# Options - how do they work?



## Nifty (18 May 2007)

Say there is an option 08 and you buy it. What is the deal?


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## BIG BWACULL (18 May 2007)

Nifty said:


> Say there is an option 08 and you buy it. What is the deal?



I think this means they expire in 2008


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## BlingBling (19 May 2007)

Nifty, I think you are going have to give us some more info..


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## shaunm (12 February 2008)

Hi,
I have been buying shares for a while now but have not looked into buying options in the listed company. How does it work and what should I look for?

Thanks


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## SevenFX (12 February 2008)

Prob worth closing this thread & following one of WayneL threads which he has written a few on Options from memory....???

Here's One.
https://www.aussiestockforums.com/forums/showthread.php?t=4416&highlight=options

p.s The search & advanced search gets great results even from few years back.
Cheers
SevenFX


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## The Mint Man (12 February 2008)

shaunm said:


> Hi,
> I have been buying shares for a while now but have not looked into buying options in the listed company. How does it work and what should I look for?
> 
> Thanks



If your fairly new to the market and only ever bought and sold shares then its probably worth doing a fair whack of research into.
In this environment options are not something you want to mess with because if you think shares have been volitile lately then you aint seen nothing!!!. Another thing to keep in mind is that options, unlike shares, trade within a fixed period.
I'm fairly new to options too and at the moment I'm only interested in selling covered calls. This (to me) is the least risky and most rewarding stratergy ATM. Providing you pick good stocks to hold in the first place of course 

Like I said DYOR.

Cheers


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## Buffettology (12 February 2008)

Yes, WayneL is the master on options!

But, I agree with the Mint Man, its something you have to do a LOT of research into!  You cannot just find out from a forum.

But I also agree with the Mint Man, covered calls are probably the best for the value investor, though naked put options arent that risky either (despite their reputation and higher level required on your options account).  Credit spreads are not very risky at all either.

Normal stock purchases are a LOT more risky than any of these strategies (no idea then, why naked put options are classed as so risky?).  Stupid.


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## wayneL (12 February 2008)

Buffettology said:


> Yes, WayneL is the master on options!
> 
> But, I agree with the Mint Man, its something you have to do a LOT of research into!  You cannot just find out from a forum.
> 
> ...



Don't forget sails and magdoran (and probably a few other quiet ones). 

Re the naked put question. 'zactly Buffett.

Yes they are less risky than straight shares, on an equal face value basis. But people can get themselves into trouble and here's how they do it.

Say a share is trading at $30. The trader notices some juicy premium on offer and sells $25 puts. OK, providing the trader doesn't mind ending up with the contracted number of shares, so far so good. Let's work on 1000 shares  and $25,000 face value for the example.

What some traders will do is, thinking that the share will never get down to $25 in 30 days, sell say, 100 US contracts (10,000 shares) to leverage the premium they are going to collect.

Suddenly we have a face value of $250,000.

You don't have to use too much imagination to know what could happen, even with blue chips. 

But this is not the option's fault, it is not intrinsically risky. It's the traders fault and a matter of position sizing. Remember that a naked put is the synthetic equal of the covered call and so the risk/reward is exactly the same. So all the naked put trader need ask him/herself is whether they would enter a 100 contract buy/write as per the above example. 

Let's look at that. The same trader would have to buy 10,000 shares @ $30 before being able to sell the calls... I don't think so.

Brokerages can counter this risk with newer traders by insisting on higher margin or cash coverage where cash available is equivalent to the value of the identical covered call position.

But as most brokerages (even those dealing in options) actually know very little about them and so perpetuate the myths.

*tip* synthetics are a great tool for learning and understanding any option strategy. Look at the synthetic equivalent to see what you might not otherwise see.


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## peter2 (12 February 2008)

Shaunm: To which option type are you referring?

I lifted this from the ASX website:

What is the difference between a company option and an exchange traded option? 

Company options are issued by companies for the purpose of raising funds. They give shareholders an opportunity to buy new shares at a fixed price on or before a predetermined date. This gives the company the ability to raise funds for future projects. The exercise of company issued options results in an increase in the company's capital.

Exchange traded options are traded over existing shares. Their exercise results in a transfer of ownership of the underlying shares, and not in an increase in the company's capital. The company is not a party to the contracts traded.


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## shaunm (12 February 2008)

Thanks for the replies people.

I was referring to company options, and how to value them against share price etc.

The other options like "puts" and "calls" I aint going near in this market.

Cheers


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## Buffettology (12 February 2008)

wayneL said:


> Don't forget sails and magdoran (and probably a few other quiet ones).
> 
> But this is not the option's fault, it is not intrinsically risky.
> 
> ...




