Options: Now for Everyone
Know the rules of the road before starting the engine.
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Like politics and religion, options are not a safe topic for conversation in polite company. Entrenched beliefs, misconceptions and different agendas tend to cloud the discussion. The battle lines are usually drawn along the subject of risk, both real and perceived.
As someone who writes an options column, I belong to the camp that believes options are a valuable investment tool that, when properly utilized, can both boost returns and reduce risk.
That said, I acknowledge the validity of many of the arguments made against options. Perhaps pointing out the most common pitfalls, rather than proselytizing on the benefits, is the best approach to bring some evenhandedness to the subject.
As with any tool, before using options, make sure you are familiar with the basic rules and guidelines that govern their behavior.
For starters, make sure you know the contract specifications the product you are trading. Items such as margin requirements (pay special attention to leverage), the exercise and settlement procedures, and what strikes and expirations are currently listed for trading are important to know and can easily be found at exchange websites such as this page on Chicago Board of Options Exchange.
For example, you should be aware that index options, such as for those on the S&P 500 or SPX, can only be exercised on expiration day and are cash settled; also note that SPX options actually cease trading on the third Thursday of the month, a day earlier than equity options, though they officially expire on the third Saturday.
By contrast, equity options, including those on the Spyder Trust (SPY), can be exercised at any time during the life of the contract. This is especially important when trading options on stocks that pay dividends.
Dealing in Dividends
If you own in-the-money calls on Exxon (XOM) make sure you know when the ex-dividend date occurs -- you will need to exercise your calls if you want to qualify for the payment. Likewise, if you are short an in-the-money call on a dividend-paying stock, be prepared for assignment and being short the actual shares the day before it goes ex-dividend.
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