Irwan’s

We have reach the 3rd series of Anatomy of Investment. Click here for the index page of Anatomy of Invesment. Today we will talk about the path less traveled by fellow investors. I planned to write about Forwards, futures and options but it’s too much and hard to understand information even to myself. However, from my preminilary reading, these three are closely related to each other. I decided to write about options first in this 3rd series. However, options are the derivation of Forwards and Futures. I thought understanding about options will make Forwards and Futures easier to learn.

Options, as its names suggest, give the buyers the option to buy or sell stock (or other instruments) at certain price in the future.

• Options that give buyers the right to sell is called Puts.
• Options that give buyers the right to buy is called Calls.

I will explain deeper about the option in buyers (aka speculators) point of view:

Put: Options that give buyers the right to sell

• A trader who buy puts have the right to sell stock at a fix priced (usually lower than current price)
• This trader is expecting the price will go down.
• Let say the trader bought a put to sell Irwan Sdn Bhd at RM9 a share, the current price is RM10. RM1 for premium. If the price go down as he expected say, RM8 , he then would buy the stock at the current price (RM8) and sell the stock to the party that sold him the puts with the fix priced (RM9)
• The puts seller have to buy the stock with fixed price no matter how low the current price is.
• If the price didn’t go down as expected, the trader don’t have the obligation to finish the puts. He just let it expired. What he lost is just the premium price he paid (RM1) to buy the put.

Call: Options that give buyers the right to buy

• It’s completely opposite with the puts.
• A trader who buy calls have the right to buy stock at a fix priced (usually higher than current price)
• This trader is expecting the price will go down.
• Let say the trader bought a call to buy Velo Sdn Bhd at RM55 a share, the current price is RM50. RM5 for premium. If the current price hike up as he expected say, RM60 , he then would buy the stock from the party that sold him the Calls at the fixed price (RM55) and sell the stock to the open market at RM60. He profits RM10 for the transaction. Minus the premium RM5, the net profit is RM5 per share.
• The calls seller have to sell the stock with the fixed price no matter how high the current price is.
• If the price didn’t go up as expected, the trader don’t have the obligation to finish the call. He just let it expired. What he lost is just the premium price he paid to buy the calls.

I hope you get the core meaning of the option.

But why there are options in the world of business?

The core function of options is to switch the risk between parties. The call/put sellers want to avoid the market volatility that would disrupt their business. The buyers, often called as speculators, would buy the puts/calls in attempts to gain profits by predicting the future price.

This last chapter concludes the the AoF for tonite. I will go to Kuala Lumpur on Sunday, that may disrupt the posting schedule for this series. Please bear with me will ya… see you

Source: wikipedia