Yes, sorry Sails!  Only entering this world, so havent as of yet met magdoran.

Exactly, only a stupid trader would enter into a deal he could not afford if he was exercised hoping to just collect premiums!  

I also read most brokers dont understand naked put options and perpetuate the myths!  Pretty scary to think most brokers dont even understand such a simple concept!  I think most people hear the words "options" and just freak out!?  You think?  Seems to be like that when I ask most of my buddies who buy shares if they know anything about them.

What are synthetics?


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## sails (13 February 2008)

Synthetic equivalents are simply using various combinations to create the same type of position.

eg. using normal Aus option contract size and all other things being equal:
 1 long put + 1000 shares = 1 long call (same option strikes)
(long put + shares may appear cheaper than a long call - this is mostly caused by cost of carry (interest).  Also one has to understand how dividends and the like affect these synthetic relationships - this is where it can get a bit tricky.

A covered call is synthetically the same as a short put at the same strikes, for the same period of time and under normal conditions.  They both produce similar losses if the market goes down; similar profits if the market stays neutral to bullish.

Charles Cottle ebooks are what really opened my eyes to the value of understanding synthetics - especially for more complex option trading.  

It's often interesting to see people who are comfortable trading covered calls - often with their shares heavily leveraged on margin, but are adamant they would never trade a short puts!  

But they are taking on similar risks and rewards.  If they are paying huge interest for their leveraged shares, this actually makes it a worse strategy to the short put.

Suggest doing a search on Magdoran's posts on options.  He has done several very detailed posts which may be helpful to you.  I have a busy life apart from trading, so my posts are a bit infrequent!


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## Buffettology (13 February 2008)

Thx Sails.


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## sydants (22 March 2011)

*How do Options work?*

Im just new to trading and was just wondering how options work. Say if i bought some options in a company would i be able to excersise them into ordinary shares as soon as i bought them or whats the procedure for that?
Thanks guys


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## builder2818 (22 March 2011)

*Re: How do Options work?*



sydants said:


> Im just new to trading and was just wondering how options work. Say if i bought some options in a company would i be able to excersise them into ordinary shares as soon as i bought them or whats the procedure for that?
> Thanks guys




You could exercise them as soon as you bought them but that would be pointless. You would be paying for the option, the brokerage for buying it and then the brokerage to exercise the option and buy the stock. You would just be better off buying the stock outright.

You don't have to exercise them but if your analysis is correct and the stock moves in the direction that you hold a long option position over, you can then just sell the option back to the market. There's a little bit more to it than that but that's the basics behind it.


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## wayneL (22 March 2011)

*Re: How do Options work?*



builder2818 said:


> You could exercise them as soon as you bought them but that would be pointless. You would be paying for the option, the brokerage for buying it and then the brokerage to exercise the option and buy the stock. You would just be better off buying the stock outright.
> 
> You don't have to exercise them but if your analysis is correct and the stock moves in the direction that you hold a long option position over, you can then just sell the option back to the market. There's a little bit more to it than that but that's the basics behind it.




Yes.

If there is any extrinsic value in the option and you exercise, you will immediately lose that value.

If you own a call option with remaining extrinsic value and you want the shares now, you are better off selling the option and buying the shares, rather than exercising the option.


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## stefan_invester (22 March 2011)

has anyone heard of Binary options before?
and how they work does anyone know?
thanks


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## mazzatelli (22 March 2011)

stefan_invester said:


> has anyone heard of Binary options before?
> and how they work does anyone know?
> thanks




Yes, there are many sub-classes of them.
Generally discontinuous payoff, touch/no touch markets, otc.
They are harder to price and model, especially near the barrier strikes.

Don't touch them, unless you know what you are doing.


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## ROE (22 March 2011)

stefan_invester said:


> has anyone heard of Binary options before?
> and how they work does anyone know?
> thanks




Stay with ETO, they guarantee someone on the other side will honour the contract
because they have margin on your balls and the price is a little more transparent 

going into options without a market marker holding the other side by the balls with their collateral someone can just decided to reneged on the deal and you left with nothing..


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## ROE (22 March 2011)

*Re: How do Options work?*



builder2818 said:


> You could exercise them as soon as you bought them but that would be pointless. You would be paying for the option, the brokerage for buying it and then the brokerage to exercise the option and buy the stock. You would just be better off buying the stock outright.
> 
> You don't have to exercise them but if your analysis is correct and the stock moves in the direction that you hold a long option position over, you can then just sell the option back to the market. There's a little bit more to it than that but that's the basics behind it.




oh I think he mean the company issue options, not ETO that how I read it...
he now want to convert to shares.

