Roland,
Been reading this thread since the beginning, wish someone could explain calls / puts for me easily.. I have option account opened on sharebuilder and want to play with $30K in ROTH IRA, but not really confident to buy/sell puts/calls. I short buy/sell stocks often, but really want to do covered calls, sell puts, etc. Any simple language to understand this stuff enough to start trading them?
I'd advise against entering in an option trading strategy without good knowledge of financial mathematics, but to sum it up:
Options will give their buyer the opportunity to buy(Call)/sell(Put) a certain stock at a certain price until (american style) a certain date. Some options (European style) can only be exercised on their last day, while others can only be exercised on some pre-determined days (Bermudian style). Most (or all) options you are likely to encounter are american-style.
Call : If you buy a call option, you are buying the right to buy that stock at the option's strike price until the expiration date.
If ABC's stock is at $110 and I hold a call option with a strike price of 100$, I can make a profit of 10$ immediately (Or hold the call and hope the stock's price gets higher before the expiration).
If the price was <=100$ at expiration, the call would expire worthless, as it would give you no advantage.
If you sell a call, it means that someone will have the opportunity to buy a certain stock from you at the strike price if and when they choose to exercise it.
Selling a covered call means that you hold the underlying stock or an option with a lower strike price. You would essentially be selling some upside potential of your stock for some immediate money.
As an example :
I own 100 shares of ABC, currently worth 100$. In my opinion (or investment strategy), I plan the stock to gain 5% over the next 6 months. I could sell 100 calls with a strike price of 105$ for (let's say) 1$ a piece. This would give me 100$ immediately, which I could use to buy more ABC shares or whatever else.
With a covered call strategy, you get to keep any dividends until exercise, the options premium and either the 100 shares (if the option was unexercised) or 100*Strike Price (if the option was exercised). All of this combined can make for a rather interesting income. This reduces the variance of your results, but limits your upside potential. As a result, it may be impossible for you to buy back your initial 100 shares if the stock happens to have gotten a lot higher.
Before actually getting into it, however, I definitely recommend an assessment of your math skills. Are you comfortable with differential equations? Can you master the maths of options pricing? Because if you can't, there are quants on Wall Street who can't wait to have you in the market.
Don't take it lightly. You'd still probably make money, because of the nature of the trade, but may inadvertantly limit you upside potential too much.