This post arises from a simple conversation, during which time the above sketch was made by yours truly, in an attempt to explain Stock Options. The example numbers are not tied to reality.
First, The Disclaimer:
I am not a Financial Advisor. I am not a Financial Professional of any sort. I have to slowly remember what Puts and Calls mean... and then, slowly assemble the other parts of an Option String... perhaps incorrectly. More importantly, I've only made twenty (or fewer) Option Trades in my life. Sure, I made money. But not that much. And I quickly decided Options were not worth the hassle of it all... for me.
A Real Disclaimer
Go Elsewhere! If Stock Options are something you want to learn about, Go Elsewhere! The degree to which I do not care if I am right or wrong is hard to communicate to another. I simply do not care. So if you do care (which you should if you don't know what Stock Options are and you wish to Play The Options Market), you really should go elsewhere.
And for those who already know what Options are all about, I hope you find the following amusing.
Seriously, Bugger Off... unless you already know or really don't care.
I'm doing this all from memory. And since it is for my own amusement, I could care less about accuracy.
I mean, I am OK with losing money on account of my own stupidity. But are you?
The above represents a fairly simply graph. The vertical axis represents the Stock Price, while the horizontal axis represents my (yeah, I should word this all in the first person, so it's my) Profit. The more Profit, the happier I get, so the smiles get bigger and bigger.
Stock Price: Vertical
Going Long refers to buying Stock straight out. It's how I own all my Stock. That's the Black Line. I have never Shorted an issue. But all the same, Shorting is represented by the Dashed Red Line.
If I am Long, if I own a Stock, my Profit is directly related to the Stock Price.
If I am Short (something I'll likely never do), my Profit is inversely related to the Stock Price. As the Stock goes down, my Profit goes up.
It's not complicated.
I mean, it is. As how does one sell that which they do not own? Well, my friend, the answer is magic... or more accurately, credit. I am not a big fan of credit, so I shall exclude any details.
Going Long: Buying then Selling
Going Short: Selling then Buying
And like I said, to accomplish the later, I would have to borrow the Stock from someone else, putting-up Collateral to secure said loan of said stock, at interest rates I am unwilling to pay. But since that is not what this post is about, that is all I shall say on the matter.
Long: Buy First... The Black Line
Short: Sell First... The Red Line
The point where those two lines intersect is the Current Stock Price.
And now, I believe I have enough words in place to start defining a few of the more difficult words and phrases used to describe Options Trading.
Put: The Right to Put the stock to another
Call: The Right to Call the stock from another
I can Buy and/or Sell a Call and/or a Put. And pretty much all Options (that I am aware of) are made from some combination of the following four Options.
Buy Put: I am Buying the Right to Sell To Another
Sell Put: I am Selling the Right for another to Sell to Me
Buy Call: I am Buying the Right to Buy from Another
Sell Call: I am Selling the Right for another to Buy from Me
There is likely little clarity there. Really, it's just an honesty check for those who know what they are doing.
Did I get it right?
Never mind, then.
I really am weak on the terminology, because I build the terms up from scratch. The terms are what I transfer my thought into at the end. But not how I think things through.
See, when I think about Stock Options, I don't even think about that Red Line. I look solely at the Black Line. Where the Red Line intersects the Black Line, it splits the Black Line in two. And that gives an Upside and a Downside.
If the Stock goes up, the Upside pays off.
And if the Stock goes down, the Downside pays off.
And what I (and not you, as betting on The Stock Market using Options is little more than gambling, so stay away; anyway, what I) do is Buy the Upside (Buy a Call) or Buy the Downside (Buy a Put).
Eh, I should move on to the next image.
But first, let me just say that I only Buy Options, as Buying first (and Selling later or simply walking away empty handed, the bet having never paid off) models traditional gambling wagers... using The Stock Market rather than Horses as the underlying determinacy.
In other words, if one Buys a Put or Call, it is much like buying a Lottery Ticket. And if one Sells a Put or Call it is much like Selling a Lottery Ticket. And as much as I wish to win the Lottery, I have no desire to ever underwrite someone else's million dollar win.
Some might say that Selling Covered Calls avoids this trap, which it does. But it also rules out the Long Shot Payout, which is the only reason I am gambling in the first place.
Anyway, moving on.
The Light Blue Arrow (which technically lays right on top of the black line, having only been shifted upwards for clarity) represents Calls. It represents the Upside.
The Pink Arrow (once again, shifted downward for clarity) represents Puts.
The short colored slashes represent various Strike Prices. The Current Price is red, somewhat lower than the current price is blue, and somewhat higher is green.
Eh, I grow weary.
So, I will be cutting this short.
If I wish to Buy the Upside (the light blue arrow), I (as in, I and not you, as you really should talk this over with some sort of professional, etc.; anyhow if I want to bet on the upside, I) Buy a Call (i.e. the right to Buy some Stock from another at a Predetermined Price). If the Strike Price (the aforementioned Predetermined Price) is equal to the current Stock Price, well, then that's what (I'm going to assume) most folks expect. But if I buy a Call at the blue dash, I am buying an 'In The Money' Call (as I am Buying the right to Buy a Stock at a Price, which is lower than the current Stock Price, so the Option is already 'In The Money'). And if I buy at the green dash, I am buying an 'Out Of The Money' Call, because the underlying Stock Price has to move upwards somewhat (whatever that means), before the Option is a Winning Bet.
Eh, I doubt that is clear.
There is the Stock Price: What the Stock is currently selling for.
And then, there is the Strike Price, which is the Price at which I am Buying (or Selling, but I find Selling Options to be a very bad idea) the right to either Buy or Sell the Stock: i.e. Call From or Put To another.
What could be simpler?
It's really not complicated. The complication comes from translating a simple line graph into words and focusing on fairly technical constructs: i.e. the upside of the top half, the downside of the bottom three quarters, and so on and so forth.
Oh, but then, here's an interesting question. Why would I want to Buy an Option that was In or Out of the Money?
Thankfully, such a question has a relatively simple (to my simple mind, anyway) answer.
Out Of The Money Options are cheaper, while In the Money Options (though costing more) have less of a House Edge.
Ah, there I go using Gambling Terms again. Options aren't free. They are Bought and Sold. And just like at a Pawn Shop, the folks who make the market (who are called Market Makers, ironically enough) make their Profits almost exclusively (I would guess, this is how I would arrange things, anyhow) from the spread between the Buy Price and the Sell Price (Bid and Ask, but I'm not going to go there), which is often substantial... when computed as a percentage of the underlying issue.
Anyhow, that's Options.
I am Buying (or Selling, but I very much prefer Buying, as the loss is predefined, it being the cost of the Option) either The Upside or The Downside of an underlying security.
I really haven't explained much.
Lord knows, I haven't even posted an Option Chart, which are things of Awe Inspiring Beauty, rivalling Interstellar Gaseous Cloud Nebula in both their size and complexity.
So, please, stay away.
If you came here looking to understand these Complex Financial Instruments (whose underlying features I have glossed over and/or completely ignored), then understand that these instruments are most likely not for you... at least, not until you talk to someone wiser than I.
My sole goal has been to try and explain how I reason about Options (however incorrectly) and nothing more.
© copyright 2020 Brett Paufler