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INTRODUCTION Welcome to the Learning Lab. The Stock and Option Strategies section of The Learning Lab is part of ValueStockFinder.com's library of materials selected to provide the beginning investor with an explanation of a variety of stock market investment techniques and resources, while offering the experienced and professional investment managers an opportunity to re-visit some of the basics in investment strategies and mechanics. In this section, Stock and Option Strategies (SOS) will provide a brief explanation of the use of ValueStockFinder.com's "Intrinsic Value Model" computer algorithm that has made ValueStockFinder.com so successful as an investment aid. The use of ValueStockFinder.com and its advanced computer model emphasizes the value of being in personal control of your stock investments. With these tools, you will be able to
- evaluate and control your investment risk; - increase the value of your stock portfolios, self-directed IRAs, and retirement funds; - predetermine your potential profits before you make an investment. ValueStockFinder.com and IVM-Pro are powerful risk management tools designed to provide prudent investors with one of the easiest, safest, and most profitable ways to obtain the highest return on invested capital. By using a combination of stocks and options, this approach can be as conservative as just buying stocks. You will see how easy it is to get the ultimate return on your assets with an approach that uses a combination of stocks and options. For example, you buy a stock and sell an option on that stock. The money this earns (the premium you receive for selling the option, minus the commission) gives you extra cash flow and downside protection on your stock. If you just buy the stock and do not sell an option, you receive neither the extra cash flow, nor the downside protection. Details about how this works are covered in this document. COVERED CALL OPTIONS AS A CONSERVATIVE STRATEGY Generally, you should only write options on stock that you are willing to own. This means that before purchasing the stock, you should analyze it according to the measurements appropriate for your investment program, such as p/e, book value, project earnings, and the industry. This program describes a very conservative use of options because it deals with options in a covered call strategy. Most sophisticated investors and pension fund managers consider the judicious use of writing covered call options to be one of the safest and most reliable investment strategies. A highly respected professional investment resource is quoted to have said, "Curiously, the most attractive option strategy when returns are concerned in relation to risk is covered call writing. It has provided profits of over 20% a year with relative consistency and it is only about half as risky as holding a portfolio of common stocks." Writing covered calls means selling a person the right to buy your stock at a certain price (exercise or strike price), within a certain time period (expiration cycle). When you sell (write) an option on stock you already own, the option is "covered" by the stock you own; therefore it is referred to as a covered call option. The money you receive is additional cash you would not have had if you just had bought the stock and did not sell an option. THE REWARD-RISK RATIO OF COVERED CALLS (OPTIONS) Although writing (selling) covered calls is considered a conservative investment strategy, it is not possible to totally eliminate every element of risk. But it also has been said that ". . . you must take some risks with your investments if you want to beat, or at least compete, with taxes and inflation." ValueStockFinder.com finds the stocks on which many investors would wish to write options. IVM-Pro is the Home-Use computer software version of the Algorithm used on the ValueStockFinder.com web site. This computer program provides the user with the means to EVALUATE AND CONTROL investment risk through the use of an effective investment strategy where an investor determines which stock to buy and which covered call to sell on that stock to generate the greatest return on investment. IVM-Pro makes it possible for the user to measure the "reward-risk" ratio before investing. Although it isn't possible to completely avoid risk, the IVM-Pro software program provides a reliable way to control it. Covered call writing can not prevent a stock from going down, but it can protect an investor on the downside by hedging the risk of a move against the stock. Writing covered call options is a reliable technique that you can learn, test, and experience at your own pace. As your confidence with IVM-Pro grows, you will realize that you can evaluate, adjust, and control your own reward-risk ratio, as you see fit. WHAT IS AN OPTION? What is an option? An option is a contract giving the purchaser the "right" (not the obligation) to buy or sell a specific number of shares of a stock at a definite price (the exercise price), on or before a specified date (the expiration date). Equity, or stock, options are sold in lots of 100 shares of stock. One option equals 100 shares of a particular stock. For example, if a stock is selling for $25 a share, an initial investment will