Options

[jmart2387]

I see 4 different types are available on W$R, but have no idea how to use them. Could someone please explain them to me? Thank you.

[beauc8]

Hey! I know this thread is rather outdated, but I see no-one has answered your questions. Options are a simple idea, but they can be complex instruments also. I haven't played options is W$R, but I can explain how the four 'positions' in options (i'm assuming W$R deals in 'American' options) work:

If you BUY a CALL option, you effectively buy the right to purchase a share, or other asset, at a specified price (the exercise or strike price) at any time up to the maturity date of the option. Logically, if the exercise price is below the market price of the asset, the holder of the option can profit. E.G. if I buy a call option with strike price £90, and at the maturity date the market price is £100, I can exercise the contract and profit £10 per share. This situation is called 'In The Money'. If the option is 'Out of the Money' - the strike price is higher than the market price - there is no benefit to the option holder to exercise the option, and the option lapses.

If you BUY a PUT option, you effectively buy the right to sell a share, or other asset, at the specified price at any time up to the maturity date. In this position, the holder of the option profits from a situation where the exercise price is above the market price - an 'in the money' situation. The holder of the option can exercise the option by buying at the market price and selling at the higher strike price, thus making a profit.

The next two positions - selling call and put options - requires an understanding of the concept of the premium in option contracts. I deliberately neglected this above for simplicity. In the first example above - a call option with strike price of £90 - the holder of the option would have purchased the option from the 'writer' of the option at a price - called a premium. The writer is the individual taking the 'sell' positions, and they are compensated by receipt of the premium. If we take the first example again, this option, depending on the writer's optimism for the stock in question, might have been priced at £2.50 premium. This means that the profit, assuming again that the market price is again £100 at the maturity date (or exercise date, since it is an american option which can be exercised at any time up to the maturity date) would actually be £7.50 (£100 - 90 - 2.50).

Therefore, if you are selling a call option, you hope for the situation that means the buyer of the option will let the option lapse - i.e. the exercise price is higher than the market price. This means you would receive a profit of £2.50 for really little effort. Again, writers of options will price the options they offer based on the probability of the outcome, and, for call options, premiums tend to be lower in options contracts with higher strike prices, since these are of lower risk of the holder exercising the option.

Conversely, if you sell a put option, you hope that the exercise price will be lower than the market price, meaning you don't have to buy the underlying shares at a price higher than their market value. In this situation, the writer receives the premium for each option contract purchased.

I hope that helps - its really just about understanding the admittedly logical concepts that underlie options and then getting some basic arithmetic right.