A open discussion on option trading

Based on some questions I had on my last Blog on buying a Call, I decided to start a discussion on the Forum of the Enabling Support Foundation. If you want to learn about option trading in a low key format, join us.

http://www.enabling.org/drupal/forum/21

An example of a Call Option

In my last blog I spoke about the option trading strategy of buying a call and now I want to suggest a way for you to actually do something about it. The investment I am considering is American Oriental Bioengineering (AOB). It will cost about $220 per 100 share contract and will not expire for two years. You can invest about $140 for a one year expiration date. In short, you buy a $5 call on AOB which will cost you $220 or $140 to control 100 shares of stock. If the company goes to 10, in the 2 year (1 year) period the option will be worth $1000. If it goes to 20, $2000 etc. You could double that if you controlled 200 shares or $440 ($180) to double your gain (but of course doubling your risk),

Why do I think this is a good investiment? 1) The market is low now and it looks like a good entry point; 2) The company is in China which is the world's fastest growing economy; 3) It is a pharmaceutical company that produces Chinese herbal medicines that have been used for a 1000 years and more; 4) MSN Money rates it a 7 (http://moneycentral.msn.com/detail/stock_quote?Symbol=aob&getquote=Get+Quote); 5) The Motley Fool listed it as a 5 star stock. http://msn.fool.com/investing/general/2009/01/22/5-star-stocks-on-the-upswing.aspx?logvisit=y&source=eedmsnlnk0010001&published=2009-01-22

Downside? Quality control issues. If a Chinese company can sell contaminated products, so could this company. The economy could not recover for 3 years.

Options for the Nervous Novice

Options for the Nervous Novice is meant for someone who knows little or nothing about options. I want to show some very useful investing strategies that provide a greater potential for gain and, at the same time, greater protection. That does not mean you can not lose, but you will lose less.

The goal is to progress from English to Optionese with as little lost in translation as possible.

Buying a call is a bullish strategy. That is, you think a stock is going up. One alternative is to buy the stock and sell it for a higher price than you bought it.

But there is another alternative. You can buy an option that will give you the right buy the stock at some set price in the future. If the stock is high enough above that price you will make a profit. Consider a stock currently at 80 which you expect to go to 100.

Stock
You can buy 100 shares for $8000 and will make a profit of $2000 if the stock goes to 100. If the stock goes down to 60 you have lost $2000. If the company went bankrupt you would have lost the whole $8000.

Option
You can also buy a Call with a Strike Price of 80 for 2 per share. An option contract controls 100 shares of the stock, so the Call would have cost you $200. If the stock goes up, the worth of option would also go up. With a stock price of 100 that same option you bought at 2 is now worth 20. The Call gave you the right to buy the stock at 80 and the stock is at 100. Since you bought the option at 2 and sold it at 20, you made $1800. If the stock went down, you would have lost $200 you paid for the option.

If you bought the stock you would have made a $2000 profit on an $8000 investment or 25%, with the stock price at 100. If the stock went bankrupt you could lose $8000.

If you bought the option you would have made a $1800 profit on a $200 investment. If the stock went down you would have lost the $200 you paid for the option.

That is a rather simplified example, but it gives an idea of the power of options. A fuller version can be found on the Market Synthesis website.
Link to the website

Feel free to ask questions and make suggestions at the Options 101 Forum.
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