Options 101

Vertical axis – payoff
Horizontal axis – share price

WHAT ON EARTH IS THAT?!
That ladies and gentlemen, is what we call a payoff diagram. Remember it well.
In case you’re wondering what Long, Short, Call and Put means….well…..(phew, this is gonna be a long day)

Here are some useful terminologies :
Long – to buy

Short – to sell

Call – a contract whereby the buyer has the option but not the obligation to purchase the underlying asset at the contracted price (exercise price) anytime before the expiry of the contract (American Option).

Put – a contract whereby the buyer has the option but not the obligation to sell the underlying asset at the contracted price anytime before the expiry of the contract.

Expiry – maturity of the contract

Exercise price – the contracted price that is agreed between the buyer and seller.

Underlying asset - It can be anything from, company shares, to commodities, and to even the weather!

American Options & European Options – most options are categorized into these 2 forms. Basically an American Option allows the option buyer to exercise his right anytime between the initiation of the contract to the expiry of the contract. On the other hand, European Options will only allow the option buyer to exercise his rights at the option contract expiry date.


So what exactly do I mean when I say, “I just did a transaction whereby I long an American call on 1000 Rolls Royce shares at an exercise price of 6 dollars expiring in August’07”?

Any takers?

Well, it means that I just bought the right to purchase 1000 Rolls Royce shares for the price of 6 dollars anytime from now till the expiry of the contract, which is in August 2007.

Here’s another Example:

“I just short an European call on 1000 Royal Bank of Scotland shares at an exercise price of 5 dollars expiring in September ‘07”

What does all this mumbo jumbo mean?
As a seller of a call option, I am now obligated to sell to the call option buyer, 1000 Royal Bank of Scotland shares at 5 dollars at the expiry date of the contract in September’07, IF he decides to exercise his rights (note – option is only exercisable on expiry because its an European option)

Now, I’m pretty sure all this is pretty confusing especially to those new to options. So I’ll leave it here for now and allow you lot to reflect on all these new terminologies.

In my next entry, I shall be explaining the payoff diagram.

And after that, we shall explore the trading strategy which I mentioned in my first entry.

(Coming up next – Options 102)

Lets Try Something Different

The last eight months has been phenomenal for the stock market. Just by investing in the local KLCI index, an average investor would have easily made a 50% capital gain return. Now that is impressive even by Warren Buffets’ standard, who averaged 23% return p.a. over his entire career.

So while the stock market basks in celebration in the longest economic boom the world has ever experienced, I shall present to you an alternative form of investment – Options. It would seem illogical for anyone at this current point of time, to be interested in this derivative form of investment, considering the Bull Run in the stock market. So why bother introducing it? The reason, plain and simple…..an extra bit of information never hurts anyone. (or was it the other way around?)

Contrary to the belief by many that Options are limited to institutional and sophisticated investors like hedge funds, Options are actually very much accessible even to an average individual. Theoretically, no amount of capital is required to start-off your options trading (save for the margin requirements).

Now, for benefit of those who haven’t got the slightest clue what I’m talking about thus far, and to those who have heard of options, but need a refresher course, I shall go through the basics options in the first part of my blog entry. And once that is out of way, I shall share with you a trading strategy that is utilized by many, that has the ‘potential’ of generating consistent return over a long period of time.

And to make things a little bit more interesting. I shall be using actual prices from the market to show you how this strategy is carried out. And you shall be the judge on the feasibility of this trading strategy.

(Coming up next – Options 101)

when it comes to creativity...

old blog of mine.

Blogging is nothing new, nor it is something extraordinary. Yet, the impact it is making to this world is fabulous.

That leads to the talk of "globalisation".

The world hasn't changed its size, yet what we observe is that the distance between you and me, has become shorter. No matter where you are, as long as there's phone line and internet access, we are not that far apart after all.

"globalisation" makes things easier, it also leads to the disruption of the natural law of economics. there used to be an era when things got expensive, demands will fall and thus price will fall. Yet, in today's context, this seems to be abit obsolete. The emergence of the oriental dragon and the south asian mammoth have created a world with new economic rules. What suppose to be going up continue to stay low, and what suppose to be coming down, continue to be up and rising. What has gone wrong?

This should be exciting because this is a brand new era that we're observing. 200 years down the road, our great great grand children will be referring to this era as the "globalizing era" or perhaps some other more fascinating terms. This is similar to the time when the europeans learnt about sailing and start doing world trades. Now, we're doing world manufacturing, world marketing and of course, a global trades.

so, what happen when it comes to creativity? In today's context, it's hard to survive if we still follow the traditional way in doing things. Why would you be writing articles for local newspaper by paying 30cents postage fees while you can choose to post a blog on line / write an article for online magazine for zero costs and with unlimited exposure? now even you and i can be a columnist on line, even you and i can do business with merely zero cost by starting a e-business. Therefore with abit of creativity, we can spot the next opportunity in this ever-changing world and make a fortune out of it.

we're observing the globalizing trend in the world that we're living in today, yet the fortunate thing is that it has just begun and might take a century or more to complete the progress. The utopia of globalization is when we're only using one currency in trading, where the oriental dragon is the only one manufacturing, the south asian mammoth is answering all your phone enquiries, the pisa leaning tower and eiffels are making the food for the world & etc etc. so before everything converges, there are opportunities for us to exploit this arbitrage. This mean that you can do something with lower price, and sell it to other continents at a higher price, thus, reap the margins and help globalizing.

when it comes to creativity, it is time for us to spot what our competitive edge is, and be able to fully utilise it, before the G-Day arrived.

Happy reading and will be back for more.

Change of Perception

Remembering not too long ago, the financial market was pricing in a possible "rate cut" by the U.S. Fed. Well, growth seems to be slowing down, inflation remain benign, housing sector woes were developing into a 'crisis' etc etc. Thus, equity and bond markets were both rallying and guess alot people out there have made some handsome profits for the last few months.

But is growth really slowing down? i am not too sure, neither does the global investing community, mainly because the "confirming numbers" are not out yet.

Nonetheless, the markets were "moving ahead of themselves" where we see huge foreign inflows flooding Asian markets, pricing in a rate cut anytime soon by the Fed. As a result, KLCI went up 23% year-to-date, while Malaysia's bond yields have dipped below its overnight rate. Crazy indeed.

The market trades on expectation. So the market priced in (i.e. BET) that the US growth was going to slow down, inflation will be kept low, housing market will go bust etc etc... However, after few months and nothing has materialised yet!

and out of a sudden, (not really that dramatic, but what da heck) US growth number published was rather resilient and employment data was still ok. Analysts out there were shouting for a possible spike up in the inflation numbers, and in turn, both market went into a technical correction last week. It is a "technical correction" because the markets were just correcting to the level that goes in line with the "revised expectation". A change of perception.

Due to the flushed liquidity in the system, coupled with the positive few good factors on global front, both bond and equity markets were positively correlated for the last few months. Both move up and down together, which is not what the financial text book has taught us.

The inversion of US yield curve (usually signify a recession) few months ago was deemed as "not telling the true story" as the "conundrum story" of excess global savings is the main culprit causing the inversion, but not the slowing economy.

Yet, at our own backyard, Malaysia's bond yield curve has been inverted for quite some time, and i believe that this time around, it is trying to tell us something...