be $2,500 for 100 shares needed for any investor to sell an option on that stock. If an option is sold for $3, the investor will receive $300 for that option, minus the commission. Quoted option prices usually refer to just one of the 100 shares that represent one option. While there are many investment strategies dealing with options, our focus will be on covered calls since they are considered by most professionals to be the most conservative, and the safest, of these investment techniques. WHAT ARE COVERED CALL OPTIONS? If we compare covered call options to real estate, they may be easier to understand. In the stock market, an option becomes a "covered call option" when there is an underlying stock against which the option is written. In the real estate market, if an investor owns a piece of property and someone is interested in the possibly of buying it, that person may offer a sum of money for an "option" to buy it during a specific period of time. When the option is accepted it is an agreement to hold the property off the market for the amount of time specified in the option. During that period, the buyer has the option of buying the property for the previously agreed (optioned) price. If the buyer decides not to buy the property during the specified period, the option money (the premium) is forfeit and the property owner keeps both the property and the option payment. If the buyer decides to purchase the property, the payment to the owner will be the agreed upon price (the strike price or option price) for that property. Additionally, the property owner keeps both the dollars paid for the purchase and the option. Selling (writing) covered call stock options works basically the same. An investor will buy a number of shares of stock and sell an option on that stock for a predetermined exercise (or strike) price, with a predetermined expiration date. When the expiration date arrives, the person who holds the option can buy the stock by paying the stockowner the agreed upon exercise price. The owner of the stock delivers it upon receipt of the exercise price while also retaining the money received for the option. It is important to remember, however, that the amount received called the premium) will always be have any amount charged by the broker as a commission for the sale. If the person who holds the option decides that the predetermined (i.e. exercise) price is too high, or he just changes his mind for any reason, he can forgo buying the stock and just allow his option to expire worthless. In this scenario, the owner of the stock keeps both the stock AND the money received for the option. Obviously, the stockholder then can sell yet another option on the same stock to someone else. It is important to note that approximately 30% of options that are sold expire worthless, meaning that they are not exercised. When you institute a regular practice of selling covered call options, it is the accumulation of option dollars received that can provides a stockholder with significant additional cash flow on stock investments. MORE ABOUT OPTIONS Investors who never have been involved in options trading may associate all "options" with gambling and high risk. It is true that some options range from very risky to very conservative. However, covered call options have been considered to be the safest and most conservative use of options and, if used properly, they can reduce the element of "risk" in the market dramatically. Investors who are familiar with real estate transactions may not hesitate to offer an option on their real estate but they feel fear and anxiety when they think about selling (i.e. writing) options on their stocks. When financial safety and potential gain are evaluated for both transactions, however, trading stock options (particularly covered calls) are safer than many real estate transactions. For example, with real estate a very small number of people may be interested in buying an option on real property. Stock options are quite different. Since many people are buying and selling options all over the world on any given day, there are "options exchanges" where options are traded just as stocks are traded. Assuming that the stock on which an investor wishes to sell an option is one that other investors will want to own (i. e., one that inspires "open interest"), there should be no difficulty in selling the option. There are 5 major exchanges where options are traded:
2. American Options Exchange 3. Pacific Exchange 4. Philadelphia Exchange 5. New York Options Exchange Buying and selling options is the same as buying and selling stocks. Option transactions are always conducted through a broker who buys and/or sells options through the traders who are on the floor of the options exchange. An option investor doesn't know (or care) who buys the option. All options are sold through an exchange where options are being traded every day. Some investors are buying those options and some are selling. If an investor sells a call option on a stock and then later wants to keep the stock (for any number of reasons, such as thinking that the option is going to be exercised), that investor can go to the exchange and buy back an option that has the same expiration date and exercise price. (See "Rolling Up" for details of this technique.) WHO WRITES COVERED CALL OPTIONS? An investor sells (i. e., writes) covered call options for 3 reasons:
