Understanding Stocks

82 UNDERSTANDING STOCKS
You also have the right to sell before the expiration date. (Some options
double or triple within days, so it’s wise to lock in a profit.)
When you call your broker (or enter your order online), you might
say, “I would like to buy five June contracts with a strike price of $25 a
share.” Each contract is worth 100 shares of stock. In this case, Bright
Light has to rise to $25 a share or higher before the third Friday in June
for you to make a profit (although you could sell it before the expiration
date for a profit). How much will this cost you? The farther away
the expiration date, the more it costs. For example, the June contracts
might cost you $2 each. If you buy five option contracts, it will cost you
$1000 (500 shares times $2 each). The July contracts might be $4 each,
(although keep in mind that the price changes constantly during the
day). There are contracts for every month of the year.
So you buy the June contracts for Bright Light at $2 each, for a cost
of $1000. (If you bought 500 shares of Bright Light stock, it would cost
you $10,000—$20 a share times 500 shares. When you buy the option,
it costs you only $1000. So for $1000 you are controlling $10,000
worth of stock.) Let’s say Bright Light rises to $25 within a week. You
are now “at the money.” As the price of Bright Light goes higher, the
price of the option rises. You can also exercise your right to buy Bright
Light stock for $25 a share.
The downside to options is that a lot of things have to go right for
you to make money. First, if Bright Light doesn’t rise to $25 a share by
the third Friday in June, you lose the entire $1000. The option will
expire worthless; as a matter of fact, according to studies, 90 percent of
options contracts expire worthless. After commissions and taxes, most
individuals don’t make a dime trading options.
Instead of buying a call option, you could always buy a put option.
In this case, you are anticipating that the price of the stock will go
down, not up. During the recent long bear market, people who bought
and sold put options cleaned up, assuming that they sold before the
expiration date.
The options game is a tough one to win. To make money on
options, you have to be right about both the timing and the price direction
of the underlying stock. If you’re wrong on either count, you will
lose your entire investment. However, if you are still fascinated by
options and want to learn more, there are dozens of option strategies.