When gaining a position with a new firm, people will often find that they have been given Stock Options, which instantly confuses people. There is though a simple method to understand stock options. The simple method to understand stock options is to basically understand that stock options are a non cash form of payment for your work. It is an added benefit that ties an employee into the success of the business, if the business is successful then the stock options are worth more, and there is a direct financial benefit to the employee.
If I want to buy 1,000 acres of land, it might take time for me to get the money together or to arrange for a loan. I therefore give the owner of the land a deposit. The deposit is an option to buy that land. It would say something to the effect that I have the right to buy the land for $1,000 an acre for the next 30 days. If at the end of the 30 days, I do not buy the land, the current owner keeps my money and can then sell the land to somebody else.
Now remember all an option is a contract between a buyer and a seller. In a contract both parties have to agree upon certain things. One of the first things that the two parties need to agree upon is the strike price. Simply put the strike price is the price in an options contract at which the underlying instrument is bought of sold if the options is exercised. So the buyer of the options contract reserves the right to purchase or sell the underlying instrument for a specified price or strike price. Think of it as the price you are locking in for a premium. The premium is the amount of money you are going to pay to lock in the strike price of the option. In other words, for a call option, I lock in the option to buy the underlying instrument for a certain strike price by a certain date. You will receive a premium for holding that stock for me until the option expires or ends.
Why would somebody buy the right to buy somebody else’s stock in a given company? Stock for any company is always going up or down in price. If I bought a Call option and the stock price goes up, I make money. If the price of a stock goes down and I had bought Puts, I would make money. In either of these cases I could sell the option to somebody for more than I bought it for. For example, let’s say Apple stock was selling for $300 a share, and I bought Call options for the 300 value and the expiration month was 3 months from now. Then tomorrow morning Apple announced a brand new iPhone that got great reviews from everybody that tested it. The price of a share of stock might jump to $350. When you buy an option you buy the control for 100 shares of the stock, so in this case I paid $30 per stock or 30 times 100, so the cost of the option was $3,000. Now if the stock moved up $50, the price of the option would probably be at $75. I could sell the 1 Call option I own for $7,500. That is a profit of $4,500. You also have the cost of the trade to buy and to sell. So let’s say I made $4,300. That would be a great day of trading – not a normal day.
The expiration date, on options, is the date at which the options contract has to be exercised by or else it expires worthless. In the previous example I would only have 3 months to find a buyer willing to pay $200,000 before I would profit. The expiration date for most options is the third Friday of the expiration month specified on the contract. Because the markets close on Friday, technically speaking Saturday is when they officially expire, but that is only for trade clearing and resolution of errors. You could not contact your broker on Saturday and tell them you wanted to exercise your option rights.
When you have mastered paper demo trading, then you can move on to real live trading with money. Stock Options For Dummies An important consideration though is that there are tax implications when it comes to stock options. At its most basic level, stock options mean buying or being given stock options at a certain price.
If I want to buy 1,000 acres of land, it might take time for me to get the money together or to arrange for a loan. I therefore give the owner of the land a deposit. The deposit is an option to buy that land. It would say something to the effect that I have the right to buy the land for $1,000 an acre for the next 30 days. If at the end of the 30 days, I do not buy the land, the current owner keeps my money and can then sell the land to somebody else.
Now remember all an option is a contract between a buyer and a seller. In a contract both parties have to agree upon certain things. One of the first things that the two parties need to agree upon is the strike price. Simply put the strike price is the price in an options contract at which the underlying instrument is bought of sold if the options is exercised. So the buyer of the options contract reserves the right to purchase or sell the underlying instrument for a specified price or strike price. Think of it as the price you are locking in for a premium. The premium is the amount of money you are going to pay to lock in the strike price of the option. In other words, for a call option, I lock in the option to buy the underlying instrument for a certain strike price by a certain date. You will receive a premium for holding that stock for me until the option expires or ends.
Why would somebody buy the right to buy somebody else’s stock in a given company? Stock for any company is always going up or down in price. If I bought a Call option and the stock price goes up, I make money. If the price of a stock goes down and I had bought Puts, I would make money. In either of these cases I could sell the option to somebody for more than I bought it for. For example, let’s say Apple stock was selling for $300 a share, and I bought Call options for the 300 value and the expiration month was 3 months from now. Then tomorrow morning Apple announced a brand new iPhone that got great reviews from everybody that tested it. The price of a share of stock might jump to $350. When you buy an option you buy the control for 100 shares of the stock, so in this case I paid $30 per stock or 30 times 100, so the cost of the option was $3,000. Now if the stock moved up $50, the price of the option would probably be at $75. I could sell the 1 Call option I own for $7,500. That is a profit of $4,500. You also have the cost of the trade to buy and to sell. So let’s say I made $4,300. That would be a great day of trading – not a normal day.
The expiration date, on options, is the date at which the options contract has to be exercised by or else it expires worthless. In the previous example I would only have 3 months to find a buyer willing to pay $200,000 before I would profit. The expiration date for most options is the third Friday of the expiration month specified on the contract. Because the markets close on Friday, technically speaking Saturday is when they officially expire, but that is only for trade clearing and resolution of errors. You could not contact your broker on Saturday and tell them you wanted to exercise your option rights.
When you have mastered paper demo trading, then you can move on to real live trading with money. Stock Options For Dummies An important consideration though is that there are tax implications when it comes to stock options. At its most basic level, stock options mean buying or being given stock options at a certain price.
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