Financial Markets For The Rest Of Us|
An Easy Guide To Money, Bonds, Futures, Stocks, Options, And Mutual Funds
One last point about options' risks. With options, your maximum potential loss is limited to the purchase price of the options. Therefore, while options are riskier than stocks (in most cases), your potential loss (based on the number of underlying shares) is always less than that of buying the stock, if you decided to sell your shares at the same time that the options expire.
Let's look at our 2 FAJ contracts again. You paid $400 for the right of exercising 200 shares of Ford by expiration date. If Ford's stock suddenly goes from $50 to $25 per share and never recovers until the expiration date of the FAJ contracts, you would lose your entire $400. But suppose instead of buying the contracts you had bought the 200 shares of Ford at $50 for $10,000. Now if Ford's stock dumps to $25 and you decide to sell you shares, your proceeds would be $5,000 for a loss of $5,000 - much greater than the $400 loss. Of course you don't have to sell your shares at all if you don't want to. You can keep them indefinitely hoping that maybe in a month, or a year, or a decade later the stock price would recover. With options you don't have that luxury. When the expiration date arrives, they are history.
This is enough on options basics for now. Let's get back to our options types and cover the other type, the put option.
So far we learned that a call option gives the right (but not the obligation) to the holder to buy a number of the underlying stock's shares (depending on the number of contracts) at the strike price prior to the option's expiration date. We also looked at several examples of call options as well as covered some basic concepts about options based on call options. Now it's time to look at the other style of options, the put options. The good news is that put options are just like call options …
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