If that the case I think you contact the company, filled in some form with a cheque
and they issues you the shares.. I never deal with company issue options, mainly ETO.


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## stefan_invester (22 March 2011)

Thanks for the info guys

I dont know why, but i found this site,http://www.marketpunter.com.au
and i have been reading about Binary options, and it seems like a really easy way to make money for some reason :S

but I don't know if thats a legit site, because i contacted them, and i need to transfer my money to a bank account in cyprus.... so yeah its a bit weird.
best to keep away i guess


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## mazzatelli (22 March 2011)

@stefan
Generally exotic options are better to use than vanilla options, better Greek exposures [e.g. discontinuity beyond the barrier in the case of no touches, minimal vega, all gamma </= 7 days out etc], but they are very complex, even for professionals.

MM's will hold all the edge, and unless you know how to model your own vol surface to price the skew and can track hedging parameters its best to stay away. When explained simply, it sounds so good - but there is a reason a lot of these are not allowed to the public and subject to gambling regs.

If you want to play around with binaries - join Oanda and play with FX box options. Again slightly different to binaries - but at least they are a trusted counter-party.


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## ROE (22 March 2011)

stefan_invester said:


> Thanks for the info guys
> 
> I dont know why, but i found this site,http://www.marketpunter.com.au
> and i have been reading about Binary options, and it seems like a really easy way to make money for some reason :S
> ...




Nothing is that easy ...if it is easy then I say it's easy to lose money

most financial advertising are designed to build you dreams, just remember that
and when those dreams dont come true it will be a F**ken nightmare 

stay with a trusted financial operator when it come to financial stuff and in Australia
it's the ASX 

That site look like a gambling site based on market derivatives.


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## wayneL (23 March 2011)

*Re: How do Options work?*



ROE said:


> oh I think he mean the company issue options, not ETO that how I read it...
> he now want to convert to shares.
> 
> If that the case I think you contact the company, filled in some form with a cheque
> and they issues you the shares.. I never deal with company issue options, mainly ETO.




Company options are still call options and may still have extrinsic value to be lost.

Unless extrinsic value is zero, it is still better to sell the options and buy the shares, rather than exercising.


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## mazzatelli (23 March 2011)

ROE said:


> Stay with ETO, they guarantee someone on the other side will honour the contract
> because they have margin on your balls and the price is a little more transparent




Most of the decent operators offering retail exotics are arms of the large banks &/or brokers e.g. UBS, Societe Generale, Oanda, Saxo

Anyway the closest replication to the binaries using vanilla options are vertical spreads - so ASX ETO's would be a fruitless uphill battle.


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## Pairs Trader (23 March 2011)

the spreads, commissions and lack of liquidity in options will eat you alive


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## wayneL (23 March 2011)

Pairs Trader said:


> the spreads, commissions and lack of liquidity in options will eat you alive




Yes and no.

Lots of things can eat you alive. If trying to swap long puts and calls for stock, the above "might" be true... but not necessarily so.

But you can do stuff with options you can't do with stocks and this is where they come into their own. 

As with everything in trading "it depends".


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## skc (23 March 2011)

stefan_invester said:


> Thanks for the info guys
> 
> I dont know why, but i found this site,http://www.marketpunter.com.au
> and i have been reading about Binary options, and it seems like a really easy way to make money for some reason :S
> ...




Your local friendly (and slightly more reputable) CFD providers also offer binaries.

Your money is probably safer with them than an cyprus account, but I highly doubt that it will be easy to make money from 'trading' binaries.

Here's a screen shot on the closing value of ASX200.





Actually that Buy 7.4 for ASX200 to finish 0 to 25pts down seems like a good bet


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## sydants (23 March 2011)

yes i understood there would be costs involved with the brokerage of buying/selling the options just there was a 8% gap between share price and option price+excersise cost which just seemed like free money


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## operandi (1 April 2011)

OK so why would you trade options? ( binary's ETO's  or otherwise)  but if you must! Dont sell em no matter what any marketeers tell you but if u must cause its only a matter of time before u get enamoured by the credit you get in the account buy the strike above(calls) below( puts), learn the Greeks especially gamma and theta cause ull prob run ur delta's. 

What likely may happen is: ull go long options, theta will chew into ur long premium, this will happen a few times and then ull think, fxck it ill sell em and get paid, ull get comfortable living off the fat of short premium not realising vol has gotten crushed to the point that the strangle is lean at which point in time vol will explode cause someone or something extraneous has occured and will take away all ur lovely little profits uve accumulated over the last months.

