Wednesday, November 7, 2007

Stock option Put and Call example

The first way that I got started investing som 30 years ago was with stock options. I found the use of puts and calls as the best way to put my knowledge of how I thought a stock could move (or not move) to use. For the novice, I will use an example of the stock GRMN. On Tuesday it had a price of around $100. For about $4 you could buy a november call (the right to buy the stock) at the $100 dollar strike price any time in the next 2 weeks. So if the stock rose to say $107 on friday, you could then sell for a $3 profit! Conversely, If the stock only moved to 102, the call would be worth about $2. Therfore producing a loss of $2. You do not have to hold an option until expiration, you may sell or buy at any time you wnat to. By the way, each stock option controls 100 shares of stock. So an option with a cost of $4 would cost $400 plus a $7-10 commision to the broker.

A Put is the opposite of a call. It is the right to sell a stock. Aside from straddles, this is the way I got started trading. I bought puts onoverextended stocks. In my experience, stocks tend to fall much faster than they rise. This is great for the use of puts. One of the problems with buying and holding of stocks is that you can only makemoney if a stock goes up. Puts allow you to profit whena stock goes down as well. In the above example of GRMN, a november 100 put cost about $4 on tuesday. If the stock moves below $96 anytime time in the next 2 weeks, you will have a profit.

I mentioned that I got started with straddles. A straddle is simply buying a put and and call at the same time. It is a very simple way to take advantage of a stock you think is ready to move!
Take and add GRMN to your watch list for the next 2 weeks. I feel confident it will move more than $8 dollars from $100. It may even move on both sides of 100, making both the put and call possibly in the green. Another stock I am keeping an eye on is GSF. I put a straddle with a cost of $3.10 at the strike price of $85 yesterday.

One subject that Investools teaches is knowing when to sell. I believe this is very important and often overlooked. Everybody talks about when to get into a trade. Knowing when to get out will make you a very sucessful trader. That is something which I will stress throughout this blog!

Have a great day!