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Russell's Ramblings  
 

Russell Rhoads
The Options Institute at CBOE

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Think You've Never Traded Options?

The terms "derivatives" and "option contracts" refer to financial instruments that sometimes strike fear in the mind of the average investor. The result is that many people never even consider using a call or put option in their personal trading or investment plans. However, many of these individuals probably have already been involved in an option trade without even realizing it.

Any sort of non-refundable deposit may be considered an option. One of my favorite examples is the personal seat license that our favorite sports team likes to sell after winning a championship or opening a new stadium. For a mere (and I'm being generous) $1,000 payment, you will now have the right to purchase a season ticket in the same spot for the next 10 years. Of course, the season ticket will also have a cost associated with it. What you are getting with this personal seat license is a right to buy season tickets, not an obligation. If you decide you don't like the new head coach or the team takes a nose dive in their performance, you have the right to pass on purchasing tickets in the future. Also, if you want, you can sell your right to another fan who wants tickets.

With some small differences, a call option on a stock functions very much in the same way. An investor purchases a call option and now has the right to buy a stock in the future. Not an obligation, just a right. The price that the call buyer will pay for the shares is set in stone, but the right to buy shares will expire. With season tickets, the price of the tickets may (probably will) change over the life of your right to buy tickets, but there is a date after which this right expires. Just like the seat license, you can choose to sell an option at any time until expiration.

Any sort of non-refundable deposit is like a call option. You pay for the right to purchase a product in the future. With a call option, you pay for the right to buy a stock in the future. So, you think you have never been involved in an option trade? Think again ...

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