Professional money managers have long used options as a hedge against unforeseen price swings in the stocks that they hold.  The dotcom boom and successive bull markets drew many individual investors into options trading, and due largely to good fortune and timing, many of those investors realized substantial returns. The members of the 6th Avenue Team in New York appreciate the benefits that options can contribute to a well-developed wealth management plan. We incorporate options into individual plans only when the plan’s goals coincide with the benefits and risks that options present to an investor. Before we recommend options or any other investment asset, we verify that our investors understand the products that we select for their consideration.

 

The Two Basic Types of Options

There are two basic types of options: puts and calls.

Put options give an investor the right to sell an asset at a set price. An investor who believes that the price of a security will go down might utilize a put option to sell the stock at a set price that is above the lower price that the security’s ultimate lower price. The spread between the security’s ultimate lower price and the put option price is the investor’s profit.

 Call options allow an investor to purchase an asset at a set price. If the ultimate market price of the asset exceeds the call option’s purchase price, the investor’s profit is the difference between the two prices.

 

Beyond Puts and Calls: Options Terminology

Like many other investment products, options and option trading have their own jargon and terminology:

·       An option’s strike price is the set purchase or sale price of the option’s underlying asset. An investor that has purchased an option to buy shares of a stock at $5.00 per share, for example, will pay that amount regardless of whether the market price of the stock is higher.

·       The expiration date is the final date on which an investor can exercise purchase or sale rights under an option. The option loses all value of the investor has not done anything with it before the expiration date.

·       An option’s premium is the difference between the option’s strike price and the underlying asset’s market price. The trading price of the option tracks the premium, and an option will be deemed to be in-the-money or out-of-the-money as a function of whether the premium is positive or negative.

  • American style options allow an investor to purchase the underlying asset any time before the expiration date, whereas European style options allow the investor to purchase the asset only on the option’s expiration date. 

  • The types of stock options that are available to be components in an investor’s portfolio are limited only by the creativity of the investment banks and other entities that create and underwrite options in the first instance. Investors can currently select from:

    ·       Exchange-traded and over-the-counter options;

    ·       Options on stocks, indexes, foreign currencies, commodities, and futures contracts;

    ·       Exchange traded fund (ETF) options;

    ·       Options with either short or long-term expiration dates;

    ·       Cash settled options;

    ·       Exotic options, including barrier, binary, chooser, compound, and look-back options.

    Investors need to remember that all options are deemed to carry a higher degree of risk than investments in the securities that underlie the option itself..

     

    Option traders can buy or sell to open, or buy or sell to close. Buying an option to open is considered a bullish strategy as it envisions that the price of the underlying security will increase above the option’s strike price. Alternately, selling to open is bearish because it reflects a belief that the security’s price will go down. An options trader will not necessarily own the underlying security when selling to open. Rather, that investor will either enter a buy to close order as the option’s expiration date approaches. Likewise, an investor will use a sell to close order to cover a prior buy to open order. 

     

    The financial consultants on the 6th Avenue Team at Ingalls & Snyder, LLC in midtown Manhattan start every client relationship with an in-depth analysis of the client’s wealth management goals. When we have developed a plan that reflects an investor’s unique individual goals, we recommend a slate of investment products that serve those goals. If options are deemed to be appropriate for the client, we provide a thorough explanation of how options fit into the overall investment strategy of the client.

    We serve the financial management needs of high net worth individuals, institutions, and not-for-profit organizations. Please see our website or call our New York offices for more information about the types of options that an investor might include in a portfolio, and to schedule an appointment with one of our investment professionals.

     

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