Curious Cat Investing Dictionary: Stock Options

Stock Options - the right to buy or sell stock at a certain price, by a specified date. Options can be covered - when you own the position you are taking an option against. Or naked when you do not own the position.

For example, if you own 100 shares of Cisco you could sell a covered call option giving someone the right to buy your shares at a specific price by a certain date. So, for example, they pay you $200 for the right to buy you 100 shares at $1 more than it is selling at right now anytime in the next 2 months. They might chose to do so, in order to leverage their investment as it only cost them $200 to benefit from the rise of 100 shares of Cisco. Of course if it doesn't go up in 2 months you benefit because you get to keep the cash.

Selling covered call allows the investor to earn a bit of extra money but they will lose out if the stock shoots up as then the investor that bought the option can buy your shares at the agreed to price even if it now is $5 a share more.

Puts are the right to sell a stock at a certain price. So if you wanted to buy Cisco but only wanted to pay $2 less than it was trading for now you could sell someone else the right to sell you Cisco at that price in the next say 3 months (in general options are for under 6 months and most actively traded at under 3 months).

Why would someone pay you to buy the right to sell at a certain price? If they are worried the stock might decrease they might want to, in a way buy insurance, that no matter how low the stock price falls they can sell it at least at a certain price. But they get to still own the stock if if goes up.

Related terms
  • selling short
  • warrents - long term options to buy a stock
  • cost basis
  • employee stock options - options granted to an employee to buy stock at a specific price (these are usually long term options - which are normally called warrnets unless they are employee stock options - just to keep things confusing :-)
  • strike price - the price the option grants a right to buy or sell at
  • in the money - when the current market price is better than the stricke price (above for a call, bellow for a put) for the owner of an option
  • Naked put - when the seller does not hold a short position in the stock
  • Covered put - when the seller does hold a short postion in the stock
  • Coved call - when the seller owns the stock
  • Naked call - when the seller does not own the stock
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Curious Cat Investing Library
Dictionary: PE ratio, Dollar Cost Averaging , Balance Sheet
Topics: China - Economics - Real Estate - Trading
Great Investors Focus: Darvas - Livermore - O'Neil - Soros
Authors: Levitt - Schwager Investment Bookstore