosive Growth

  4. Option Terminology • Exercising the Option Contract • Strike Price/Exercise Price • Long Position • Option Writers • Short Position

  5. Option Contract • European-Style Option • Exercised only on specific date • American-Style Option • Exercise anytime

  6. Options Versus Stocks • Options • Low-cost for taking a position • Limit loss to purchase price • Optimist • Buys call option • Pessimist • Buys put option

  7. Asset Between Relationship Option In-the-money option Out-of-the-money option At-the-money option Naked option Covered option

  8. Option Clearing Corporation (OCC) • Maintains Records of Trades • Facilitates • Validation • Delivery • Settlement • Owned by Exchanges CBOE AMEX NYSE PHLX • Issues All Option Contracts • Guarantees Both Sides

  9. Option Values • Intrinsic Value • Immediately exercised • Time Value • Current value above intrinsic value

  10. Payoff Diagrams • Illustrate • The value line • The P/L line • Both

  11. $ Value and Profit or Loss Value Line Stock Price at Expiration P/L Line

  12. Investment Strategies Using Options • Protective Put Buying • Put option and stock • Sets a floor for losses • Covered Call Writing • Call option and stock • Sets a ceiling on the potential gain • Receives the call premium • Bull Spread • Allow investors to profit if prices rise • Limits investors’ losses if prices fall • Price will rise by small amount

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