Am I understanding buying options on stock correctly
Here is a quick and dirty explanation of options. In a nutshell, you pay a certain amount to buy a contract that gives you the right, but not the obligation, to buy or sell a stock at a predetermined price at some date in the future. They come in a few flavors:  I'll give you $100 if you let me buy 10,000 shares of XYZ for $10 more   per share than it is trading at today any time before   August 10th. I'll give you $100 if you promise to buy 10,000 shares of XYZ from me   for $10 less per share than it is trading at today if I ask before August 10th. There are also two main types based on the expiration behavior:  There are lots of strategies that employ options, too many to go into.  Two key uses are.. Leverage: Buying Call options can give you a much higher return on your investment than just investing in the actual stock. However, with much higher risk of losing all of your investment instead of just some of it when the stock drops. Hedging: If you already own the underlying stock, put options can be used to buy down risk of serious drops in a holding. "Options have legitimate uses as a way of hedging a bet, but in the hands of anyone but an expert they're gambling, not investing. They are EXTREMELY volatile compared to normal stocks, and are one of the best ways to lose your shirt in the stock market yet invented. How options actually work is that you're negotiating a promise that, at some future date or range of dates, they will let you purchase some specific number of shares (call), or they will let you sell them that number of shares (put), at a price specified in the option contract. The price you pay (or are paid) to obtain that contract depends on what the option's seller thinks the stock is likely to be worth when it reaches that date. (Note that if you don't already own the shares needed to back up a put option, you're promising to pay whatever it takes to buy those shares so you can sell them at the agreed upon price.) Note that by definition you're betting directly against experts, as opposed to a normal investment where you're usually trying to ride along with the experts. You are claiming that you can predict the future value of the stock better than they can, and that you will make a profit (on the difference between the value locked in by the option and the actual value at that time) which exceeds the cost of purchasing the option in the first place.  Let me say that again: the option's price will have been set based on an expert's opinion of what the stock is likely to do in that time. If they think that it's really likely to be up $10 per share when the option comes due (really unlikely for a $20 stock!!!), they will try to charge you almost $10 per share to purchase the option at the current price. ""Almost"" because you're giving them a guaranteed profit now and assuming all the risk. If they're less sure it will go up that much, you'll pay less for the option -- but again, you're giving them hard money now and betting that you can predict the probabilities better than they can. Unless you have information that the experts don't have -- in which case you're probably committing insider trading -- this is a very hard bet to win. And it can be extremely misleading, since the price during the option period may cross back and forth over the ""enough that you'll make a profit"" line many times. Until you actually commit to exercising the option or not, that's all imaginary money which may vanish the next minute. Unless you are willing and able to invest pro-level resources in this, you'd probably get better odds in Atlantic City, and definitely get better odds in Las Vegas. If you don't see the sucker at the poker table, he's sitting in your seat. And betting against the guy who designed and is running the game is usually Not a Good Idea." There is a reason why most professional option traders are sellers instead of buyers. Option sellers IMO are analogous to insurance companies that come out ahead in the long run. That is not to say if you are bullish about a stock then you should not buy it. I personally would never buy an option outright and look to reduce my cost basis by selling options around it such as:
I am very surprised no one mentioned the Stock Repair Option Strategy which has real benefits and is one of the mainstream Option Strategies. Quote: Who Should Consider Using the Stock Repair Strategy? In a nutshell, you are buying call options with current strike price (at-the-money) and sell call options with higher strike price (out-of-the-money), all with the same expiry dates.  The only reason to also sell call options here is to recover your premium paid for the other call options. If you are comfortable paying that premium, you just buy the call options without selling the others. In case your stock will rise moderately to a price between the two strike prices, your call option will rise together with your stock, so you will be faster to recover your money. This is the main reason it is called Repair. If you have sold any call options, as the price rises, you have to be careful when it reaches the strike price of the options sold, as from there on you will begin incurring losses. It is however exactly the lucky outcome you were hoping for, your stock is higher, and you can buy back those loss making options - then or shortly before. If you didn't sell any options and payed your premium, you don't need to worry at all at this stage. WARNING It should be noted that the Stock Repair Strategy offers no protection for your stock price further falling down. In that case all those options will expire worthless or you can sell back the ones your bought but likely not for much. In order to have the downside protection for your stock, there are other strategies, the simplest one being buying a Put Option at-the-money or slightly lower. That will effectively cut your possible losses to the Option Premium (which is the main use of that option).  Again, if you hate to pay that premium, you can offset it by selling other options that you either hope won't be exercised or take steps to protect you against those. The stock had quite a run-up, so it was do to fall anyway. I would want it to fall further before I start buying shares. Best Buy will be around for the long term because people still need to see and feel the merchandise as well as get some good advice from the tech nerds in the store.  Circuit City got crushed, but Best Buy is the leader and will remain so. Online Commerce is growing like crazy, but the correctly-run brick and mortar stores will always be around. I had a coworker whose stock picking skills were clearly in the 1% level. I had a few hundred shares of EMC, bought at $10. When my coworker bought at $80, I quietly sold as it spiked to $100. It then crashed, as did many high tech stocks, and my friend sold his shares close to the $4 bottom advising that the company would go under. So I backed up the truck at $5, which for me, at the time, meant 1000 shares. This was one of nearly 50 trades I made over a good 10 year period. He was loud enough to hear throughout the office, and his trades, whether buy or sell, were 100% wrong.  Individual stocks are very tough, as other posters have offered. That, combined with taking advice from those who probably had no business giving it.  