Hello fellow Bullhunters
This post will be the final excerpt from The Bullhunters Guide to the US Stock Market so I would like to hear your thoughts and what you have learned from this experience. I know for myself that it has been very helpful in understanding the stock market in a bit more depth. Although the ebook is a summary of the goings on of how the stock market works and how a share is valued, this tool is useful for the newbies starting out in the stock market and wanting to develop a trading system that will work for them. So let’s look at Intrinsic Value and Time Value and how that factors in to trading options…
Intrinsic Value and Time Value
Options are valued based on intrinsic value and time value. Intrinsic value is the positive difference between the stock’s current price and the option’s strike price. Since the strike price in the above example (previous post – Trading Options) is higher than the underlying stock, the options have no intrinsic value (intrinsic value cannot be negative). Therefore all $0.10 of the option’s value is time value.
As options get nearer to expiration, their time value erodes. Its like making a bet that you will run a marathon in the next 365 days. By day 100, it is less likely you will do so, but not entirely impossible. By day 364, the odds are you are not going to do it. The same is true of stock options, so as the expiration draws nearer, investors are willing to pay less and less for the time value.
But imagine Microsoft hit $35 a share on December 26. Now the $32.50 calls would have $2.50 of intrinsic value plus some time value. Instead of exercising your options – which would require you to buy 3,500 shares of stock – you could simply sell your option to a market for $250-plus per contract.
Options Go the Other Way Too
In addition to calls, there are also puts. Puts give you the right to sell a stock at a specified price within a specified period of time. This way, you can make money when a stock goes down, without taking on the risk of shorting.
For a real mindbender, you can short a put contract. This means you are selling the right to sell a stock at a certain price within a certain period of time. Confused yet? Don’t worry. In this book, I only want to cover the basics of the stock market. We can talk about derivatives in more detail in another book. Stay posted.
More Bullhunter on the Way
So there it is. The Bullhunters Guide to the US Stock Market first installment. While boring at first glance, following the financial markets can be the most entertaining hobby in the world. Once you understand the basics and begin to dig in, it is like following a sport that has no off-season.
I wouldn’t mind some feedback just to know how you are traveling and how you are getting along with the stock market and whether you are trading. How have we helped you with this blog and the ebook download. The reason I ask is because in order to give you what you want specifically, I need to know what it is.
To Your Success
Angela Recchia
Graduate Support
Universal Wealth Creation © 2004 – 2007
{ 2 comments… read them below or add one }
Hi Ange,
Yes, I’m confused. I know nothing about buying and selling shares but I’m learning. I’m hoping that even though I don’t fully understand everything you say; if I keep reading it’ll start to make more sense.
I know you say this is for newbies but maybe I need something even more basic. We’ll see.
The biggest hurdle I think with learning about the stock market is learning the language. I know that when I started I thought I had become privy to a secret society.
I would suggest for anyone starting to learn about trading to write every new word they learn on a list with an explanation beside each and stick the list on the wall. That way you will start to become familiar with them.