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Option trading

MatthewMatthew
edited April 2007 in Investing
Synthetik/Eleua/all

Can you guys give me a quick explanation of shorting stocks and the difference between puts/calls? Can you give me an example of how you guys are executing these trades with your brokers? The online references I have seen are complicated and I don't want to screw up any transactions. Can you guys also tell me what housing entities will be good to short in the near future? Thanks.

Comments

  • aylesayles
    Good luck, I do not believe there is short answer to applying these strategies... 20 credits of upper level finance, derivitives, and risk management at your local university should do the trick.

    Here are some good graphs that explain the strategies a bit. This is definitely not all of them. Buyers/sellers of calls have unlimited upside/downside risk as the asset price increases. Buyers/sellers of puts have upside/downside risk limited to the spot price of the asset (less the premium).

    http://en.wikipedia.org/wiki/Stock_option

    The Black Sholes model is also a good way to evaluate the pricing of the position. (correct me if i'm wrong) that is how i recall it...
  • AlanAlan
    Real estate can also be a hedge against inflation. One alternative to the housing bubble is that inflation is much higher than reported and the market is responding accordingly.

    If the dollar does lose 90% of its value over the next ten years, then that $600k loan becomes a $60k loan in today's dollars.

    Mexico occassionally devalues its currency. Rumors are that the officials in the know take out huge loans in Mexican Pesos, convert the loan to USD, then pay the loan back after the devaluation.
  • synthetiksynthetik
    This is true but I highly doubt it's going to take 10 years. When this unwinds, it'll probably happen quickly.

    Instead of doing something dumb like getting a home loan, invest in PM's, then convert them back into dollars after the crash and buy real estate for LESS than pennies on the dollar.

    Cash is likely to be king, but not so much if you had it in the stock market or in a bank. if you didn't have your money in dollars (you had it in gold or maybe some offshore mining companies) you should be very rich. Who knows what will happen.
  • EleuaEleua
    Alan,

    Your scenario of housing being a hedge against inflation needs some modification.

    Yes, if the US peso loses 90%, you will be paying back the bank at 10 cents on the dollar.

    Question: Will your earnings keep pace with inflation, or will you be earning 10 cents on the dollar?

    If your earnings don't track inflation (as they now are not), but internationally traded commodities do, you will have less money left over to devote to housing. While this is no big deal to your situation, if you ever try to sell, your buyer will find that he doesn't have the money to devote to PITI, and you can lose both ways on real estate.
  • EleuaEleua
    Here are some good graphs that explain the strategies a bit. This is definitely not all of them. Buyers/sellers of calls have unlimited upside/downside risk as the asset price increases. Buyers/sellers of puts have upside/downside risk limited to the spot price of the asset (less the premium).

    Not true.

    Calls are an insurance policy against a stock rising in value.
    Puts are an insurance policy against a stock falling in value.

    Writers (sellers) of either puts or calls are taking the position of the insurance company.

    Buyers of either puts or calls are taking the position of the insured.

    It is true that the writer of a call is exposing himself to unlimited liability. The writer of a put is exposing himself to liability which is limited to the strike price.

    The buyer of either a put or call is only exposing himself to the risk of losing his premium.
  • EleuaEleua
    With PUT options you are also expecting the value of the stock to go down, however you have to be correct in not only the direction, but timing.

    I would only add one thing to this...magnitude.

    When you "short," you have to be correct on direction only.

    When you buy a put, you have to be correct on direction, timing, and magnitude.

    By magnitude, I mean "how far will it move?"

    Example: If you have some June $20 strike puts on Crapstock.com, and you also hold the June $17.50, one can be right and the other wrong.

    If CRAP drops from $23/share to $18/share by the June expiration, you got the direction correct, and the timing. You were correct on magnitude on your $20s, but wrong on your $17.50s.

    You got paid on your $20s, but your $17.50s went to put heaven.

    Options are quite simple, dangerous, and lucrative. One thing I can guarantee is that you will never be bored when trading options.

    It is death by 1000 cuts most of the time. However, when you get paid, it is like pulling off the "Brinks Job."
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