David John MarottaDavid John Marotta is the President of Marotta Wealth Management, a fee-only financial planning and asset management firm in Charlottesville, Virginia. He is an oft-quoted writer and speaker on financial matters and his weekly financial column can be found at www.eMarotta.com
Host: What are Options?
David Marotta: Options are the ability to buy stock or sell stock that you don t really have. So, for example, you might buy the option of buying stock at some price, but you haven t really bought the stock itself. You just have an option to buy the stock at a given price. If the stock price then goes up in value, you exercise your option, buy it at that price and sell it at the new value. If a stock doesn t go up in value, you just let your option expire. Buying an option to buy stock at a certain price is much less expensive then buying the stock itself. So, it mainly costs you a few dollars of share to buy the option. It might cost you $50 a share to buy the stock. So, what you are getting is you are getting all of the upside potential on a stock but you are not getting and of the downside risk, but you are paying dearly for it. You are paying a couple of percent on the stock for it. Similarly, you can sell a stock you don t own. What you sell is you sell someone else the option of buying the stock at this price. Now, if the stock goes up in value, you have to buy the stock and give it to them at that price, because you don t really own the stock, but if the stock goes down in value, then you have made money because you sold them the option to buy at this, you sold the stock at this price and you haven t delivered it, so you can buy it at this price and then deliver it to them back at that price.
So, options are a way, they are also called derivatives and there a way of trading, not on the markets themselves, but on the movements of the markets themselves. So, if you are familiar with math and you remember your calculus, the first derivative was how much the curve moved in and rather than the curve itself. So, derivatives are a way which direction the stock market is moving and so you can sell assured and if you think the stock is going down and you can sell options, if you think the stock is going up.