I have some basic fundamental queries about trading options. I would be very grateful if anyone could confirm my understanding and/or point me in the right direction.
1. Say a stock is at $520, and I buy a put at $520 for $21.85, and the share price falls soon after to $519. Is my unrealised gain 100*$1 - $21.85 ? Or in english, the option contract size multiplied by the share price difference minus the cost of buying the option (ignoring fees)
2. If I find myself in a profitable situation with an option, how do I convert my position in to money in my account? I figure I have the ability to either sell the option back to the options market or exercise the option any time prior to expiration?
3. If I were to exercise the put option, what are the actual mechanics of how this works? Do I need to physically own the stock before exercising? Same for call options, will I need to physically take ownership of the stock? Just in case it makes a difference in the answer, I'll be trading through a retail broker (say, MB Trading).
Any pointers appreciated!
Last edited by phabian; October 23rd, 2013 at 10:55 AM.
1) No not quite. The cost of your put is not 21.85 but $2185 in the above example. You would need to find out from your trading platform what the cost of the option would be selling for at 519 (this will change with volatility and time decay) and then subtract the two and multiply by 100.
2) Correct, if you bought a single option or have a complex debit spread you would sell it, if you sold an option or sold a credit spread you would buy it back, the difference less commissions is your profit. At expiration if the position is in the money the option (only for equities) will be automatically exercised. But always check your brokers procedures here. Also there are American style and European style options, the former can be exercised anytime prior to expiration the latter only on the last trading day.
3) No you don't need to own the stock before exercising a put option....in this case you will get a short stock position. For a call you will get a long stock position. The you can immediately buy it or sell it or keep it.
Since you bought the 520 Put and the Stock fell to 519 a Share, you have a Gain of 1x 100= $100 Instrinsic Value.
You did not mention what month as this will come into play, as you will have to add what time value the Options Model has Calculated for this 520 Strike.
An Option controls 100 shares...hence $1 gain times 100 or $1 x 100=$100 for the Instrinsic value/In the Money value plus time value that depends on Option Model that calculates this such as Black Scholes.
So you have Instrinsic and Time Values that determine the Options Strike Value at any given time.
I suggest you watch Live Quotes and the Underlying Instrument/Stock to see how the Different Strikes behave, and also read a bit more on Valuation of Option Prices so you better understand.
Paper Trade Chart set ups with your Different Option Strikes.
Last edited by sandptrader; October 23rd, 2013 at 06:43 PM.
As the above poster said, it depends on the delta, as well as the theta. Here is a great link that will work out all of your P&L for you. I use it before I enter a position to see what profit I will have when an underlying security reaches a certain point.