2. To lower the net price paid for the stock. As soon as an investor sells an option, his investment in the stock is lowered by the amount he receives for the option. 3. To protect his stock on the downside -- if the stock price drops. WHO BUYS OPTIONS THAT COVERED CALL WRITERS SELL? An investor buys a covered call option for one of three reasons:
2. Most investors, however, buy options with no intention of buying the stock. Similarly, many investors sell options with no intention of selling the underlying stock. 3. To hedge their risk and protect against their position in the stock market. It is interesting to note that those who write (sell) a covered call are using a "conservative strategy," with the hope of leveraging their money for a large profit; those who buy the option are using a "speculative strategy." COVERED CALL OPTIONS COMPARED TO JUST BUYING STOCK If an investor purchases stock, the only way for that investor to make a profit on his investment is to wait until the price of the stock rises higher than the price he paid; however, there is no downside protection if the price of the stock drops below what the investor paid. An investment strategy using covered calls, however, allows an investor to make money three different ways:
2. If the stock price stays either the same or below the exercise price - the investor will make the money received for the option (the premium, minus the commission) PLUS the investor retains the stock and, then, may sell another option on the same stock (again increasing cash flow). 3. If the stock goes down less than the premium received for the option - the investor makes the money received for the option AND the investor will have lowered the cost of the stock by the amount received for the option. COVERED CALLS VS BONDS Many retired people living on fixed incomes find it difficult to maintain their standard of living with income from bonds and money market accounts. Bonds and money market accounts have a fixed rate based on the existing interest rate (which may be as low as 5% to 8%, or less). Covered call options can provide a return of between 18% to 40% with very little more risk. A highly respected analytical firm has said that "writing covered calls is safer than just buying stock." Some investors may feel that bonds are safer than buying stock and selling covered calls because bonds are based on a fixed amount of money returned to the owner at the due date and because many bonds are backed by a government body or are federally insured. But few investors keep bonds until the due date. Meanwhile, bonds can fluctuate dramatically because of changes in the prevailing interest rate. Additionally, it has been noted that bonds generally lose buying power for many investors over a period of time because of inflation. With little effort, using covered call options, an investor can exceed the returns on both bond and money market investments by a considerable amount. USING CALL OPTIONS IN CONJUNCTION WITH STOCK ALREADY OWNED Many investors have stocks that they bought some time ago and have "put in the drawer" waiting for the price of the stock to rise. Some of those stocks have, indeed, appreciated substantially in terms of market value; however, the investors receive little in the way of percent returns from actual dividends relative to the market value of the stock. Even though these investors now may be in need of the extra income (especially if they are retired), they are reluctant to sell these stocks because they will incur a huge capital gains tax. Investors in this situation can use IVM-Pro to help them select the options (covered calls) they could sell to release these "locked in assets" (sometimes also called "hidden assets") and increase cash flow without incurring a large capital gains tax. Obviously, however, when an investor has stock that has been owned for a period of years, stock whose value has appreciated significantly, it would be foolish to allow that stock to be called away because of the significant capital gains tax that would be incurred. Under these circumstances, if this type of stock option is exercised and the stock would be subject to be called away, the investor could buy, in the open market, the same number of shares being called and deliver those shares to cover. This is the accepted technique for retaining the original shares while enjoying the benefits of the added cash flow from existing investments. An example of increasing cash flow would be to assume that the investor owns 1000 shares of CCC stock purchased ten years ago for $20 per share (for a total investment of $20,000). Currently, the stock sells for $60 per share (a total present value of $60,000 for 1,000 shares). The dividend is 2% of the market value, or $1,200. There is an opportunity for the investor to sell a 90-day option on the stock for $4.00 a share with a strike price (the price at which the stock must be surrendered) of $65.00. Selling this call on the 1000 shares would equal $4,000 (a 20% return on the original investment). If the stock price were to rise to $65 or above and the option is exercised, the investor will be required to deliver the 1000 of CCC stock. However, since the investor does not wish to incur you do not want to incur a large capital gains tax, the investor then can choose one of two possible actions:
