As a relative newbie myself I've found that selling puts to be the best way to use options. When you sell a put you receive a premium for the obligation to buy at stock at a later date for a specified strike price. Say you're thinking about buying CAT but you don't know if the price is right today. Looking at the options chain I see that you could sell a May $105 put for about .55. That put expires on Sat. so if CAT closes above $104.45 tomorrow you will be above your cost. If the stock stays above $105 the option will expire worthless and you get to keep the 55 cents. If it goes up you won't gain and more than the 55 cents and you come away without having purchased shares. I often look for puts that I can sell hoping that they will expire worthless. It's like selling an insurance contract to someone hoping that they never collect. What you need to do is look at an options chain and get your head wrapped around what happens when you either buy or sell a contract. Important: 1 contract = 100 shares !
Don't forget to mention the risk you're assuming when you take that position. It certainly isn't likely but if the stock should drop lets say $20 on some world incident or scandal you need to come up with the $2000 to unwind the position. You took the $55 premium and now have risk up to the entire value of the stock.
Think Enron, WorldCom, GM.
Make sure you understand the risks.
BBerg, not everybody on here is a rude as toothy. It seems to me that you’re asking a reasonable question as a noobie. I recommend, as toothy is in her own special way, that you do some basic reading on option strategies. I'm sure you can do a web search on call options or put options and get a wealth of information.
I'll get you started. Options are a contract to buy or sell 100 shares of a specific stock for a specific price at a specific time. Your August 110 call is the right to buy 100 shares of Caterpillar on or before 8/10 for $110. The current price of that contract is currently offered, using your info, at $3.95 per share. There is an open bid from someone else at $3.85.
So you’re going to bet that Cat will be above $113.95 by the close of the market on August 8th. The $110 you're going to spend for the stock plus the $3.95 you'll spend now for the option (plus commissions). The advantage of buying options is the leverage you get. You're buying the upside potential above $110 of 100 shares of Cat for $395 plus commission. The disadvantage is you get no gain from today's price of $105 until $113.95, and the risk is you can lose all of you investment. If Cat doesn't go above $113.95 anytime between now and 8/10 the option will expire worthless. 100% loss. The counter party keeps the $395 and moves on. The upside is you get all the gain above the $113.95. If the stock goes to $130 in July your option will be worth $25 per share plus what ever time value is left, maybe $0.50, minus the $3.95 you initially paid so maybe $22ish per share. $2200 for a $395 bet not bad but will it happen?
Purchasing a put is just the opposite, it give you the right to force someone to buy your 100 shares at a specific price on a specific day.
Take note, the majority of people that buy options, lose money. Think about it this way, there are three things a stock can do in the future. It can go up, it can go down and it can stay the same. Let's say that each alternative is equally likely. When you buy an at the money put or a call your counting on it either going up (the call) or going down (the put). If each of the three alternatives are equally likely you're taking the 33% chance of a good outcome, the seller is getting the 66% chance and your money. Now who knows what the probabilities really are but recognize for the leverage your getting you taking the weak side of the bet.
An advantage of options is you can close out your position at any time before 8/10. If Cat goes to $120 next week you can sell the call take the profit and the transaction is done. There is no obligation to keep the position open until August.
Be careful with options. Many brokers won't even let you buy or sell options without a lot of market experience. For goodness sake don't even consider selling options if you don't really understand what you're doing because you can have unlimited risk.
Hope this helps a little. I encourage you to read a bunch before you put you toe in the water.
Rich...thanks for the info. i was misunderstanding...i have done a little bit of homework and understood it as you are banking that it will be above $110 by august...not the $113.95.
I understand stocks fairly well and was just looking for another alternative to maximize gains and only became semi-interested in options in the last couple days and i'll of course do some more homework. Thank You again for the clarification!
Obviously I can't do the simple math in paragraph 3. It should read.
The upside is you get all the gain above the $113.95. If the stock goes to $130 in July your option will be worth $20 per share plus what ever time value is left, maybe $0.50, minus the $3.95 you initially paid so maybe $17ish per share. $1700 for a $395 bet not bad but will it happen?