Understanding Stock Options
Module 1: Option Basics
Lesson 3: Understanding Stock Options
Understanding Stock Options
Employee Stock Options
As an employee understanding stock options can buy quite the task. Usually when they are offered to you they don't come with an instruction manual.
The kind of stock options I'm referring to are employee stock options. When you mention stock option investing most people assume you are talking about employee stock options.
**When I refer to stock options trading on this site I'm not referring to employee stock options. The nature of employee stock options is such that you cannot trade them. The stock options must be converted into stock.**
Employee stock options are when an employer gives its employee the right to buy a specific number of shares of the company's stock for a given period of time and at a price that the employer specifies.
Unless the company goes out of business or the stock doesn't perform well, offering stock options is a good way to motivate workers to accept jobs and stay on.
It's a form of delayed gratification. It is hoped that the stock share price will go up so that the employee can exercise their options and then sell the stock at a higher price.
If you're working for a company whose stock price is trading for $30 and you have purchased several employee stock options that grant you the right to buy the stock at $5, you might think twice about leaving the company and losing out on such a great deal.
Understanding Stock Options
Vs.
Trading Stocks
Stock option investing can provide someone with a small sum of money the chance to earn a high return on that money. This allows them to build up their investment account quicker.
Not many people have $30,000 laying around that they can invest in stocks, but most can find $90.
At the time of this writing the stock price for Apple Inc. just closed at $99.72. So if you wanted to buy one share of Apple computer it would cost you $99.72, plus commissions.
Let's say that one year later the stock has gone up in value by 10%. You would have made roughly $10 on your $99 investment.
Now earning 10% return on your money is great, but waiting a whole year just to earn $10 sucks!
Everyone knows the more money you invest in stocks the more money you can make. Now let's see how the same $90 can be used with stock option investing...
Stock Option Investing if
You Don't Have Much Money
I'll show you a $90 option trade that I just closed out. Looking at each of the blue arrows lets go over this trade. The symbol is "HUM" which is the stock symbol for Humana Inc.
Using my trading tools I saw that a potential trade was on the horizon. The stock looked like it was about to take off in price. I bought "2" contracts of a Feb 2009 45 Call option for $.45. You will learn more about call options in lesson 6, but essentially you buy call options when you think the stock is going to rise.
Now that you all know the definition of a stock option what rights did I purchase with this Call option?
Yes, it means I bought the right, but not the obligation, to buy (Call option) 200 shares (2 contracts) of Humana Inc. for the price of $.45 on or before February of 2009.
**If you are confused and are still having a hard time understanding stock options then go back to the previous lesson, and review it again.**
I paid $90 for these contracts. If you recall 1 option contract = 100 shares of stock. So you always multiply the options quoted price by 100 ($.45*100 shares=$45).
I bought 2 contracts ($45 * 2= $90). If this confuses you don't worry, we will get into how options are priced in another lesson. Just know I paid $90 for these 2 contracts.
Let's see how this trade turned out:
I closed the trade roughly 15 days after I entered it. The options went up in value to $1.65, or $165. I bought two contracts so that means $330 ($165 *2) was put back into my account. Remember though I only invested $90 on this trade. Let's see how much money I made.
$330 - $90 = $240 profit or 267% return on my money. Not bad for 15 days and only spending $90.
So this goes to show that you don't need a great deal of money to make a decent return on your money. Now I can't retire on $240 but 267% return on your investment is still 267%.
I hope this goes to show why stock option investing is so appealing. Stock options are one of the best investment vehicles I have ever learned about!
Disclaimer: this is a very high risk trade; hence the reason I only invested $90. These returns don't happen often, but they do happen nonetheless. The purpose of the example was to show you that you don't really need a large sum of money to make decent investment returns.
Are You Interested in
Stock Option Investing?
I hope by now I have at least convinced you to learn about stock option investing. It's not for everyone, but I do feel that everyone should at least learn about them.
Understanding stock options takes time, so don't feel rushed. The stock market and the earning potential of stock option investing will still be here when you're ready to trade with real money.
Now let's move on to "Lesson 4: Stock Options Trading".
Module Instructions: According to how the site is set up, you are now in Module 1: Lesson 3 (Understanding Stock Options). For the most effective learning experience, read through each lesson in this module one by one, in the exact same order as they are listed in the table of contents to the left.
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