Stock Learning

Basic Strategies

The versatility of options stems from the variety of strategies available to the investor. Some of the more basic uses of options are explained in the following examples.
For purposes of illustration, commission and transaction costs, tax considerations and the costs involved in margin accounts have been omitted from the examples. These factors will affect a strategy’s potential outcome, so always check with your broker and tax advisor before entering into any of these strategies. The following examples also assume that all options are American-style and, therefore, can be exercised at any time before expiration. In all of the following examples, the premiums used are felt to be reasonable but, in reality, will not necessarily exist at or prior to expiration for a similar option.

Buying Calls

A call option contract gives its holder the right to buy a specified number of shares of the underlying stock at the given strike price on or before the expiration date of the contract.

1. Buying calls to participate in upward price movements

Buying an XYZ July 50 call option gives you the right to purchase 100 shares of XYZ common stock at a cost of $50 per share at any time before the option expires in July. The right to buy stock at a fixed price becomes more valuable as the price of the underlying stock increases.
Assume that the price of the underlying shares was $50 at the time you bought your option and the premium you paid was $3.50 (or $350). If the price of XYZ stock climbs to $55 before your option expires and the premium rises to $5.50, you have two choices in disposing of your in-the-money option:

The following article summarizes several of the psychological pitfalls that interfere with accurate pattern recognition. My hope is that traders can focus on these three “vices” as mental preparation prior to entering the markets. One of the best ways of becoming an observer to your negative behavioral patterns - rather than a trader lost in those patterns - is to periodically take your emotional temperature. That means standing back and asking yourself: Am I falling prey to one of the vices below? Remember, observing and interrupting your patterns are the first steps in altering them! Your patterns lose control over you as you become better at not identifying with them. When you become an observer to your patterns, you are separating yourself from them. What great progress that is!


Vice Number One: PERFECTIONISM

Perfectionism is often the chief culprit when the pain of losing exceeds the pleasure of winning. Desperately trying to feel good about themselves, perfectionists set unrealistically high ideals. They think they will finally be OK if they just accomplish X. (For X, you could substitute many things, including looks, wealth, popularity, or achievement). Because X is an unattainable goal, perfectionists ironically use their ideals as a basis for self-criticism when their performance doesn’t match up. After all, is achieving X will make me OK, then I must not be OK if I fail to achieve X. The emotional theme of the perfectionist is “not good enough”.