Financial Markets Book Financial Markets For The Rest Of Us
An Easy Guide To Money, Bonds, Futures, Stocks, Options, And Mutual Funds
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by Robert Hashemian

Page 299

that Ford's stock is at $50, you can deduce that FMJ is at the money. FMI is $5 out of the money while FML is $10 in the money. If Ford's stock moves up to $55, then FMJ will be $5 out of the money while FMK will become at the money.

Put options, just like call options, are subject to time decay whereby they lose more of their time value as they get closer to their expiration dates. The loss in time value follows the same downward curve as that of call options, translating into a faster loss of value as the expiration days gets nearer. The risk/reward factors also work the same way for put options as they do for call options. Short time to expiration, too far out of the money, low-priced underlying stock, and low-volatility underlying stock are all conditions which introduce more risk in put options. Riskier put options have lower premiums associated with them and they have a higher probability of expiring worthless. However if they happen to be timed just right, they could have huge returns. For example with Ford trading at $50, if you buy 10 FMH contracts strike price $40, with 20 days to go at $1/8 premium for a total of $125, and Ford happens to plunge to $25 the next day, your contracts would then be $15 in the money plus perhaps $1 in time value for a total premium of $16. Selling all 10 contracts, your proceeds would be $3,200 for a whopping return of 2,460%! Of course chances are that Ford will never drop by that much, or it may even go higher than $50, in which case your options would eventually expire worthless and you will lose your $125 investment. Risk/reward ratio at work.

I am not going to belabor put options. Again, all of the concepts we covered for call options apply to put options. They are a bit intimidating at first and take some getting used to. The reason should be obvious. Most of us have been trained to believe that rising stock prices equates to profits and therefore are a good thing.With shorting stocks and now put options, we have to shift from that paradigm and


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    Table of Contents Copyright and Disclaimer Foreword Money
    Bonds Futures Stocks Options
    Mutual Funds Retirement Final Words Appendix A
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