Understanding Options

If you’ve ever wondered what “options” are, read on. Assume that you want to invest in Morse Code Telecommunications (ticker: TAPTAP). You can simply buy some shares of its stock — or you might use options, which come in two main varieties: calls and puts. Buying a call gives you the right to buy a specified number of shares at a specified price within a certain period of time (typically a few months). Puts give you the right to sell shares at a specified price within a specified period. Imagine that TAPTAP is selling for $50 per share, and you buy $6 “July $55” call options for it. You’ll pay a total of $600 for options to buy 100 shares at $55 apiece. If, just before your options expire, TAPTAP is selling for, say, $65 per share, you can exercise them and buy 100 shares for $5,500. Then you can keep them — or sell them at their current price, for $6,500. Your profit may seem to be $1,000, but you paid $600 for the options, so it’s really $400, less commissions and taxes. If TAPTAP stays at $55 or falls, your $600 would be entirely lost. You essentially bet that the stock will top $61 per share — $55 plus $6 — by July. Options are enticing because of the leverage they offer. With $1,000, you can only buy 20 shares of a $50 stock. Alternatively, that $1,000 could buy many options tied to hundreds of shares of stock. With options, if things don’t go your way in a short time frame, the options will expire worthless. Most options expire unexercised. If you’ve researched the company and believe that TAPTAP stock will rise, you’re generally best off buying its stock. You won’t have a shortterm deadline, and you can hang on until it reaches your target price. Options are not for beginning investors, and many advanced investors steer clear, too. Still, there are some lower-risk options strategies. There are also long-term “LEAPS” options that you could investigate. Learn more at fool.com/investing/options/optionsa-foolish-introduction.aspx.