# How to use options...



## dj_420 (19 September 2006)

I am new to the whole options approach and wanted some advice on how to use them.

i know you purchase them so you have the right to convert them to shares on a certain date???

my questions are 

how do you convert options to shares
does one option count as one share

why if options are much cheaper than shares would anyone buy shares and not options then convert them


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## Magdoran (19 September 2006)

dj_420 said:
			
		

> I am new to the whole options approach and wanted some advice on how to use them.
> 
> i know you purchase them so you have the right to convert them to shares on a certain date???
> 
> ...



Hello dj_420


Why not do a bit of research in the derivative area; there is a huge library of threads which cover a large range of options knowledge.  There are even some reviews of a variety of books which you may find useful.

I would also suggest that you visit the ASX website and register for the free online courses that are available.  These are a really good place to start to get the foundations of knowledge about how options work.

Now, in answer to your questions:

Standard Australian Exchange traded options are 1000 shares per contract, but this can be modified in special circumstances due to stock adjustments of some kind or a modification which is listed.  In the US the standard number of shares is 100 per contract.

If you buy a call option you are buying the right but not the obligation to purchase the contracted amount of shares for a specific company by the specified expiry date at a specified price (the “exercise” or “strike” price).  

If the exercise type is American, you can “exercise your option at any time up till and including the expiry day, and notify your broker that you want to exercise your right to purchase 1000 (unless modified) shares per contract at the exercise price.  You then pay the full price based on the exercise price per share, and any resulting brokerage.  You then receive the shares the next trading day.  If the exercise type is European, you can only exercise the option on the expiry day.

If you buy a put, you have the right to sell a share, but not the obligation.

Note that you can sell options (although I caution you about this until you fully understand the risks involved) to gain premium, but then you are undertaking to fulfil the contract if assigned.

As to your question why would anyone buy shares and not options, this is in part because there are risks which you need to understand with options.  Please read the ASX disclosure document on the risks involved.

Options have hidden complexities (the “Greeks), and things like volatility, theta (time) decay, and concepts like delta (gamma, vega, rho etc), should be fully understood, and these actually need to be considered against shares which are comparatively less complex.

Don’t forget, options are complex leveraged instruments and if not understood can result in significant losses.

Personally I don’t tend to deal in shares unless I have to, but that is because I am aware of the complexities of the “Greeks” – factors which affect the theoretical value of options, and market conditions which can adversely affect the actual value of options.  Have a read of the threads regarding option values and Greeks, especially volatility.

Things like “contest risk” where the market makers skew the buy and sell prices to make a margin are a cost in the process.  The market maker spread can significantly add to losses or reduce profits if not managed and understood.  

The value of options is also affected by “volatility” – essentially each option behaves uniquely in part depending on what the underlying share does, but other factors can affect it’s value outside of the underlying share price action.  Be aware of this.

For example, I and others in the past have bought calls on a surge in a stock, seen the stock continue to move in our favour, only to see the value of the option go DOWN.  This was often because of theta (time) decay, and because we bought when volatility was high, and when volatility declined later this reduced the market value of the option - In some cases well below the entry price, even when the stock moved reasonably in the direction you thought it would.

So, please be aware of these traps, have a read of the ASX site, threads, and recommended books.


Hope this helps.


Regards,


Magdoran


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## wayneL (20 September 2006)

dj_420 said:
			
		

> I am new to the whole options approach and wanted some advice on how to use them.
> 
> i know you purchase them so you have the right to convert them to shares on a certain date???
> 
> ...




Best to go the library and read up... or read the ASX site or others. A good beginners book is "options" by guy bower, available in Joe,s bookshop

http://www.moneybags.com.au/default.asp?d=0&t=1&id=4601&c=0&a=74


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## dj_420 (20 September 2006)

Thanks wayne and magdoran

i have begun researching and reading through the threads on this topic. the hardest things i find to understand are although you can purchase calls and puts, how does one do it, i mean when you go onto comsec website it only shows one lot of options for a stock not the calls and puts.

i have an idea that options used in the USA and AUST are very different and have different rules attached to them as such


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## wayneL (20 September 2006)

wayneL said:
			
		

> Best to go the library and read up... or read the ASX site or others. A good beginners book is "options" by guy bower, available in Joe,s bookshop
> 
> http://www.moneybags.com.au/default.asp?d=0&t=1&id=4601&c=0&a=74




I actually didn't notice Mags post... DOH!  

Notwithstanding, the above is still a good book to start with.

Re Differences between USA & Aus. Structurally, the only differences are.

1/ The size of contracts USA = 100 sahres Aus = 1000 shares (these can be adjusted where there has been a corporate action)

2/ Margin Rules... only relevant if selling

3/ Rules regarding strike intervals and tick size

plus a few other minor odds 'n sods. But in essenseThey are the same

In practice the US market is much bigger, more liquid, and IMO offers more opportunities. There are pros and cons for each which Mag and I argue about, but I suspect there is more pedagogery involved than anything else. You can make money in either market.

I would just echo Mags words about learning the minute' of options. It pays  

Good Luck


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