2. Another, perhaps better, way to prevent the original stock from being called away is to use a procedure called "rolling up". "ROLLING UP" (a.k.a., “rolling forward” or “buying back”) "Rolling up" is the best strategy to use to keep a stock from being "called" when its market price has risen to the option's exercise (strike) price. A few days before the date for the expiration of the option (assuming the stock has risen to the strike price), the investor may buy back the option and then sell another option at a higher price with an expiration date that is farther out. The day before the expiration date of the first option, the option will no longer have any time value; therefore, the price of the expiring option will only be its intrinsic value. The second, or new, option the investor sells, however, will include in its price both time value and intrinsic value. Therefore, it is usually true that the sale of the farther out (dated later than the expiration of the present option) option will be sufficient to cover the cost of buying back the near option. Of course, the exercise price of the option being acquired also will be increased. To be absolutely certain that a particular stock is not "called," the investor may wish to keep "rolling up" several times. There is no end to the flexibility and the potential rewards of improving cash flow through this technique. BUYING STOCK AND SELLING AN OPTION (THE "BUY-WRITE" ORDER) Stocks and options have their own exchanges, and the prices fluctuate rapidly. Successfully using covered call options become more assured when there is a predetermined positive result from the transaction. That is, the effective use of the combination of buying a stock and selling a related covered call option at prices that will make it a certainty that the investor will achieve the precise, predetermined percent return. This technique is called a "Buy-write" order. A "Buy-write" strategy, then, means buying a stock and selling an option at the same time. For example, using ValueStockFinder.com or a software program like IVM-Pro, the investor may first determine the most desirable stock (or stocks) based on the program's analysis of the stock's intrinsic value. The web site and the program will show the current price quote for the stock (current price in the market). IVM-Pro software then will automatically download all of the available options (calls and puts) for the selected stock or stocks. The investor may evaluate the combination of the stock with each of its available call options and automatically illustrate on the computer screen, the return on investment if the option expires and the return on investment if the stock is called away. These returns are illustrated for both the short term and the annualized returns. To complete an effective "Buy-write," the investor will see the recommended combination of prices to place on the "Buy-write" order. The obvious price for the stock and the price for the option that would generate the best return is illustrated on the screen and it will be the same as the break-even point for the transaction (the price of the stock minus the sale of the option). In a sample telephone conversation between an investor and the investor's stock broker, the investor would call the broker and say: I want to "Buy-write" 100 shares of CCC for $50.00 and at the same time sell one July $55 call option for $2.00 for a net cost to me of $48.00. On the other hand, if the investor buys the stock and then sells the option separately, the investor may discover that the net price originally calculated had narrowed because of the inevitable fluctuation of both the stock and the option prices. Additionally, because of these changes in price, it would be possible that the investor also would not actually get to complete the transaction at the same gain. By using the "Buy-write" technique (an accepted technique used by knowledgeable investors), the average investor can avoid these unpleasant surprises. COVERED CALL OPTIONS AS A BULLISH STRATEGY An illustration of an investor who is bullish about a stock is an investor who will buy the stock and sell an "out of the money" option. An option is "out of the money" when the exercise price of the option is higher than the price of the stock on which the option is written. If the stock reaches the exercise price, the investor will enjoy the increase in the value of the stock from its original purchase price PLUS the amount received for the covered call option sale. The investor's "downside" protection will only be the amount received for the sale of the option. For example, if CCC is selling for $50 a share the investor should sell a call option at $55 or $60 (depending on which option offers the best annualized return). At the time the stock reaches the exercise price and may be called away, the investor will have the increase in the price of the stock, PLUS the money received for the sale of the call option. COVERED CALL OPTIONS AS A BEARISH STRATEGY If the investor is less bullish about the stock (or even bearish, the more aggressive strategy would be to