US8229840B2 - Short-term option trading system - Google Patents

This is trading on the options exchange

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Trading options is very different from trading stocks because options have distinct characteristics from stocks. Investors need to take the time to understand the terminology and concepts involved with options before trading them. Options are financial derivatives, meaning that they derive their value from the underlying security or stock.

US8229840B2 - Short-term option trading system - Google Patents

Options give the buyer the right, but not the obligation, to buy or sell the underlying stock at a pre-determined price. Options have a cost associated with them, called a premium, and an expiration date.

A call option is profitable when the strike price is below the stock's market price since the trader can buy the stock at a lower price.

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A put option is profitable when the strike is higher than the stock's market price since the trader can sell the stock at a higher price. Understanding Stock Options Trading Trading stocks can be compared to gambling in a casino : You're betting against the house, so if all the customers have an this is trading on the options exchange string of luck, they could all win.

Trading options is more like betting on horses at the racetrack: Each person bets against all the other people there.

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The track simply takes a small cut for providing the facilities. So trading options, like betting at the horse track, is a zero-sum game. The option buyer's gain is the option seller's loss and vice versa. One important difference between stocks and options is that stocks give you a small piece of ownership in a company, while options are just contracts that give you the right to buy or sell the stock at a specific price by a specific date.

It's important to remember that there are always two sides to every option transaction: a buyer and a seller. In other words, for every option purchased, there's always someone else selling it.

The strike price may be set by reference to the spot price market price of the underlying security or commodity on the day an option is taken out, or it may be fixed at a discount or at a premium. The seller has the corresponding obligation to fulfill the transaction i. An option that conveys to the owner the right to buy at a specific price is referred to as a call ; an option that conveys the right of the owner to sell at a specific price is referred to as a put. The seller may grant an option to a buyer as part of another transaction, such as a share issue or as part of an employee incentive scheme, otherwise a buyer would pay a premium to the seller for the option. A call option would normally be exercised only when the strike price is below the market value of the underlying asset, while a put option would normally be exercised only when the strike price is above the market value.

Types of Options The two types of options are calls and puts. When you buy a call optionyou have the right, but not the obligation, to purchase a stock at a set price, called the strike priceany time before the option expires. When you buy a put optionyou have the right, but not the obligation, to sell a stock at this is trading on the options exchange strike price any time before the expiration date.

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This is known as writing an option, and it explains one of the main sources of options since neither the associated company nor the options exchange issues the options. When you write a put, you may be obligated to buy shares at the strike price any time before expiration.

Most exchange-traded options are American style, and all stock options are American style.

  • The previously unknown values of the option are assigned at the time or after the time the trade is completed.
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Many index options are European style. The buyer of an option can't lose more than the initial premium paid for the contract, no matter what happens to the underlying security. So the risk to the buyer is never more than the amount paid for the option.

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The profit potential, on the other hand, is theoretically unlimited. In return for the premium received from the buyer, the seller of an option assumes the risk of having to deliver if a call option or taking delivery if a put option of the shares of the stock.

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Unless that option is covered by another option or a position in the underlying stock, the seller's loss can be open-ended, meaning the seller can lose much more than the original premium received. Please note that options are not available at just any price. Also, only strike prices within a reasonable range around the current stock price are generally traded.

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Far in- or out-of-the-money options might not be available. Option Profitability When the strike price of a call option is above the current price of the stock, the call is not profitable or out-of-the-money.

In other words, an investor is not going to buy a stock at a higher price the strike than the current market price of the stock. When the call option strike price is below the stock's price, it's considered in-the-money since the investor can buy the stock for a lower price than in the current market.

Getting Acquainted With Options Trading

Put options are the exact opposite. They're considered out-of-the-money when the strike price is below the stock price since an investor wouldn't sell the stock at a lower price the strike than in the market.

Put options are in-the-money when the strike price is above the stock price since investors can sell the stock at the higher strike price than the market price of the stock. Expiration Dates All stock options expire on a certain date, called the expiration date. For normal listed options, this can be up to nine months from the date the options are first listed for trading.

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Longer-term option contracts, called long-term equity anticipation securities LEAPSare also available on many stocks. These can have expiration dates up to three years from the listing date. Monthly options expire on the third Friday of the expiration month, while weekly options expire on each of the other Fridays in a month.

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A stock option contract entitles the owner of the contract to shares of the underlying stock upon expiration.