Papale’s Market Pep Talk

Opening weekend.  Every year millions of football fans look forward to this weekend.  Right now every team is undefeated and holding up high hopes for the season.  Maybe some higher than others.  Either way it ushers in a long standing tradition of Sunday afternoons with friends and food.  So if you’re watching the game this weekend good luck to your home team or fantasy team.  Playoffs are only 16 weeks away.

Options are derivative instruments.  That means they get derive their value from some underlying instrument, like a stock or future or commodity.  And most of us know they can be used for leverage, speculation and hedging.  But one of the great things about options is they can allow us mere mortals to make money even when we are wrong about what we think the underlying will do.  Let’s face it, if we knew for sure what an underlying was going to do, we would back the truck up and buy as many options as we could.

Buying options pays off big if we are right.  The problem is if we are wrong – and that means missing on both price move and when the move will happen – we can lose most or all of the value of an option.  For those of us that can’t rely on our crystal ball or are just a bit more risk averse, selling options allows us to make a profit, albeit usually smaller, even when the market behaves differently than we predicted.

For example MSFT is trading around $45.  The October 44 puts are trading around $0.50.  That means I can make $0.50 if MSFT goes up, stays flat or even drops a bit.  In fact I break even if MSFT drops to $43.50 (strike less premium collected).  The point is even if we are a bit wrong in our stock prediction, we can still make some money by strategically selling options.  Maybe not as sexy as buying tons of calls and making 500% in a month but its tried and true and is much more forgiving of stocks that don’t do what they are supposed to do.

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