sell (write) an "in the money" option. An option is "in the money" when the exercise price is below the price of the stock on which the option is written. The investor, therefore, agrees to sell the stock for less than its cost. However, the investor will still make a significant profit on the transaction because of the higher price received for the "in the money" option. For example, an investor likes CCC company's stock (for which the investor paid $50 per share for 100 shares). However, the investor is not too positive about CCC's immediate future or, perhaps, believes that there may be a pause in the entire stock market that could adversely affect CCC's stock price. The investor then may sell an option with an exercise price of $45. Since the option will be for less than the current selling price of the stock, it may be assume that the option probably will sell for $7. The intrinsic price of the option will be $5 and the time cost will be $2. It is important to note that if the stock is called at $45, the investor will have lost $5 per share on the stock's original price. However, the investor also will have received $7 per share for the option. The effect is that the investor will have profited by $2 per share on the original investment. Moreover, the investor also will have impressive "downside" protection because the investor will lose nothing unless the price of the stock actually falls below $43 a share. (Since options are sold in lots of 100 shares of stock; the initial investment in the example above would be $5,000 for the stock, $700 for the option, etc.) USING COVERED CALLS TO INCREASE CASH FLOW IN A 401(k) ACCOUNT Many investors have stocks in pension or 401(k) funds that have had substantial capital gains. Selling the stock will make the investor liable for a significant capital gains tax. The investor still can increase the yield on this asset without selling the stock. The investor writes an option on the stock that is "out of the money." If the stock gets near the exercise price a week before the expiration date, the investor can buy back the original option and sell another option that has an expiration date "farther out". In all probability this new option will pay for the option the investor had to buy back. Additionally, if the stock does not rise to the option's exercise price, the investor may deposit the premium received for the option into the retirement account tax free. The proceeds from the transactions will be income received without investing additional funds. Because of continuing changes in tax legislation, it would be advisable to confirm that this approach still is acceptable under the tax laws. LIKE ANY INVESTMENT APPROACH, COVERED CALLS REQUIRE DILIGENT EFFORT Even though ValueStockFinder.com and IVM-Pro are tools that will automatically gather and present the analytical information needed by an investor to decided whether to buy a stock and concurrently write a covered call option (a "Buy-write"), it is important always to follow a prudent investor's process of analyzing the underlying stock further. As noted earlier, any investor only should write options on stock that the investor is willing to own. IVM-Pro software (for purchase from this web site) also offers other resources for continuing analysis of any of the stocks of interest to any investor (go to the HOME page and click on IVM-Pro Software). THE DOWNSIDE When the price of the underlying stock goes down in a stock market reversal the investor will lose money. However, using these techniques, an investor will lose less money if the investor has sold an option against the stock (by the amount you receive for the option) instead of simply buying and holding the stock and waiting to see what happens to its price. IF THE STOCK GOES DOWN LESS THAN THE AMOUNT RECEIVED FOR THE OPTION SOLD, THE INVESTOR ACTUALLY WILL MAKE MONEY! For example, if an investor buys 100 shares of XYX for $50 a share and sells an option for $2.50 a share with an exercise price of $55 and an expiration date in 60 days, if the stock goes down to $45 the investor will lose $2.50 per share ($50 paid for the stock less $2.50 paid for the option equals a net cost per share of $47.50). HOWEVER, if an investor had only bought the stock at $50 per share (without selling the covered call option) and held on to the stock, the investor would have lost $5 a share, or twice as much as would have been lost if the investor had bought the stock and sold the option. Moreover, if the stock only drops in price by $2.50, the investor would have lost nothing! "STOP LOSS" AND COVERED CALLS An investor may choose to defend against deep and sudden losses that market volatility might cause by employing a "stop loss" strategy. This is done by placing a "stop loss" order on an investment at the same time as a covered call order. Many investment advisors suggest, for example, that a "stop loss" order be placed with the broker (at the time of purchase) at 10% below the purchase price of the stock. For example, if an investor purchased CCC at $73.87 per share and also wished to sell a covered call option on that stock (a "Buy-write"), the broker probably would suggest a "stop loss" order at 10% below that purchase price ($73.87 less $7.38 equals a "stop loss" price of $66.49). The