by John Lansing 09/09/08
WHAT CAN HAPPEN TO A LONG OPTION POSITION?
When you buy an option, the underlying stock can do one of three things.
More Trading Ideas
1. It can go in the direction you believe it is going to go. (A long call option becomes profitable when the stock trades up to, and through, the strike price; a long put option becomes profitable when the stock drops down through the strike price.) When the stock crosses the strike price in your favor, that makes the trade in-the-money. The deeper the in-the-money the option, the higher your potential returns.
2. It can trade in the opposite direction. If this happens, you may lose the full value of your investment if the stock doesn't change direction during the life of your trade.
3. The stock enters a holding pattern. If the stock trades relatively flat, your option could expire worthless, thanks to decreasing value due to time loss. (This is for options that are trading out-of-the-money; if the option is in-the-money, there is value by closing the option position or by exercising it.)
In some instances, the option may lose value even if the underlying stock is going in the direction you hoped it would. This is because the value of the time loss exceeds any increase in the value of the option due to changing stock prices.
This is where stocks and options diverge significantly. Where stocks will still hold some value in neutral and declining markets -- barring any dramatic events specific to the individual company -- options can lose much or all of their value.
Bryan Perry
Use Option Collars to Button Up Gains
If one of your stock has made some significant gains, a collar is an option strategy that can help you preserve your profits and protect you in case the shares take a tumble.
Exchange-traded funds (ETFs) are turning into the 'next big thing' in many investment circles.
Take Options Profits in STRIDES
Learn about a type of hybrid security that is structured like a bond and matures in a fairly short time frame, and even pays dividends.
Build Your Own ETF with Options
If you're finding it tough to grind out profits in the current trading environment, consider this strategy: Create your own ETF with options from stocks in hot sectors.
You don't have to buy the same number of contracts with every options trade you make, especially when trading the options of higher-dollar stocks.
