Inspired by this article on CNN, I’d like to ask about this special day.
What exactly is “the quarterly expiration of stock options and futures and index options and futures”? I’m not up on stock market lingo, and while I sort of kind of know what an option is, I don’t know about option expirations.
Could someone clue this market noob in? Thanks!!
An option is a contract allowing me to buy (or sell) a fixed quantity of a fixed stock from_/to someone at a fixed price. For example, I might pay you $1,000, in return you grant me to sell me 200 shares of X Corporation for $50 each at a fixed date if I wish to buy them.
If X stocks are at $55 each, I make a profit of $5 on each one, yielding $1,000 to me, minus the $1,000 I paid for the option, I break even. If the stocks are higher than $55, I make a profit (at your cost, of course, since you have to deliver me stocks for a price that’s lower than they are currently worth), if less, I lose money. It basically is a bet in which you bet on falling stock prices while I suspect them to rise. Frequently the actual stocks aren’t actually exchanged, you would simply pay me the difference between stock price and our fixed price.
Apparently, the markets have a certain preference for certain days to choose as the decicive dates. In the example above, I might try to influence the stock prices of X Corporation, eg by buying large quantities of them so my profit increases. If many others do so simultaneously, the price might rise not because the company is doing well but because many have been speculating on it.
So basically, when I grant you the stocks to sell, I don’t hand you the actual stocks, I just agree to pay you the difference after the specified date (assuming that the stocks rise in value and I lose the bet).
I guess the part that confuses me is . . . well, what happens to the stocks themselves? Is it that I’d have to pay another $1000 to buy them under the terms of the options agreement and thus lose $1000?
If so, I understand. I’m not paying you the first $1,000 for the stocks themselves (That would be an ordinary stock transfer). I’m paying you for the option to buy them at a later date at the $50 per share. Whether they happen to sell for $60 or $40 on the day of reckoning makes no difference. The first payment is for the option and the second payment is for the stocks themselves.
Assuming I’ve got the first part, then my next question is: Who sets the dates of expiration. Is it a stock market authority, or is it tradition?
Danke, Schnitte. This market stuff is like MS Access. It seems sooooo simple, until you actually have to think about it.
Yes. Big banks permanently issue “warrants” - standardized option certificates that include such a deal. By buying such a warrant you’re purchasing a right to buy/sell* a stock at a fixed price at a fixed date. The terms of contract of those warrants usually specify that the bank won’t deliver you the stock but it will simply pay you the difference if the stock happens to rise.
If X stocks, in our example, happen to drop below the $50 mark in our example, I surely would not want buy them as specified in our contract, and I don’t have to - after all, I only purchased the right to buy them, if I wish, not the duty to do so. In this case I would not exercise the right I purchased, and the initial $1,000 payment is lost. You’ve won the bet. The terms of a warrant would specify that in this case the warrant is worthless, and the money you paid for it is gone to the bank.
Warrants and options that specify non-physical delivery, but simply payment of the difference, can also have interest rates, indexes or whatever as underlying commodity instead of stock.
Yep, that’s right.
The initial payment can be very low compared to the volume of the option deal itself - that’s why you can win (or lose) plenty of money with relatively little initial stake. This is called the leverage.
I don’t know about that, sorry. Probably someone else will jump in soon.
[sub]* If it’s the right to buy, the warrant is called a “call”, if it’s the right to sell, the warrant is a “put.”[/sub]