Hello,
I’m hoping someone can explain how options work because it seems very confusing. I’ve been trying to wrap my head around it but there is a lot to wrap around. For example, how would a person make money off of selling puts? How do premiums work? Why is it better to buy a 30-day, $100 call option on a $95 stock than it is to buy a 30-day $96 call option? Would the buying it at $96 make for better profit? How does margin trading work and how does one increase their buying power using margin trading?
Thanks in advance for your help in understanding this topic.
In: Economics
>For example, how would a person make money off of selling puts?
You buy put options (which is a guarantee to sell a limited number of shares at a certain price, for a limited time.) Imagine you buy 100 $5 put options. The market price for the stock drops to $4. Even though the price is $4, you have a guarantee to be able to sell them at $5. So you buy 100 shares off the market for $400, and sell them for $500, making $100 minus the premium.
> How do premiums work?
The premium is simply the price of a option. Nobody’s going to give you a guarantee to buy things or sell things at a certain price for free. You have to pay for it. You might imagine you paid 50 cents each for the $5 puts, or $50 total since you bought 100 of them. Your total profit is $100-$50=$50.
The two most important factors in determining the premium is the volatility of the stock (since a more volatile stock is more likely to jump above the call price or below the put price) and the expiration time of an option (since a stock is more likely to go up or down in 2 years than 2 weeks)
It’s worth nothing that many entities which buy options do not intend to make profit from them. They buy them as insurance, to control risk. When an entity has call or put options, they have a guarantee that no matter what happens, they can buy or sell shares for a certain price.
> Why is it better to buy a 30-day, $100 call option on a $95 stock than it is to buy a 30-day $96 call option? Would the buying it at $96 make for better profit?
Simple. It might be better because the premium is cheaper. The $96 call option is obviously better if they were the same price. But they won’t be the same price.
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