Unlocking the Power of Options

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Introduction

In our previous article, we delved into the fundamentals of options, explaining what they are and how they function within the financial markets. With a grasp of the basics, we now turn our attention to the diverse array of options available to investors. This article aims to broaden your understanding by exploring the various types of options, their unique characteristics, and how they can be strategically employed to enhance your investment portfolio. Understanding these different types of options is crucial in navigating the complexities of the market. Let's dive in and uncover the multifaceted world of options trading.🚀🔥.

What is Long Call?

As a young investor, you're navigating the exciting world of stock markets, and understanding options can be a game-changer. One strategy that deserves your attention is "Going Long" on call options. But what does that even mean? Let's break it down.

Going long on a call means you're taking a bullish stance. In simpler terms, you believe a stock's price will rise. When you're in a "long call position," you own the right (but not the obligation) to buy shares at a predetermined price—known as the strike price.

1. Meet Mario: Our Aspiring Investor

Let's meet Mario, a young investor eager to capitalize on ABC stock. Currently trading at $120 per share, ABC has its Q2 earnings announcement around the corner. Mario predicts a 20% surge post-announcement. The catch? His wallet is feeling a bit light this month—payday isn't until next month.

2. The Long Call Solution

Mario doesn't want to miss out on potential gains. So, he dives into the world of options. He buys a long call option with a strike price of $120 per share. Here's how it works:

• Premium Payment: Mario shells out $3 per share as the premium for his call option. Since options contracts come in 100-share increments, his total cost is $300.

• Best-Case Scenario: If ABC behaves as Mario hopes and jumps 20%, he can exercise his call option. He'll snag a $144 stock (thanks to the $120 strike price) minus the premium he paid.

• Risk Alert: But what if ABC doesn't cooperate? If the stock stagnates or drops, Marco loses the $300 he invested in the option.

3. The Takeaway

Going long on calls can be a strategic move for Mario. It's a way to participate in potential gains without committing large sums upfront. Just remember, options come with risks, so tread carefully.

What is a Short Call?

As a budding investor, you're probably familiar with buying stocks and holding onto them, hoping they'll rise. But have you considered the flip side? Enter "Going Short" on call options—a strategy that lets you profit even when a stock is heading south.

When you're in a "short call position," you're the seller of the call. In other words, someone else has the right to call away your shares at a specific price (the strike price) until the option expires. It's like renting out your stock for a fee.

1. Meet Mary: Our Savvy Investor

Let's meet Mary, a tech-savvy investor. She owns 100 shares of XYZ stock, currently trading at $50 per share. But the tech industry is facing headwinds, and Mary believes her shares will eventually rebound. In the meantime, she wants to squeeze some profit out of them.

2. The Short Call Solution

Mary decides to write a short call on her XYZ stock. Here's how it works:

• Setting the Stage: She selects a strike price of $60 per share and an expiration date one year from now. Why? Because she's confident XYZ won't surge significantly during that time.

• Collecting the Premium: By selling the call, Mary pockets a premium of $2 per share. That's $200 straight into her pocket. Not bad for a few clicks!

• Two Scenarios:

  - Scenario A (Correct Prediction): If XYZ behaves as Mary expects (stays flat or declines), she keeps the premium. Essentially, she's made $200 without breaking a sweat.

  - Scenario B (Wrong Call): If ABC defies her prediction and shoots up, she must sell her shares at the $60 strike price. But here's the silver lining: She originally bought them at $50. So, even in this case, she pockets a cool $10 per share.

3. The Takeaway

"Going short" on calls isn't just for seasoned traders—it's a smart move. It's like renting out your stock while waiting for better days. Just remember, risks exist, so tread carefully and stay informed.🎤📈

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What is a Covered Call?

A covered call is like a financial two-step. Here's how it works:

1. Own the Stock: You already have ABC shares.

2. Sell a Call Option: You sell someone else the right to buy your shares at a specific price (the strike price) until the option expires.

Why "Covered"? Because your stock cushions you. If the buyer exercises the option, you're ready to deliver the shares without breaking a sweat.

Your risk? Limited to the premium you received for selling the call.

1. Mary's Covered Call Adventure

Let's say Mary sells a covered call on her XYZ stock with a $60 strike price. She pockets a premium of $200. If ABC stays below $60, she keeps the premium—easy money!

But wait, there's more:

- Risk Alert: If XYZ skyrockets (theoretically, to infinity and beyond), Mary must sell her shares at $60. If the market goes wild, her losses could be... well, catastrophic.

2. Uncovered Calls: The High-Wire Act

Now, picture Mary as a daredevil. Instead of owning XYZ shares, she sells an uncovered call. No safety net this time. If XYZ stays below $60, she pockets $200—just like before.

But here's the twist:

- The Abyss: If XYZ defies gravity and shoots up, Mary faces a dilemma. She must buy shares at whatever price the market dictates. Yikes! Her losses? Potentially unlimited.

3. The Takeaway

Young investors, listen up! Covered calls are like wearing a helmet while riding a bike. Uncovered calls? More like tightrope walking without a net. Beginners, stick to covered calls or other strategies. Safety first!! 🎩📉

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What is a Long Put?

A long put gives the holder the right, but not the obligation, to sell the underlying asset at a predetermined price (called the strike price) within a specified period (the *expiration date*).

1. Meet Harry: Our Savvy Investor

• Harry owns 100 shares of ABC stock, currently trading at $50 per share.

• He buys a long put option with a strike price of $60.

• If ABC's price falls below $60, Harry can exercise the option and sell his shares at that price.

• If ABC rises and stays above $60, the option becomes worthless.

- Risk Alert - there is limited to the premium paid for the option, providing downside protection.

2. The Takeaway

The key takeaway from a long put strategy is that it provides downside protection for investors. By purchasing a put option, you gain the right to sell an underlying asset at a predetermined price (the strike price) within a specified timeframe. If the asset's price falls, the put option becomes valuable, allowing you to limit potential losses. However, if the asset rises or remains above the strike price, the option may expire worthless, and your risk is limited to the premium paid for the option. 📉🚀 

What is a Short Put?

A trader sells the right to sell short the option’s underlying asset for a specified price (known as the strike price).

The idea behind a short put is to profit from an increase in the stock’s price by collecting the premium associated with selling the put.

However, if the stock price falls below the strike price, the option writer faces potential losses.

1. Meet Amy: Our Aspiring Investor

Amy wants to buy a stock at $25, but it currently trades at $27. She sells a put option with a strike price of $25.

If the price falls below $25, she will be required to buy the stock at $25 which she wanted to do anyway). In this case, she receives a premium for writing the option, effectively reducing your purchase price.

If the price doesn’t drop below $25, you keep the premium.

2. The Takeaway

The key takeaway from a short put strategy is that it allows Amy to collect a premium by selling the right to sell short an underlying asset at a specified price (the strike price). However, if the asset's price falls below the strike price, Amy may face potential losses. Always research thoroughly and consider professional advice when using options! 📉🚀

The Bottom Line

This list of options strategies is just the tip of the iceberg. There are countless combinations to suit every stock, investor, and market condition.

Before diving into options trading, beginners should take time to learn and practice paper trading. While the lower cost of options trading can be appealing, it comes with higher risks that need careful management.

If you want to benefit from options trading, consider this online course conducted by Sean Seah, an International Speaker and Best Selling Author on the topic of Investing and Entrepreneurship. He is featured on Channel News Asia, News Papers, Radio and Investment Magazines. He is also frequently invited to conferences and shared the same stage as Richard Branson, Mary Buffett, Gary Vee, Steve Wozniak and many more.

Happy Investing!