The good option traders ive seen trade options long, pay for premium so it costs em nothing to have on, keep em on their books over and over again, and when they kick in they go buy a house CASH.


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## wayneL (1 April 2011)

operandi said:


> OK so why would you trade options? ( binary's ETO's  or otherwise)  but if you must! Dont sell em no matter what any marketeers tell you but if u must cause its only a matter of time before u get enamoured by the credit you get in the account buy the strike above(calls) below( puts), learn the Greeks especially gamma and theta cause ull prob run ur delta's.
> 
> What likely may happen is: ull go long options, theta will chew into ur long premium, this will happen a few times and then ull think, fxck it ill sell em and get paid, ull get comfortable living off the fat of short premium not realising vol has gotten crushed to the point that the strangle is lean at which point in time vol will explode cause someone or something extraneous has occured and will take away all ur lovely little profits uve accumulated over the last months.
> 
> The good option traders ive seen trade options long, pay for premium so it costs em nothing to have on, keep em on their books over and over again, and when they kick in they go buy a house CASH.




There is a time to short premium, there is a time to long premium and there is a time to spread.


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## mazzatelli (1 April 2011)

operandi said:


> The good option traders I've seen trade options long, pay for premium so it costs em nothing to have on, keep em on their books over and over again, and when they kick in they go buy a house CASH.




What do they do? Buy strangles?


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## sails (1 April 2011)

operandi said:


> ...The good option traders ive seen trade options long, pay for premium so it costs em nothing to have on... CASH.




How can you pay for something that costs you nothing? 

And if that means selling premium to eventually pay for long premium, then there is a risk of reduced profit (capped by the short) in the event of the big move...


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## operandi (1 April 2011)

sails said:


> How can you pay for something that costs you nothing?
> 
> And if that means selling premium to eventually pay for long premium, then there is a risk of reduced profit (capped by the short) in the event of the big move...




Nah IMO ur not thinking like an option trader.. ...When ur long options u pay(buy)   premium, that premium "wastes away" as they get closer to expiry. Wasting away means losing money for the trader. Trader looks down at his sheets knows how much he's losing so he hussles around other strikes, order flow and the underlying to pay for this. If he's husled well, he's got the long options on for "nothing" (or  essentially paid for), if he's over he's happy  BUT if premium explodes (cause thats the kicker), he's very happy indeed.  It's not a reduced profit if ur loaded up and spread out.

IMO unless uve got the "couta" electronic eye trading software dont even go there the blokes in London and Chicago are just too on the money.  These guys are on the money   http://goo.gl/rmwUY  ( btw is this allowed in this joint)

Always spread, spread everything against everything and everything against everything again


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## wayneL (1 April 2011)

operandi said:


> Nah IMO ur not thinking like an option trader.. ...When ur long options u pay(buy)   premium, that premium "wastes away" as they get closer to expiry. Wasting away means losing money for the trader. Trader looks down at his sheets knows how much he's losing so he hussles around other strikes, order flow and the underlying to pay for this. If he's husled well, he's got the long options on for "nothing" (or  essentially paid for), if he's over he's happy  BUT if premium explodes (cause thats the kicker), he's very happy indeed.  It's not a reduced profit if ur loaded up and spread out.




Gamma scalping?

Please tell us more.



> IMO unless uve got the "couta" electronic eye trading software dont even go there the blokes in London and Chicago are just too on the money.




Why tell us muppets about this then?


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## mazzatelli (2 April 2011)

operandi said:


> Nah IMO ur not thinking like an option trader.. ...When ur long options u pay(buy)   premium, that premium "wastes away" as they get closer to expiry. Wasting away means losing money for the trader. Trader looks down at his sheets knows how much he's losing so he hussles around other strikes, order flow and the underlying to pay for this. If he's husled well, he's got the long options on for "nothing" (or  essentially paid for), if he's over he's happy  BUT if premium explodes (cause thats the kicker), he's very happy indeed.  It's not a reduced profit if ur loaded up and spread out.
> 
> IMO unless uve got the "couta" electronic eye trading software dont even go there the blokes in London and Chicago are just too on the money.  These guys are on the money   http://goo.gl/rmwUY  ( btw is this allowed in this joint)
> 
> Always spread, spread everything against everything and everything against everything again




The firm you quote are market makers employing high freq/algorithmic trading, no different to Optiver, Tibra etc.

What you described, isn't even the way these firms trade!!!


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## cutz (2 April 2011)

LOL,

Correct me if i'm wrong but I thought "the sheets" disappeared back in the ninties.


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## kingcarmleo (3 April 2011)

Options provide more leverage as the underlying assets increases significantly.


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