Options Trading Tutorial

Trading out stock options vs. exercising options?

My question is what is the difference between trading out a stock option and exercising an option. Do you need capital when trading out an option as you do when exercising them? Also, is there really any difference between trading out an option and buying the stock and selling/shorting it for a profit? So when you "trade out" the option, do you need to capital to do so, or are you just selling the contract. Guess what I am wondering is, can you make money on options without having a bunch of cash to back the exercising of them? So when you "trade out" the option, do you need to capital to do so, or are you just selling the contract. Guess what I am wondering is, can you make money on options without having a bunch of cash to back the exercising of them?

Public Comments

1. Well I think I understand your question so here goes: On an American Option (one in which you can exercise before expiry) when you trade out the option you should just get a cash settlement where as if you exercise the option you will have to face the bid ask spread in the market. EX. Say you will exercise a long call: you exercise the option to buy at 20$. So you buy. Then you go into the market and sell at $25. You lose money by taking that into the market because the broker who handles that transaction is taking you on the spread. If you short your position on the option, however, you will make the difference in the value of that option and not risk the bid-ask spread exposure. You DO need capital to exercise them. otherwise how would you buy the 600 underlying shares at 20$ each?? There is a huge difference b/w stocks and options. Options - you pay for a contract which gives you the obligations to transact. You do not own anything. a Pro is that you can control thousands of shares for a fraction of the price. Stocks - you buy and your stuck with them. Con - You do not have as much leverage as you do with options. there are numerous models on the web that will show you the magnification that options will do to your winnings.
2. Well here is my explanation of stock options/renting shares and how I've come to understand them. Essentially, you buy shares when they are trading at a low price, and then sell the right to buy the shares (if they increase in value to a pre-determined amount, by a pre-determined date) to a third party. You are paid an upfront figure for each share, which you get to keep. Example being that if you wanted to rent out your 1000 shares at the current call option of 40 cents each then you will be paid $400 up front by the company "renting" your shares. This $400.00 is yours to keep the only catch is they can be sold by the third party if the shares go up to the agreed price then they have the right to buy out your shares or exercise them - so this amount will be predetermined by you and the third party before you proceed. So within a period of a month you have received the $400.00 up front plus your capital gain on those shares, if they went up $1.00 then you have made yourself $1400.00 in that one month. If they don't reach the pre-determined amount, you keep the shares and can put them back on the option market. The other option is you sign a contract with a company saying you will buy 1000 shares if they fall to $10.00. The company pays you upfront for each share you agree to buy based on the put option chart which lets say is 50 cents per share, then if the shares do drop to $10.00 you are obliged to buy them. So you have now been paid $500.00 you buy the shares and now option them out and basing ourselves on the above mentioned figures you have made $900.00 and only just bought these shares....Not bad! In saying that if the shares never drop to $10.00 in that month then you have been paid $500.00 for something you will never buy. There is a whole book and DVD dedicated to this strategy that you can get for free - http://www.free-dvd.com.au
3. I enjoy buying and selling options as a secondary source of my income. I'm mainly a premium seller, meaning I like to capture time decay. This can be done a number of ways but the most common was is use Iron Condors which are two credit spreads. Most of the time you can get 5-10% return a month with this strategy. You can risk as little as $100