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If you use Yahoo! Finance to get up-to-date investing information, perhaps you've clicked on that "Options" link when viewing a stock quote.
On that page you might see some familiar terms, but some might be mysterious. Let's see what I can do to demystify that content.
I learn best with help from examples, so I'll walk you through one. I randomly chose FCX - Freeport-McMoRan Copper & Gold. See below for a screen snapshot from June 25, 2008 with numbered labels; sorry if they're a little confusing!
1. Company name: Freeport-McMoRan Copper & Gold Inc.
2. Stock ticker: FCX
3. Recent trade information: time of trade, price per share, dollar change for the day, percent change
4. Expiration of options: Options "expire" or are only good until a certain date, since options provide the right (but not the obligation) to buy/sell at a certain price by a certain date. That "certain date" is called the "expiration." Only the month and year pairs appear in these links because, magically, options always expire on the third Friday of any given month. If you want to see data on options that expire in Nov 08, for example, you would click the Nov 08 link.
5. Option type: There are two standard types of options: "call" and "put." One call option contract provides the contract holder the right, but not the obligation, to purchase 100 shares of the corresponding stock at a certain price by the expiration date. The top section shows data on call options; more on put options in (8).
6. Expiration date: This header area shows the exact date when the displayed options expire.
7. Advertisements: Horizontally across the top you'll find (typically broker) ads, and you'll find more ads on the right-hand side.
8. Option type: One put option contract provides the contract holder the right, but not the obligation, to sell 100 shares of the corresponding stock at a certain price by the expiration date. This bottom section shows data on put options.
9. Strike: The strike price is the dollar amount at which the contract holder can buy or sell the underlying shares.
10. Symbol: Since options contracts can apply to different stocks (FCX in this case), have different types (call/put), strike prices (85, 90, ...) and expirations (Jul 08, Aug 08, ...), it's helpful to identify all that in one little symbol. When you buy or sell an option, you'll need this symbol to identify what you're buying or selling. For help decoding these symbols, check out this Investopedia page.
11. Last: Just like stocks, options contracts can have some monetary value. The last represents the price* at which that particular options contract changed hands. *I say price, but remember that options contracts are good for 100 shares. I like to think of the last as a per share price. That being the case, to figure out the dollar value of an options contract you should multiply the last by 100 (or simply move the decimal point two places over). So, for example, symbol FCXGQ.X last changed hands for $3,225 (32.25 * 100).
12. Chg: Options contract prices can move up and down, so the Change represents how much the last has changed since the trading day started.
13. Bid: The bid represents the highest price someone is willing to pay for at least one options contract at that moment.
14. Ask: The ask represents the lowest price at which someone is willing to sell at least one options contract at that moment.
15. Vol[ume]: The volume represents how many of that options contract have changed hands that trading day.
16. Open Int[erest]: The open interest represents how many outstanding contracts there are of a particular option. Let me clarify what I mean by "outstanding contracts." Go to the PUT OPTIONS section and look at the 85 Strike. Now look at the Open Int column: 612. That 612 means there are 612 put option contracts out there with strike price 85 and expiration in Jul 08. If I were to write 10 new put contracts at the Bid price of 0.20, at that moment the Open Int number would rise to 622 (612 + 10 = 622). If I were to buy 10 of those put options contracts and exercise them, the number would fall to 602 (612 - 10 = 602). In a later entry I'll describe what it means to write options contracts.
There is plenty more to learn about even just Yahoo!'s options pages, but I hope that breakdown is helpful! Options can be very confusing, complicated, and risky, so PLEASE do your own careful research before trading options.
Disclosure: I have no position, long or short, in FCX.
It turns out that Apple, Inc.'s stock (ticker: AAPL) was a stellar performer in 2007. It also performed really well in 2006:
Perhaps surprisingly, the purpose of this entry isn't to pump AAPL. Instead I'm going to explain how buying and selling stocks in increments is one of the most powerful money-making (and money-preserving) tools you can utilize as a stock investor.
Increments? I want BIG gains!
What do I mean by "buying and selling stocks in increments?" Have a seat on my hypothetical stock sofa. Ask yourself, "What is my stock investing dream?" If you're like me, it involves something along the lines of: buy 1,000,000 shares low and sell 1,000,000 shares high. I'm a king! Hooray... hooray... feed me grapes, dammit ... HOORAY! er... ah hem.
