What Is An 'Option'?
So what is an 'Option' anyway?
Years ago I had an options trading mentor who was this old grizzled guy from Chicago.
When I first met him, he came across quite intimidating and even a bit scary on the surface.
But after I got to know him, he turned out to be one of the sweetest and nicest guys around.
Like a big lovable teddy bear - with a heart of pure gold.
Anyway, one of the things I loved so much about him was his ability to take potentially complex ideas and explain them in a way that was super easy and simple to understand.
For example, the way he explained ‘options’.
Here’s what he would say…
Think of an option like it’s a ‘coupon’.
For example, let’s say that...
Once upon a time a guy named Frank lived in a fictional place called ‘Options Land’, and he was thinking about buying a ‘widget’.
Now he wasn’t quite ready to purchase one today - but he knew that there was a very good chance that within the next 60 days he might need to buy one.
AND - he really liked the price that widgets were currently going for - and even though he wasn’t quite ready to buy one right now - he would love to have the opportunity to lock one in at todays price.
So what should he do?
Well, he should go over to the ‘Coupon Store’ and BUY a ‘WIDGET COUPON’ - which would allow him to ‘lock in’ todays widget price for the next 60 days.
And once he bought that coupon - he would be guaranteed the right to buy a widget at todays price at any time he wanted over the next 60 days.
Here’s how it would work -
Let's say that todays current price for a widget is $100.00
And Frank can lock in that price for the next 60 days by buying a coupon for $10.00.
So Frank goes ahead and buys that coupon for 10 bucks.
Now, let’s say that over the next 60 days, the price of widgets skyrocket - and they go up to over $1,000.00 per widget.
Well, thankfully, Frank bought that coupon for $10.00.
Because if it turns out that he really does want to buy a widget within the next 60 days - he can simply go and turn in his coupon and buy a widget for just $100.00 instead of the going rate of $1,000.00 - saving a significant amount of money.
So good thing he bought that coupon!
But let’s say that at the end of 60 days, Frank decided that he didn’t want to buy a widget after all. Things happened, and as it turned out, he just didn’t need one.
Well, all is not lost.
Not by a long shot -
Because - since the price of widgets have gone up so much - Frank COULD simply sell his COUPON to someone else who DOES want a widget - and that person will gladly pay Frank a lot of money for a coupon that will allow THEM to buy a widget for just $100.00 bucks.
So in this scenario, Frank wins either way.
He can either buy a widget for himself at a significant discount -
Or - he can simply sell the coupon to someone else for a big profit.
Either way Frank wins...
But now, lets look at scenario where after Frank buys the coupon, the price of widgets don't really move much at all.
In fact, let’s say that the price of widgets stay exactly the same.
So in this scenario, at the end of 60 days, Frank could just go out on the open market and buy a widget for $100.00.
So the coupon he bought doesn’t really do him any good.
In fact, it cost him a little bit of money - $10.00 - the price he spent to purchase the coupon.
But, even though it cost him $10 bucks, it DID provide him with some ‘piece of mind’ during that 60 day period - knowing that if the price of widgets did go up - he would be able to purchase one at a lower cost...
Now, lets look at a scenario where the price of widgets DROP after Frank bought the $10.00 coupon.
In this scenario, let’s say that the price of widgets CRASH - and at the end of 60 days widgets are going for just $50.00 a pop.
Well, in this case, since the coupon gives Frank the right to buy a widget at $100.00 - the coupon is worthless to him since he can just go out on the open market and buy one for half of that - $50.00.
So in this case, Frank lost $10.00 - the cost of the coupon.
However - just like the previous scenario, the coupon DID provide him with some ‘piece of mind’ during that 60 day period - knowing that if the price of widgets did move up - he would be able to purchase one at a lower cost.
AND - the other important thing to consider - is that if Frank had initially bought a ‘real widget’ for $100.00 instead of just the coupon for $10.00 - right now he would be sitting on a much bigger loss.
For example, if Frank had purchased a real widget for $100.00 - and the price dropped down to $50.00 - Frank would have a loss of $50.00.
However, since he instead purchased the coupon for just $10.00 - he’s only lost that $10.00 instead of the $50.00.
So in this scenario, even though Frank might be disappointed that he lost $10.00 on the coupon - he is thankful that he only lost $10.00 rather than the $50.00 he would have lost if he had instead purchased the real widget itself.
Anyway, OPTIONS work very much in the same way.
In the stock market, OPTIONS are like the ‘Coupon’ - and the ‘Widgets’ are the STOCK.
Most stocks in the stock market have ‘options’ (coupons) - which can allow you to do very much the same thing Frank did with his ‘widget coupon’.
For example, if you were thinking about taking a position in stock XYZ - but for any number or reasons didn’t want to buy the actual shares -
You could instead buy an OPTION (coupon) on stock XYZ - for much less money than it would cost you to buy the actual shares - while STILL HAVING THE SAME SORT OF CONTROL of the stock (widget) - very much like Frank had with the 'widget coupon' in the story above.
PLUS - there are additional and WAY ‘cooler' ways to use options - including our FAVORITE way to use them - which allows us to safely and simply churn out and generate a steady stream of consistent income - spending just a few minutes every month.
And that is what we'll be getting into in our next lessons...
So be sure to stay tuned - keep your eye out for our next email - and we'll see you next time.