w00t. I love puts.
What a nice profit to wake up to! On exp day as well!
Yerp! Glad I held on until the bitter end!
Just consider it another form of Chinese to decipher.
A “put” option is a right to sell a stock at a fixed price (the “strike price”) by some deadline (“expiration”). People trade (buy and/or sell) “contracts” (bundles of 100 put options) at a “premium” to cover the risk of the trade.
Example: you think that Microsoft is going to drop like a brick over the next few months. You buy a July $30 put which means that on July 18, 2008, whoever sells you the contract will be obligated to buy 100 shares of MSFT at $30. If the stock price is $30.00 or higher, your option is worth zero (and when enough options are on a stock, the options market-makers will do their utter damndest to “pin” the stock at the “max pain” price, at which their losses are minimized – I’ve seen 'em do exactly that on MSO back in early 2005). If the stock price is $20, each contract is worth $1000 ($10 * 100 puts per contract). If the stock price is $25, each contract is worth $500.
Today, MSFT closed at $33.01. July $30 puts closed at an asking price of $1.40. These are “OTM”, out of the money, as opposed to “ITM”, in the money. The “intrinsic value” on an OTM is $0 (since the stock price is greater than the strike price). The “premium” is $3.01 + $1.40 = $4.41. If you buy them at that price, Microsoft must decline at least $4.41 ($28.60) by July 18 in order for you to break even. If Microsoft ends up at $28.90, you lose a bit, but still have some money left at the end. If Microsoft ends up at $23, you make $5.60 per option, or in other words you quadruple your money, a nice 300% return (less trading costs).
Of course, between now and then, the stock price might dip and rise, causing the intrinsic value to go up and down, with the premium getting adjusted according to such factors as volatility (VIX), length of time until expiration, and stock price. You can sell at some intermediate time, or you can hold on to the bitter end. “Black-Scholes” is one popular model for calculating a reasonable price for an option.
Back to my original post. I had puts on UA. In the last week or so, UA dropped sharply.
Today was options expiration day (third Friday of every month). The stock declined $9 in one day. That means that anyone who bought ITM put option contracts yesterday made a $900 profit per option contract (less transaction fees, premiums, and so on). Someone who bought OTM puts might easily have made a 600% return overnight. I damn near did that (actually, 500%) on CROX a couple of months ago, but just couldn’t pull the trigger.
I wasn’t quite that lucky this time. I bought 'em about three or four months ago, I think, and forgot about 'em until I had to go close out my positions today. I can’t check the pricing and timing right now (I’m on a library computer at the moment, and there’s no way in hell I’m gonna type my trading account password on a public machine, especially not one running MS-Windows), but IIRC, I paid about $5 per option, and I got rid of 'em today for about $22, for a 340% return.
If I’d bet my life’s savings on that one trade, I’d be able to retire in style, but I’m not insane. So I made a good chunk of change, and I think I’ll go pick up an ASUS Eee this weekend.
With the exception of AMZN, I made money on all of my expiring puts today, and even on AMZN I didn’t lose much (for a long time, it looked like that one was going to be a zero; instead, I only lost 35% – I made some of that up on some Octobers, and counting the Aprils I’m net ahead already anyway).
Oh well. It’s been a good day.
Wow, what a great post. I can’t say I understand all of what you just explained, but it’s one of my near future goals (3 to 5 years cause I got a lot of stuff going on) to figure this stuff out enough to invest. I’ve had no financial education at all and other than just paying my bills before spending the rest, I have no idea about money management. This is something I seriously want to change.
Umm. Well, what I’m describing is options trading, not stocks. Options are a derivative of stocks. You take a stock, add a fixed price point and a direction and a time limit, and that’s basically an option.
You probably don’t want to fuck with options. They are a fantastic way to make money IN THE RIGHT SITUATION. They are also a fantastic way to go broke. Most options expire worthless, or at the very least worth considerably less than what you paid for them.
I think what prepared me best for playing with them was playing blackjack on a semi-pro team for a couple of years. Throwing $500 into a couple of betting circles, getting dealt a 16 vs. dealer blackjack, and watching it all go into the tray without even getting a chance to take a hit, then doing it over and over again – just because you’ve calculated that there’s a 3% advantage to the player at the moment – is a good way to learn the necessary attitude.
Trade stocks for a few years, play blackjack semi-professionally, find someone from the LSE who worked for the CBOE to tutor you, and then you might consider playing with options. They’re a lot more fun than blackjack, and the brokerages won’t backroom you if you’re too successful at them.
ETA: Oh yeah, a key term you used is “money management”. That’s a big part of options, and is why it would be insane to put one’s whole net worth into a single options trade, no matter how great it looks up front. If you ever get into them, do yourself a favor and read up on “Kelly betting”, sometimes called “the Kelly criterion”. Possibly the greatest lesson blackjack and statistics can teach. Hell, it’s even a good idea for stock investors.