Options and Their Role in Increasing Equilibrium

Investors, both big and small, are attracted to stock options because of four factors -- absolute risk, the ability to play both directions of a market, the opportunity to buy time, and very high leverage (Mackevich, 1984). While all are significant, the most important is leverage. For a small amount of money, stock options investors can control hundreds of shares of stock, and their profits are leveraged accordingly -as is their risk, of course. Yet, when the market is moving rapidly in either direction, such investors count their gains in thousands of percentage points.

For such gains, the options investor pays a price in increased risk. While timing is important in standard stock transactions, it can be the key for options holders (Mackevich, 1984). While options allow the investor to buy time, this feature means he or she is also playing against a clock. However, because the options investor is buying time -- locking in a purchase or sale price of a specific stock for up to nine months -- options offer small and big investors alike an equal opportunity to fine tune their investments.

Investors can also profit with options from a relatively small investments, and with them, one can play either direction of the market with equal success (Mackevich, 1984). For many investors, the most appealing feature of options is predetermined, absolute risk. Such investors know, from the start, exactly how much mone

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at any time before the Friday preceding the third Saturday of July. (Most brokers require that they be notified before that option is exercised.) An XYZ/July/90 'put' would allow the buyer to sell a hundred shares of XYZ for $90 per share any time before the Friday preceding the third Saturday of July. For any given stock, there might be trading in a number of puts and calls with identical strike prices but different expiration dates, or the reverse (Mackevich, 1984). For example, at any given time, there can be XYZ 90 calls and puts offered for July, October, and January any time after April. At the same time, there can also be XYZ/July/80 calls, or XYZ/July/70s, or XYZ/July/100s, all offered simultaneously. The reason for this is that additional options with higher or lower exercise prices are introduced when a significant change occurs in the market price of the underlying stock. Considering all the combinations of exercise prices and expiration dates, it is not uncommon for a dozen or more options to be traded on the stock of a single company at any one time, especially if the company is a large, major one (Mackevich, 1984). Also, an individual investor may choose to write (sell) call or put options depending on their a

Category: Economics - O