Let me clarify; that used to be something like my stock dream.
Reality kicked in and I learned the hard way that I'm not very good at predicting what will happen to a stock price tomorrow or next week or even a month from now. Ultimately I figured out that when I do thorough homework on a company/stock, my odds of making profit over the long term are a lot better. Over the short term, forget about it.
Given that tomorrow my favorite stock could trade at a discount compared to how it's trading today, why not snap up that bargain tomorrow? Then again, it could sky-rocket on a buy-out rumor, too. Face it: without [probably illegal] insider trading information, you never really know what's going to happen to a stock price in the future.
Accept it, learn it, live it. Come up with trading strategies that embrace this philosophy. Don't worry; I'm not going Plato on you, but check out the following scenarios that illustrate the advantages of buying in increments. Small pieces... not big chunks.
Let's assume you have $300k to "play" with (ha!).
Example 1: The quickly skyrocketing stock
Suppose you buy 1,000 shares of a stock that's trading for $85 / share. Within a few weeks the stock is trading around $98 / share. Sweet!You sell all and catch a net gain of $13k or 15%. Yeah, you could have bought 3,500 shares and made a bunch more money... but you just made $13k in a few weeks! If you're sad about making $13k in a few weeks, you may have other problems.
Example 2: The tanking stock
Suppose you buy 4,000 shares of a stock that's trading for $75 / share. You're sure that conditions haven't changed, but the stock drops immediately after your purchase. The next month it hits $60 / share. The next month it hits $50 / share.Ouch. Now you're down $100k or 33%. If only you had the power to see the future and had waited those two months... or realistically, what if you had purchased 1,000 shares at $75 / share. You'd still be down 33%, but that 33% would translate into a loss of a more manageable $25k instead $100k. I don't know about you, but if I absolutely had to choose between losing $25k or $100k then first I'd click my heels together three times and then I'd pick the $25k loss.
Example 3: The tanking stock that recovers
You buy another 1,250 shares at $60 / share; same total cost of $75k, but this time you get more shares. Good deal! You've spent $150k so far and have another $150k in cash.
A month passes and the "impossible" happens: your stock sinks to $50 / share. You're nervous, angry, and you've begun to consume your daily share of Top-Ramen noodles... but you're confident that your research and evaluation of economic conditions are spot on. This time $75k buys you 1,500 shares. You somehow remain calm. You're left with $75k in cash and you've spent $225k purchasing stock.
Incredibly positive news comes out and within a month your stock shoots back up toward $75/share. Nice! If you had invested all your $300k @ $75 / share initially, you'd be breaking even and back to $300k.
Since instead you invested wisely and broke your purchase into three increments, your 3,750 shares are now worth $281k for a 25% gain. Add that to your $75k cash and your portfolio has grown from $300k to $356k ($281k stock + $75k cash). Again, you could have broken even but instead you're up $50k+. Winner!
Conclusion
As you can see, buying in increments has its definite advantages while the disadvantages are few. Yeah, yeah ... in Example 1 you could have made more money, but let's not be greedy. Profit is profit is profit.
In a future entry I'll go through some examples to illustrate how selling in increments can also be very advantageous. Sure, there are some situations where experts advise dumping all (for example when there's an abrupt executive management change), but even in those cases you never know beforehand if it's the most profitable thing to do.
In general if you sell in increments you can lock in gains while also giving your stock the chance to climb higher (while also shielding yourself from potentially more severe losses). Craziness, a free lunch, the best of both worlds, and so on. Woohoo!
If you can tell the future, disregard everything I've written in this entry today. If you're like me and can't tell the future (go Packers!), consider buying stock in increments instead of in one big chunk (this process is also known as dollar cost averaging). You just might thank yourself later.
Oh, by the way... all the above three examples track AAPL stock movement over some period in the last two years. Check it out:
Full disclosure: I do not have any position, long or short, in AAPL at the time of writing.
What are options, anyway? A stock option represents the right, but not the obligation, to buy or sell stock at a specified price by a certain date. In other words, with stock options you can choose to buy or sell stock at a given strike price, but you don't have to.