investor's potential loss on that trade then would be $7.38. BUT if the investor were to sell an option on the stock at the same time it was purchased ("buy write") and simultaneously placed a stop order, the potential loss would be substantially lower. For example, if the stock were purchased at a price of $73.87 per share and, simultaneously, a call option were sold for $2.67 per share (with a strike price of $75 in 60 days), AND if the investor placed the same 10% stop order ($66.49), the loss would be only $4.71 per share if the stock's price declined to the stop loss. This illustration shows that the resulting loss from using stock purchases with covered call sales AND stop losses actually will be 6% of the original investment instead of the 10% loss the investor would experience without this type of protective transaction. IF THE STOCK WERE TO DECLINE ONLY BY 4%, THE INVESTOR WOULD BREAK EVEN AND NOT SUFFER ANY LOSS ATALL ($73.87 - $2.67 = $71.20). "Stop Loss" orders are an intelligent safety precaution. If an investor does not choose to give stop loss orders, the investor should create a "mental" stop loss by carefully watching the movement of each stock's market price. "SHOULDS" TO CONSIDER WHEN WRITING COVERED CALL OPTIONS The following basic criteria should be considered when evaluating stock for covered call writing:
2. The stock should be one the investor is willing to own over the long term. 3. The underlying value of the stock should be ranked #1or #2 by Value Line. 4. Short-term options sold "at the money" will usually provide the best annualized return. (An investor can determine which option to sell by examining the various stock/option combinations on the Options Tab of IVM-Pro to determine the most substantial returns). 5. Dividends will increase the annualized return, so it is important for an investor to attempt to buy a stock before its ex-dividend date. 6. If the annualized return shown in the IVM-Pro software program is less than an 18% return to the investor, the option premium for that transaction probably is too low. An investor should evaluate on of the other stock/option combinations until the most acceptable one is found and then execute a "Buy-write" strategy. 7. The price of the option is directly affected by changes in the underlying stock's volatility. More volatility in the underlying stock boosts the price of the option. When volatility eases, the price of the option declines. The stock selected should have acceptable volatility. 8. The more uncertainty about a stock's future direction, the higher its volatility and premium. When a stock exhibits a clear trend, the price volatility tends to be low and the time value of options tends to contract. 9. While writing covered calls is basically a bullish strategy there are times when an investor can use writing "in the money" options as a defensive, or bearish strategy. If, for example, an investor believes that a specific stock might be going down in price, writing an "in the money" option will protect the investor to the extent that the call is in the money. Additionally, the investor will receive the income for the option sold. SUMMARY Increased Cash Flow. One of the most significant benefits from selling covered calls is increased cash flow. However, it is increased cash flow generated by one of the most conservative investment techniques available. Selection of the appropriate common stocks and the sale of call options is a strategy that is appealing to any investor who wishes to optimize his or her return from capital. Any investor can generate a reasonably profitable return using the covered call strategy. Many investors who fail to explore the potential benefits of selling covered calls as an integral part of a total investment strategy usually buy a stock and wait for its price to rise. However, most investors never sell the stock and, as a result, many never experience the gains they anticipated by investing. One of the advantages of the covered calls strategy of investing is that it helps an investor learn how to make disciplined decisions. An investor using covered calls as part of a comprehensive investment strategy will be in control of more of the risk factors that could adversely affect any portfolio. An investor who uses ValueStockFinder.com (which also uses the IVM-Pro Intrinsic Value Model Software) will be able to find reliable information to help choose the stocks to buy and the options that are the most profitable to sell. With the appropriate information, even a beginning investor may learn to proceed with confidence knowing that investment choices are based on sound, conservative, proved investment strategies. ValueStockFinder.com and its Intrinsic Value Model Algorithm are designed to help the investor by EXPLANATION OF SYMBOLS Name of Stock: (sample stock is Micron Technology). Stock ticker symbol is MU Name of Option: Date and Strike code symbols: MUJM. ("J" represents an expiration date of 10/21/95; M is a strike price of $65). In all option symbols, the second to the last letter signifies the expiration date and the last letter signifies the strike price. Number of Options: (one call option = 100 shares of stock). All other symbols are self-explanatory. Expiration Months: Letters designate the months.
