What are options?
David Marotta: Options are the ability to buy stock or sell stock that you don’t really have. So, for example you might buy the option of buying stock at some price. But you haven’t really bought the stock itself. You just have an option to buy the stock at a given price. If the stock price then goes up in value, you exercise your option, buy it at that price, and sell it at the new value. If the stock doesn’t go up in value, you just let your option expire.
Buying an option to buy stock at a certain price is much less expensive that buying a stock itself. So, it mainly cost you a few dollars of share to buy the option, it might cause you $50.00 of share to buy the stock. So, what’s your getting is you’re getting all of the upside potential on a stock, but you’re not getting any of the downside risk but you’re paying dearly for it. You’re paying a couple of percent on the stock for it.
Similarly, you can sell a stock you don’t own. What you sell is you sell someone else the option of buying the stock at this price. Now, if the stock goes up in value, you have to buy the stock and give it to them at that price because you don’t really own the stock. But if the stock goes down in value, then you’ve made money because you sold them the option to buy at this—you sold the stock at this price and you haven’t delivered it so you can buy it at this price and then deliver it to them back at that price.
So options are a way of—they’re also called derivatives and they are a way of trading not on the market themselves but on the movements of the markets themselves. So, if you’re familiar with math and you remember your calculus, the first derivative was how much the curve moved rather than the curve it self. And so derivatives are which direction is the stock market is moving, and so you can sell short and if you think the stock is going down and you can sell options if you think the stock is going up.
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