Individual companies grant stock options
I first became aware of stock options during the Internet Boom of the late 1990s / early 2000s. I would read in the news that Wealthy McCEO and many other company executives were getting crazy rich thanks to stock options. Companies can grant stock options to employees, which often encourages employees to stick with the company for an extended period of time.
How employee stock option plans benefit the company and the employee
How would stock options entice an employee to stay at a company? Here’s an example. Suppose Company XYZ is a public company and XYZ stock trades for $10/share. Upon hiring a top-level manager (let's call the manager by Smarty Pants), XYZ might grant Smarty Pants the option to buy 10,000 shares of XYZ @ $10/share.
With shares of XYZ trading for $10/share, Smarty Pants probably wouldn't want to do anything with those options. Why bother, since she could buy shares for the same price on the open market? Typically companies don't allow the option holder to exercise the option (i.e., perform the purchase prescribed by the option contract) right away, anyways.
Companies control when the employee stock options become vested (i.e., eligible for exercise). XYZ might tell Smarty Pants that her options become 50% vested after two years and 100% vested after four years. This would mean that after being with the company for two years, Smarty Pants could exercise the option to buy 5k of those 10k shares @ $10/share. After four years she could exercise the option to buy the remaining 5k shares, still @ $10/share.
Suppose a year passes and XYZ stock becomes an increasingly attractive investment. Shares of XYZ now trade at $20/share. Ho, ho, ho - Santa Claus just came to town. Just for sticking with the company, Smarty Pants could -- in a single transaction -- realize a gain of $10/share. But wait… her options aren’t vested yet. They become 50% vested two years (not one year) after the initial grant. Bummer. Now she’ll have to stick around for another year to realize that potentially saucy gain.
Suppose yet another year passes, and XYZ now trades for $25/share. Hot dog! Smarty Pants can buy 5k shares @ $10/share only to turn around and sell them on the open market for $25/share. Putting this transaction into the numbers:
Purchase price = $10/share * 5,000 shares = $50,000
Sale price = $25/share * 5,000 shares = $125,000
Net gain = Sale price - purchase price = $125,000 - $50,000 = $75,000
Smarty Pants was rewarded for sticking with the company as the company's stock performed well. During that time period, Smarty Pants also had incentive to help the company perform well. If she were to help the company to perform better, in theory XYZ stock might trade at a higher price per share and she could end up with more dough for herself.
Employees won’t always make a profit on stock options
Of course, if investors had viewed XYZ stock as a decreasingly attractive investment then the share price might have dropped over that two-year initial vesting period. If the stock performed so poorly then Smarty Pants’ options might have expired before she got a chance to exercise them in a profitable transaction.
What do I mean by expire? Just as companies control stock options vesting periods, companies also control when that contract expires. Like I mentioned above, stock options represent the right -- but not the obligation -- to purchase shares by a certain date. If XYZ stock traded at no higher than $8/share between the time the options were vested and when they expired, then there would be no reason for Smarty Pants to exercise the options. If she were to go through with it, she’d lose $2/share on the transaction (since her option was to purchase shares at $10/share, whereas the market was paying up to $8/share). That sounds like a bogus deal because it is a bogus deal.
Impact of employee stock option plans on share price
Although employee stock option plans can be good for the company and good for the employee, investors should be aware of a company’s stock option granting practices. These practices can add downward pressure to a company’s share price. Thinking in terms of supply and demand, when an employee buys shares through a stock option plan then more shares all of a sudden become available for trading (and therefore supply increases). More supply means more pieces to the same size pie, so each piece has to be a little smaller. Following an employee stock option exercise, each outstanding share is worth some fraction less than it was before.
Companies can offset the dilutive effects of option exercises by buying back shares on the open market. If a company buys back more shares than are issued into the trading pool, the number of outstanding shares decreases and so each share -- in theory -- becomes worth a little more. Something to consider!
Insider activity
When employees of a public company buy or sell shares of that company, that’s commonly referred to as insider activity. Insider activity is completely normal, and you can investigate insider transactions yourself. This information is available online, and one site I visit to obtain information on insider transactions is Yahoo!’s insider activity area like this one. On that page we can see that on 25 October 2007, a Yahoo! Directory named Terry Semel exercised options to net more than $8 million in a single swoop. Not too shabby.