Strike Prices: (The most commonly used. Contact a stock broker for strike prices not included here)
IVM-Pro Software is designed to allow the user to try various stock and options and different expiration dates for each to help the investor determine the combination that will produce the best annualized returns. GLOSSARY Understanding how and why options work requires that the investor be familiar with a few terms that are normally used in buying and selling options. Initially these terms may sound complex, but they will become familiar in a short time. AT THE MONEY: An option is "at the money" when its exercise price is the same as the underlying stock on which it is written. (e. g., CCC stock is $75 a share and the exercise price of the option is $75 a share) BUY-WRITE: A "Buy-write" strategy means buying a stock and selling one of its options at the same time. CALL OPTION: A call option gives the purchaser the right to buy a security at a certain price before a certain date. COVERED CALL OPTION: A call option is "covered" when the person who writes (sells) the call owns the underlying stock. DELTA: A measure of how the option's price will change if the price of the underlying stock changes. DOWNSIDE: The risk or loss incurred when the value of a stock is going down. EX-DIVIDEND DATE: The date that establishes when stockholders will receive the a dividend distribution (cash dividends, stock dividends, and/or rights issues). EXERCISE PRICE: The price at which the option holder has the right to purchase the underlying stock; also called the "strike price." EXPIRATION CYCLE: Every stock option is assigned a particular expiration cycle. All equity options trade four months at a time: two near months plus two additional months of their respective cycles. EXPIRATION DATE: The expiration date of all stock options is the Saturday immediately following the third Friday of the expiration month. The last day to trade (or exercise) expiring options is the third Friday of the expiration month. If Friday is a holiday, the last trading day will be the preceding Thursday. IN THE MONEY: An option is "in the money" when the exercise price is below the price of the stock the option is written on. INTRINSIC VALUE OF AN CALL OPTION: The difference between the current price of the stock and the option's exercise price. OPEN INTEREST: The degree of interest investors have in a stock. When determining what option to sell, the investor should find out how much open interest there is in that stock. The number of options that have been bought on that stock determines the option interest. The greater the open interest, the greater the liquidity. Liquidity is important when an investor wants to buy or sell an option. OPTION: The purchased right to buy a stock at a specified future date at a definite price. OUT OF THE MONEY: An option is "out of the money" when the exercise price of the option is higher than the price of the stock on which the option is written. PREMIUM: The trading price of the option. It is equal to the sum of the option's intrinsic value and its time value. ROLLING UP: "Rolling up" (also called "rolling forward" or “rolling out”) means to buy back an option and sell another option farther out (i. e., with a later expiration date). This strategy is used to prevent the sale of a stock when its market price has risen to the option's exercise (or strike) price. STOP LOSS: An order on a transaction that limits potential loss to a designated per cent of (or dollar amount below) the sale price. STRIKE PRICE: The price at which the option holder has the right to purchase the underlying stock; also called the "exercise price". TIME VALUE: Prior to an option's maturity, its premium has time value as well as intrinsic value. The amount of time value is dependent on the time left before the option's expiration date. | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
