August 17, 2022

Money

So, you are eager to get rich and your search led you here. Keep reading.

I put all of this together when educating myself to be able to read the book "The Big Short" by Michael Lewis. I should also read his book "Liars Poker", and maybe watch the movies based on these books.

Ultimately this is all about the surprising things that go on on Wall Street.

Options

Here we are talking about calls and puts. We may also get to talking about long and short, but hold that thought for a while. These are generally called "options", but may also be called "derivatives".

A call option is a contract you buy. You buy the contract, not the item. The contract expires at some specified time and gives you the option to buy some thing at a price specified in the contract. It is up to you whether you want to exercise the option or not. If you don't, you are out whatever you paid for the option, but that is it.

Note that the amount you pay for the option does not apply to the purchase, if the call option is actually exercise. In other words the option cost is not a "down payment" as is sometimes stated.

In the US, you can exercise the option at any time. Apparently in Europe you must make your decision on the expiration date.

The price specified in the contract is called the "strike price". The current market price is called the "spot price". There is no end of jargon in this game. Note that people sometimes talk about the "option spot price" which is how much it currently costs to buy the option, not the underlying security. As you might expect, there is room for confusion unless you pay close attention. The cost of the option is sometimes called the "premium", which makes things clearer.

The person buying a call, expects the price to rise. You have a contract to buy at a strike price below spot, so you can buy at that lower price and sell on the market to make money.

The person selling the call expects the price to fall. If it does, the buyer of the call will just walk away and they pocket the premium. They won't want to buy at a price above spot and then need to sell at a loss on the market.

A put option is a contract to sell rather than buy at a given price, again called the "strike" price'. This requires a buyer willing to commit to buying something at a contracted price. Once again, the option need not be exercised.

A person buying a put expects the price of whatever it is to fall. If the price falls and they can buy as much of the thing at the current spot price (below the strike price in their contract) then they have a buyer commited to buy it and they make money.

A person selling a put expect the price to rise. What they hope to do is to pocket the money paid them for the put option and never have to buy at the lower strike price (the seller whould then have to be selling at below the current spot price). The sane seller will just walk away from the option.

Bulls and Bears

A bull market is a market where prices are on the rise and investor confidence is high.

A bear market is a time of trouble, recession, or depression. Prices are falling, confidence is low, investors want to sell and run for cover.

Bears are sellers and bulls are buyers.

The terms "buyers market" or "sellers market" are sometimes used in connection with bear or bull markets, but in what I have found to be conflicting ways. To my thinking, a buyers market is where supply exceeds demand, prices are thus low, and if a buyer can't get the deal he wants, he can move right along to the next seller. I would expect that in a "bear market" with lots of sellers eager to sell and bail out as they expect prices to continue to plummet.

Long and Short

These terms seem to be used in a variety of different ways.


Have any comments? Questions? Drop me a line!

Tom's Money pages / tom@mmto.org