This article was contributed by “Vayama.” a regular contributor to“Topstocks.

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Put and Call Options.

Put options are like insurance.

example, http://www.asx.com.au/asx/markets/searchOptionPrices.do?method=searchByUnderlyingCode&underlyingCode=bhp&selectedYearMonth=&optionType=P

BHP put options.

Go to the last one. Expires on 28/06/12, costs $9.565 and gives you the right to sell your BHP shares anytime up to the expiry date for $48. So anytime time BHP falls below $39.50, you have protected your investment and are in the black. If at 28/06/12 a BHP share is worth over $48 then your put option becomes worthless because it is cheaper to sell on market.

Another example, BHPWM. Expires on 29/01/09, costs $ 12.405 and gives you the right to sell your BHP shares anytime up to the expiry date for $58. Currently the BHP price is $46.70. Together the option and share will cost you $59.10.

So if the BHP price reaches $58 on 29/01/09, you have paid $1.10 a share to protect your $46.70 in capital and will have made nil profit on 29/01/09. So anytime time BHP falls below $46.70, you have protected your investment and are in the black.

If at 29/01/09 a BHP share is worth over $58 then your put option becomes worthless because it is cheaper to sell on market.

In general, put options are most useful for those who purchase shares to gain dividends. BHP pays a small dividend so the put option cost is not really worth it in comparison to a bank stock.

Put options can be traded. For example, if you think the share price has peaked, you can buy put options. It is another way to short a stock.

Example, $58 BHP put option is worth $12.40 today when BHP is $46.70. The differential is $11.30. If the BHP share price falls to $40 then the price of the put options will grow to around $19 because people can buy an option to sell BHP for $58 when it is trading on market at $40. Thus when BHP falls from $46.70 to $40 which is by 14%, the put options appreciates in price by 58%.

I remember when WBC was $31 and I wanted to buy some put options at 75 cents however I was gutless. Today WBC is $22 and those put options are worth $8.50. I would have made a profit of 1013%.

CALL OPTIONS.

Call options are not ‘insurance’ but I will discuss them.

call options are the opposite of put options. they give you the right to buy a share for a certain price.

One trades or invests in call options if they think the share price will go up…

Example, WBC share price is currently $22.50..

WBC announces profit in October and is ex-dividend around 10/11/08

I can buy a $22.00 WBC call option today expiring on 27/11/08 for $2.65.

If WBC share price is $26 prior to ex-dividend, my call option will be worth $26 - $22 = around $4. I make a 51% gain on my $2.65 investment.

If WBC is worth $21 prior to ex-dividend, my call option will be worthless because it is cheaper to buy on market.



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