LET’S TALK OPTIONS

I like options. I normally trade in equities; nevertheless, I like options. I will briefly explain the good and bad of option trading. The bad side of an option is that options expire. The good side is, not nearly, as much money is needed to trade options. December 23rd Microsoft (MSFT) ended the day valued at $36.58. If I purchased 1000 shares of MSFT it would require an output of $36,580.00 plus commission. With most companies, I could purchase MSFT on margin, but that is another topic and one I do not recommend. Let us look at what I could do with an option on MSFT.

The January 35 option last price was $1.96. Options trade in contracts and one contract is normally 100 shares, thus 1000 shares of MSFT would be 10 contracts. If I purchase 10 contracts of MSFT and control 1000 shares, my outlay would be $1960. plus commission and fees. To make this easier to understand I am going to change the price of MSFT to an even number. Let us assume MSFT is trading at $35. Now my investment would be an even $35,000. If during the coming month before MSFT options expire, MSFT goes up in value to $45 we would make $10,000 profit on our trade. If instead of buying the equity, we bought the $35 January call option at $1.96 our investment would have been $1960. If the equity increased to a value of $45 per share, our option would have increased in value at least $10 per share as well. We can purchase the stock at $35 per share by exercising our option, or we can sell the option at the higher value and take the $10 selling price for the option.

Let us now look at the percentages involved in these transactions. If we purchased the equity at $35 per share, our risk is $35,000. However, the risk is not as great because MSFT is not likely to go down in value to $0.00. If we bought the option, our risk would be $1960 and we could lose that amount of money if the equity should go down in value. However, $1960 is the maximum risk of loss.

Here are the percentages:

______ Purchase Price Sale Price__Profit____Percentage

Equity price:..$35............ $45.............. $10 ........28.571%
1000 Shares .$35,000 .......$45,000 .........$10,000 ....28.571%
10 $35 calls ..$1960 .........$10,000 .........$8040 ......410%

The risk with the option trade is if the stock drops enough, your options may be worthless when they expire on the third Friday of January. In reality, I would not expect MSFT to increase $10 in that month although it has happened. I would think a $5 increase would be a reasonable expectation if I have done my research. The point I am trying to show is the percentages involved in the two types of trades. If you trade equities on MSFT and the equity increases in value by $10, you make a profit of $10 per share but if you have traded in call options your investment is a small fraction of what you would have invested in equity trades but the profit would have been equal. Percentage wise, the options trade would have been considerably more valuable.

Please be advised the above scenarios are intended as examples only and should not be construed as actual prices. Their intention is solely to relate possibilities in trading options, and how we can view these types of trades.