1/ Options 101 - Call Options
Over the last few months, with the rise of Robinhood and the day trading boom, options trading has been featured prominently in the news (for better or for worse).
But what is an option and how does it work?
Here’s Options 101 - Call Options!
Over the last few months, with the rise of Robinhood and the day trading boom, options trading has been featured prominently in the news (for better or for worse).
But what is an option and how does it work?
Here’s Options 101 - Call Options!
2/ In simple terms, an option is a contract.
It gives the buyer the right, but not the obligation, to buy (a “call”) or sell (a “put”) an asset.
It specifies the price at which the asset can be bought or sold (“strike”) as well as a date this must occur before (“expiration”).
It gives the buyer the right, but not the obligation, to buy (a “call”) or sell (a “put”) an asset.
It specifies the price at which the asset can be bought or sold (“strike”) as well as a date this must occur before (“expiration”).
3/ The buyer of the option has to pay to have that right to buy or sell. The “premium” is the price they pay for the option.
Let’s use a simple example to illustrate how this works. In this thread, we will cover the call option.
(Don’t worry, Bears, I’ll cover the put soon!)
Let’s use a simple example to illustrate how this works. In this thread, we will cover the call option.
(Don’t worry, Bears, I’ll cover the put soon!)
4/ Imagine you are in the market for a new house.
You find the perfect one in a town nearby. You hear the town may get a nice new mall, so housing prices may rise quickly.
Paul, the house’s owner, wants $1M for it. You don’t have that kind of money today, but you will soon.
You find the perfect one in a town nearby. You hear the town may get a nice new mall, so housing prices may rise quickly.
Paul, the house’s owner, wants $1M for it. You don’t have that kind of money today, but you will soon.
5/ You don’t want Paul to put the house on the market. You worry someone else will snatch it up!
So you offer Paul a deal.
You’ll pay him $50K today for the right to buy the house for $1M before December 31.
Paul agrees to the deal.
So you offer Paul a deal.
You’ll pay him $50K today for the right to buy the house for $1M before December 31.
Paul agrees to the deal.
6/ Congratulations, you just bought a call option!
Strike = $1M
Expiration = December 31
Premium = $50K
One of two scenarios now plays out:
1️⃣ - Mall Built = 🏠 Prices ⬆️
2️⃣ - Mall Not Built = 🏠 Prices ⬇️
Strike = $1M
Expiration = December 31
Premium = $50K
One of two scenarios now plays out:
1️⃣ - Mall Built = 🏠 Prices ⬆️
2️⃣ - Mall Not Built = 🏠 Prices ⬇️
7/ In scenario 1, you “exercise” your option to buy the house for $1M. You are happy. The house is worth $1.2M now and you got it for $1M (plus the $50K option premium).
In scenario 2, you don’t exercise. The house is now only worth $900K. You’re only out the $50K, so it’s ok.
In scenario 2, you don’t exercise. The house is now only worth $900K. You’re only out the $50K, so it’s ok.
8/ So you were effectively in control of a $1M house for only $50K.
There are more nuances to this - selling/writing, pricing dynamics - but we can save those for 102 and 103!
I hope this was a helpful primer!
Stay tuned for part 2 of Options 101, where I’ll cover put options.
There are more nuances to this - selling/writing, pricing dynamics - but we can save those for 102 and 103!
I hope this was a helpful primer!
Stay tuned for part 2 of Options 101, where I’ll cover put options.