For the record, I am semi-retired. Not from stock picks, but from budgeting 20% of income to savings, and being indexed (S&P) with 90% of the funds.  If there are options on your stock, you might sell calls for a few years, but that's a long term prospect. I'd sell and take my losses. Lesson learned. I hope. "To understand the VXX ETF, you need to understand VIX futures, to understand VIX futures you need to understand VIX, to understand VIX you need to understand options pricing formulas such as the ""Black Scholes"" formula Those are your prerequisites. Learn at your own pace. Short Answer: When you buy VXX you are buying the underlying are front month VIX futures. Limited by the supply of the ETF's NAV (Net Asset Value) units. It is assumed that the ETF manager is actually buying and selling more VIX front month futures to back the underlying ETF. Long Answer: Assume nobody knows what an options contract should be worth. Therefore formulas have been devised to standardize how to price an options contract. The Black-Scholes formula is widely used, one of the variables in this formula is ""Implied Volatility"", which basically accounts for the mispricing of options when the other variables (Intrinsic Value, delta, gamma, theta...) don't completely explain how much the option is worth. People are willing to pay more for options when the perception is that they will be more profitable, ""implied volatility"" tracks these changes in an option's demand, where the rest of the black-scholes formula creates a price for an option that will always be the same. Each stock in the market that also trades standardized options will have implied volatility which can be computed from the price of those options. The ""Volatility Index"" (VIX), looks at the implied volatility of MANY STOCK's options contracts. Specifically the ""implied volatility of out the money puts on the S&P 500"". If you don't know what that quoted part of the sentence means, then you have at least five other individual questions to ask before you re-read this answer and understand the relevance of these followup questions: Why would people buy out-the-money puts on the S&P 500? Why would people pay more for out-the-money puts on the S&P 500 on some days and pay less for them on other days? This is really the key to the whole puzzle. Anyway, now that we have this data, people wanted to speculate on the future value of the VIX. So VIX futures contracts began trading and with it there came a liquid market. There doesn't need to be anything physical to back a financial product anymore. A lot of people don't trade futures, retail investors have practically only heard of ""the stock market"". So one investment bank decided to make a fund that only holds VIX futures that expire within a month. (front month futures). They split that fund up into shares and listed it on the stock market, like alchemy the VXX was formed. Volatility studies are fascinating, and get way more complex than this now that the VXX ETF also has liquid options contracts trading on it too, and there are leveraged VIX ETF funds that also trade options" "Simply put, yes. I bought that call. I was betting the shares would rise in value by Jan 2018, and chose the $130 strike. With a strike nearly a year away, I paid a premium that was all time value as the shares traded at   Now the shares are replaced by $128. The time value has gone to zero, and there is no intrinsic ""in the money"" value. If the shares were bought at $140, the time value stills drops to zero, but the option is closed at $10 in the money.  My answer was for a cash deal. In a case where the old shares are replaced by new shares or a combination of shares and money, the options terms are changed to reflect the combination of new assets for old.  Update based on disclosure that it's Monsanto we are discussing.   Bayer and Monsanto have announced that they signed a definitive   agreement under which Bayer will acquire Monsanto for USD 128 per   share in an all-cash transaction. Based on Monsanto’s closing share   price on May 9, 2016, the day before Bayer’s first written proposal to   Monsanto, the offer represents a premium of 44 percent to that price.  You can see that the deal has been in the works for some time now. Further research shows they expect the deal to close by ""the end of 2017"". It's not a done deal. This is why the options are still trading.   Now the shares are replaced by $128. The time value has gone to zero, and there is no intrinsic ""in the money"" value. If the shares were bought at $140, the time value stills drops to zero, but the option is closed at $10 in the money.  My answer was for a cash deal. In a case where the old shares are replaced by new shares or a combination of shares and money, the options terms are changed to reflect the combination of new assets for old.  Update based on disclosure that it's Monsanto we are discussing.  Bayer and Monsanto have announced that they signed a definitive   agreement under which Bayer will acquire Monsanto for USD 128 per   share in an all-cash transaction. Based on Monsanto’s closing share   price on May 9, 2016, the day before Bayer’s first written proposal to   Monsanto, the offer represents a premium of 44 percent to that price. You can see that the deal has been in the works for some time now. Further research shows they expect the deal to close by ""the end of 2017"". It's not a done deal. This is why the options are still trading." "There are a number of strategies using options and shares together.  One that sells large potential upside gains to assure more consistent medium returns is to ""write covered calls"".  This fairly conservative and is a reasonable entry point into options for an individual investor. Deeper dive into covered calls" Here is the answer for #3 from my brokerage: Your math is correct. Typically, option traders never take delivery of the stock simply to then turn around and sell it at the higher price that the stock is trading at. You wold always expect the option to have a higher value that simply selling the stock at market price. There are many factors involved in options pricing and the math behind it is quite complicated, but unless it is right at expiration, the option will have a higher price than the stock itself. "Suppose the stock is $41 at expiry. The graph says I will lose money. I think I paid $37.20 for (net debit) at this price. I would make money, not lose. What am I missing? The `net debit' doesn't have anything to do with your P/L graph. Your graph is also showing your profit and loss for NOW and only one expiration. Your trade has two expirations, and I don't know which one that graph is showing. That is the ""mystery"" behind that graph. Regardless, your PUTs are mitigating your loss as you would expect, if you didn't have the put you would simply lose more money at that particular price range. If you don't like that particular range then you will have to consider a different contract. it was originally a simple covered call, I added a put to protect from stock going lower.. Your strike prices are all over the place and NBIX has a contract at every whole number.... there is nothing simple about this trade. You typically won't find an ""always profitable"" combination of options. Also, changes in volatility can distort your projects greatly."