When I refer to time value and intrinsic value remember that they are simply components of the total premium price. An option contract has only one price but it is instructive to examine the two components of that price: intrinsic value and time value.
Apple Inc. (AAPL) Option Chain - Stock Puts & Calls
The Foolish bottom line
Options aren't terribly difficult to understand. Calls are the right to buy, and puts are the right to sell. For every buyer of an option, there's a corresponding seller. Different option users may be employing different strategies, or perhaps they're flat-out gambling. But you probably don't really care -- all you're interested in is how to use them appropriately in your own portfolio.
Option Types: Calls & Puts
Scenario 6: If Clorox stock takes a beating over the next few months and falls to $65 per share, you&rsquo re protected. You can exercise your put option and still sell your shares for $75 each even though the stock is trading at a significantly lower price. And if you feel confident that Clorox stock will recover, you could hold onto your stock and simply resell your put option, which will surely have gone up in price given the dive that Clorox stock has taken.
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Understanding Options Risk &ndash How to Trade Options
Time Isn&rsquo t Necessarily On Your Side
Prices Can Move Very Quickly
Losses Can Be Subtantial on Naked Short Positions
Other Common Pitfalls
My mission is to educate everyday people on the deep, strategic underpinnings of the stock markets, and exploit that knowledge with the use of OPTIONS. THERE IS NOTHING RANDOM about the markets. There are surprises all the time, but there's always a method behind every madness. And my goal is to get you to this point of understanding and awareness. That's when it starts to fit in.
If the stock is at $9 then the price of the option contract might be 55 cents (so $55 per contract, since again each contract represents the right to buy 655 shares). If the stock is at $6 it should make intuitive sense that the right to buy at $65 would be quite a bit less, pricing again determined by the market.
In fact, because the time value of an option is usually decaying, you must constantly reassess whether you think the stock will move in your favor, and move fast enough, to outweigh the time decay that will occur in the contract over time (the ways in which volatility or lack of volatility can bloat or reduce time value of premiums is beyond the scope of this tutorial).
Implied Volatility is the "wildcard" in Option prices. Ignore it, and you will pay a price. In fact, it's so important we have at least four different varieties - Volatility, Implied Volatility, Historical Volatility, and Future or Expected Volatility. We use the real-world examples to explain the concept of Volatility in simple terms. Then we study how Volatility is quantified in Stocks and Options. And how Volatility finds a back-door to embed itself into Option prices. Implied Volatility considerations are critical when choosing between a buyer and seller profile. We break this complex topic down into simple terms and show you an example of NFLX and CAT options that should make it absolutely clear what this is all about.
Note that tradable options essentially amount to contracts between two parties. The companies whose securities underlie the option contracts are themselves not involved in the transactions, and cash flows between the various parties in the market. In any option trade, the counterparty may be another investor, or perhaps a market maker (a type of middle man offering to both buy and sell a particular security in the hopes of making a profit on the differing bid/ask prices).