Understand stock index options and individual stock options in 10 minutes

From: Ideal Forum (55188.com) Author: Wan Zhangpu

Understand stock index options in 10 minutes: Buffett cleverly used Coca-Cola to buy the bottom.

"Full-market simulated trading of stock index options will be launched on November 8." This news means that China's financial market has made another breakthrough in product structure after margin trading, stock index futures, and government bond futures. Will further integrate with international mature markets. Although options are relatively unfamiliar to ordinary investors, they have an irreplaceable position among financial products due to their asymmetric risk and return characteristics. The purpose of this article is to use simple explanations to let you understand in 10 minutes what options trading is and how to use options to better buy the bottom and escape the top in the stock market.

Options are like insurance against big risks

Options, also known as options, have appeared in the U.S. and European markets as early as the late 18th century, but it was not until 1973 that Chicago options trading It became a big business after it opened.

What is the value of options to investment? To a certain extent, it can be compared to buying insurance in life. Currently, you can buy a one-year accident insurance with a coverage amount of 500,000 yuan for 275 yuan. If you unfortunately die due to an accident within a year, the insurance company will compensate you 500,000 yuan. If there are no accidents within a year, then you will only lose 275 yuan in premiums. With the possibility of wasting 275 yuan in premiums in exchange for a high compensation of 500,000 yuan, insurance is obviously a financial product with extremely asymmetric expenditure and return. For this reason, it can be an excellent risk management tool to help us compensate for the financial losses caused by accidents.

The purest application of options is similar to this. For example, as of October 22, 2013, the U.S. S&P500 index closed at 1,754.67 points, an increase of more than 20% so far this year. At this time, investors may have a conflicting mentality. They are worried about peaking after a big rise and taking profits, but they are also afraid that the U.S. stock market will continue to rise and be short after selling. At this time, options can help you.

Option risks are limited and returns are unlimited

Currently, the transaction price of a put option with an exercise price of 1,750 points expiring on March 22, 2014 is 63.10 points. This option means that you have the right to sell the S&P 500 Index at 1750 points before March 22, 2014.

Let’s take a look at your profits under two extreme situations. The first is that as you are worried, the U.S. stock market did not live up to expectations like the A shares. It quickly fell by 500 points, leaving only 1254.67 points. At this time, if you execute the sell option, you can still sell the U.S. stock in your hand at a price of 1750 points. Even if the income is calculated at 1754.67, your total loss is only 4.67 points in price loss (1754.67-1750=4.67) and the original purchase price. The 63.10-point option premium paid for this option totaled only 67.77 points, which was a 500-point drop compared to the U.S. stock market, and the loss was only 13.55% of the latter. Using this mechanism of options, no matter how much the U.S. stock market falls, your maximum loss is only 67.77 points.

The second is that the U.S. stock market continues to go crazy, quickly rising by 500 points to 2254.67 points. At that time, the option you sold at 1750 points obviously became a piece of waste paper, but the stock you held still enjoyed the 500-point rise, and your actual return was 436.9 points (500-63.1). If U.S. stocks rise even more, the gains will be further expanded.

As you can see from the above, using this mechanism of options, no matter how much the U.S. stock market drops, your maximum loss is only 67.77 points. But if U.S. stocks rise, your income can rise accordingly. Obviously, in a rising market, owning a put option can greatly avoid the risk of a sharp decline in the underlying underlying (in the above example, the S&P500 Index), while at the same time enjoying most of the upside potential.

Understand the five attributes of options

Although options are good, they are much more complicated than futures.

To understand an option, tracking the underlying, buying and selling direction, strike price, expiration date and contract type are the five most important attributes.

Let’s talk about the tracking target first. Options are called derivative financial products because they do not exist alone but rely on a tracking target. For example, the above example mentioned options that track the S&P500 index, and the simulated trading of A shares in the future will be options that track the CSI 300 index. These options that track the stock index are called stock index options. Of course, developed markets also have individual stock options that track individual stocks and ETF options that track ETFs.

According to the buying and selling direction, options can be divided into two categories: call options and put options. The former has the right to buy the tracking target, while the latter has the right to sell the tracking target. As for the execution price, it is the price of buying or selling the tracking target.

The expiration date is the validity period of the option. After the validity period, the rights contained in the option disappear. This is a bit like the insurance period of insurance.

However, the expiration date is slightly different depending on whether the option contract type is European or American. This time, CICC has adopted a European option structure, which means that the option cannot be exercised before the expiration date; while the American option popular in the United States is The right to exercise an option at any time before the expiration date.

How Buffett uses options to buy the bottom

When the stock market crashes, if you believe that the bottom is not far away, how will you use options to participate? Many people will choose to buy call options, but this may not be a good choice. Near the bottom, the option's implied volatility is high, which means that the option is very expensive at this time. Even if the index rebounds after buying the call option, the decline in the implied volatility will also damage the income of the option.

Therefore, the scheming stock god Buffett’s favorite thing is to sell put options in turbulent environments. Take Coca-Cola for example. In April 1993, Buffett issued 5 million put options with an option premium of US$1.50, with an expiration date of December 17 of that year and an exercise price of US$35. At that time, the market price of Coca-Cola was about US$40. This means that the investors who bought these 5 million put options from Buffett were worried that Coca-Cola would fall from $40 to less than $35, so they gained the opportunity to sell Coca-Cola shares to Buffett for $35 on December 17, 1993. Of course, the premise is to first pay Buffett a premium of US$1.50 per option (just like paying insurance premiums to an insurance company).

For Buffett, if the price of Coca-Cola was above US$35 on December 17, 1993, obviously no one would be willing to sell it at US$35, so this option would be a piece of waste paper, Buffett You can take the US$7.5 million (US$1.5 × 5 million shares) option premium received previously for free; but if the stock price is lower than US$35 by then, Buffett must buy 5 million shares of Coca-Cola at US$35, of course because he received US$1.5 previously. Because of the option premium, Buffett only really loses money when Coca-Cola falls below $33.50.

For Buffett, there is already a desire to continue to increase his holdings of Coca-Cola. If Coca-Cola does not fall, then it is good to earn some option premium in vain; but if it falls sharply, then the option premium is equal to the market subsidy of $1.5 for you to buy Coca-Cola, which is also good. For a long-term investor, this becomes an investment method that is suitable for both ups and downs.