Some people take into account insider activity when constructing opinions on a company or a company’s share price. People buy and sell shares all day, but presumably directors know more about the company than the average investor does. If a director buys shares on the open market, that’s often interpreted that the director has faith in the company.
When an insider dumps a lot of shares, some believe that demonstrates lack of faith in the company. While that may end up being the case sometimes, remember that insiders are individual people. Insiders have their own financial wellbeing to consider, and sound principles like diversification apply to them, too. Just because an insider sells shares or exercises options, that doesn’t necessarily imply upcoming problems. Some insiders participate in stock option exercise plans that force regular, periodic exercising of options and selling of shares at predetermined time intervals. This allows insiders to sell stock in a way that some consider less predictive.
Insider activity is interesting to look at, but it doesn’t necessarily imply anything. It can be a useful piece of information when evaluating a stock, but I strongly would advise against using it as the sole indicator of whether to buy or sell shares.
Summary
Stock options can be good for the company, good for the employee, and good for the investor (for example, if the company ultimately spends less on hiring since their employees stick around). Stock options can also be a negative for a stock, so be aware of what's going on and you'll have a more informed and complete view of a company and that company's valuation.
Long story short, I hope you and I get rich off of stock options ... Cha-ching!
Here's a scenario for you...
You've just bought a smokin' hot stock (ticker REDHOT) for $100/share, but you're a little nervous. If you're like me, buying REDHOT shares today means REDHOT almost certainly will trade lower tomorrow. Worse yet, will REDHOT tank? Will you lose all your money? JUMPING JEHOSEPHAT!!
Down to Business...
When you go to sell shares of a stock and you select your order type, you may notice "Stop Market" or "Stop Limit" order types. The concept behind "Stop Loss" or "Stop" sell orders is this: if the stock price drops to the activation price, a sell order is triggered automatically. By using a stop loss sell order you can, with some pre-planning, protect your capital in the event of a stock price drop (even if you aren't in front of your PC watching quotes all day). Here's a situation where that might prove valuable...
You buy 100 shares of REDHOT for $100 / share because you're looking to make some crazy cash, but if the stock doesn't rise right away you're packin' your REDHOT bags. You decide that if REDHOT drops to $98 / share, you want to sell your stock automatically for whatever the market is willing to pay at that moment. After purchasing the shares, you immediately place a "Stop Market" sell order to sell all your shares if the stock drops to an activation price of $98.
Incidentally, REDHOT cools down and falls from $100/share to $92/share the next day. That means that the stock traded at your activation price, which means your sell order got triggered. Maybe your 100 shares sold for $97.98/share.
In this example, here's what happened in money terms:
Initial buy: 100 shares x $100/share = $10,000 invested
Sale executed: 100 shares x $97.98 = $9,798 left; => loss of ($10,000 - $9,798) = $202.
Value with no stop loss order: 100 shares x $92/share = $9200; => paper loss of ($10,000 - $9,200) = $800.
Not great, but not bad. The stock didn't rise right away and instead it tanked, costing you $202 instead of a more depressing $800.
Sounds like a dream come true?
Not so fast!
Depending on the type of investment you're making, using stop loss orders may not make the most sense. One "stop loss" rule I keep in mind isn't right all the time, but I think it's reasonable:
If you're making what you consider to be a risky (quick? super-growth?) stock trade, consider using a stop loss order. If you're smack-dab in the middle of a long-term value investment, stop loss orders might not be most sensible way to go.
Why do I like that general rule?
If I'm in the middle of a long term value investment, chances are I've put some thought into how much I think a stock is worth. I'm owning the stock in the first place because I trust my judgment that the stock is headed higher. If the stock has reached a point where I'm concerned it may drop lower (in other words, maybe it's reached a valuation I find fair or even rich), why sell lower when I could sell now for more profit? Thanks, Grandpa Stan.
Time for another example. Suppose I own a stock with ticker BESTVAL. BESTVAL is trading at $50/share, and I had purchased the stock at $42/share. I figure $50/share is a high valuation, and I'm afraid BESTVAL is going to drop soon. Since profit is the name of the game, logic tells me to sell BESTVAL at the highest available price (buy low and sell high, right?). By entering a stop loss order with an activation price of let's say $48 / share, I could end up selling the stock at a price that's 4% lower than the current price. What gives? I'll take my $50/share, thank you very much.
Conclusion
How you approach your trades is 100% up to you, but you may want to consider these examples when making some order type selection decisions.
Happy investing!
Full disclosure: BESTVAL and REDHOT are not real stock tickers. So, yeah...
(P.S. for more information on order types, check out the wikipedia page on stock orders)
Options trading can be a powerful tool for either the speculator/trader or the risk avoider. In this entry I'm going to provide you with a situation where you might want to buy (and later sell) put options. As always, perform your own comprehensive research before making ANY investment decisions; do not make decisions based solely on content you gather at this site.
Quick Intro
Options can come in different flavors, notably puts or calls. Options contracts represent the right, but not the obligation, to buy or sell a security by a certain date for a certain price. For more in-depth info on options, check out the wikipedia options entry.
A put option provides the option contract holder the right, but not the obligation, to sell 100 shares of a security at a certain price. How might you use put options to bring home some extra clams?
Put Option Example #1
You want to make profit off of a stock that you believe is going to sink soon. Let's give that stock the ticker HOTSTOX. You're not comfortable selling short. If you sell short and the stock rises (maybe you're out enjoying fresh air instead of closely monitoring the streaming ticker?), the downside of your investment is limitless. AKA you could owe a hell of a lot of money to your brokerage. Alternatively if you buy a put option, the most you can lose is what you put in.
Wait a minute... how could owning (and then selling) put options make you money if the stock sinks? Good question. I mean, why would a put have any value at all?
Suppose you owned a stock that was trading for $30/share. If someone offered to buy that stock from you for $50, that's a pretty good deal for you. You'd be pocketing a premium bonus of $20/share (on top of the $30 it's worth) all in one profitable swoop. Not too shabby.
So the ability to sell your shares for a certain price might be worth something to you. At a very basic level, that's one way I like to think of puts. The ability to sell stock at a certain price -- if I want to -- is worth something to me. If I were to pay $20 to sell my shares tomorrow at $50, I'd break even, so that doesn't sound too attractive. But there is some price where it might be worth it to me. That's one thing to consider when figuring out how much put options are worth to you. Some refer to that difference as the intrinsic value of an option.
So now you see that put options are worth something to someone, here's an example of putting ... puts to use for you:
Suppose HOTSTOX is trading for $54/share, and here we are in early November. You strongly believe HOTSTOX will drop by at least a few points by December. You browse over to the HOTSTOX options listing on Yahoo! Finance to discover that DEC 55 puts (i.e., put options that expire in December and give you the right to sell 100 HOTSTOX shares for $55/share) are trading for $3.20. Note that this $3.20 amount describes cost per share. Since each options contract applies to 100 shares...
# of shares per contract: 100
option price per share: $3.20
total option contract price to you: 100 shares x $3.20 / share = $320 [+ commission]
You bite your upper lip and place a limit order to buy 1 put option contract for $3.20. You sleep well that night.
The next day an OPEC bigwig stubs his toe while getting on a boat in the Persian Gulf, and HOTSTOX drops from $54 all the way down to $51. You still hold the right to sell shares of HOTSTOX at $55, so the difference there just got bigger. You check the options pricing for HOTSTOX and notice that the same put options you bought yesterday for $3.20 are trading for $5.00* now. You jump up and down for joy and place a limit sell order for your put option $5.00. Your profit on the transaction?
purchase price: $320 per contract (remember, 100 shares per contract)So that's one example of how you might buy and sell a put in order to collect some serious cabbage (+56% in that example). Keep in mind that gains might not happen that quickly; gains might not be that sharply; and gains might not happen at all.
sales price: $500 per contract
net change: $500 - $320 = $180! (minus some $ for commissions)
Also, remember that in this case you have to sell at some point in order to make money. Picking a selling point might be tough, but you've got to come up with something that works for you. I'd advise against buying/selling any securities/options/etc. until you've come up with a selling plan that you can stick to.
Good luck!
Full disclosure: HOTSTOX is not a real stock ticker, so I definitely don't own any position in HOTSTOX. Proceed with caution when trading any securities, especially options.
* Note that an options contract price takes into account other things in addition to intrinsic value. Visit the wikipedia options page mentioned above for more information on options.
