Wednesday, June 28, 2006

[EMFI] Offers call options

There has been some interest in stock options, EMFi offer the simplest of stock options covered by her own portfolio.

Namely: Out of the money, short term covered call options, American style.
All options EMFi writes expire on the 14th of the month after the option is bought.

What is a Call Option?
Answers.com: "An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument at a specified price within a specific time period."

Investopedia: "It may help you to remember that a call option gives you the right to "call in" (buy) an asset. You profit on a call when the underlying asset increases in price."

EMFi: "A Call option is the right to buy a certain stock {x} at a certain price {y} until a certain time {t}. You purchase that right to buy for a certain price {p} from the option issuer {EMFi}. If you don't exercise your option before or on {t} then the option expires and is worthless."

Why would I buy a Call option?
Well, there are different reasons, first of all options give a leverage effect, are higher risk, higher gain. You can lose your complete investment in a few days time or it can increase in price tenfold. But I will describe some use-cases where you may want to buy a call option.

1) Speculate on a stock that is hard to sell.
Lets say there is a stock ticker: AAAA that hasn't performed well and only trades for like 1 share every week, the price has been stagnant for a while around 30mio isk.
You really think that this month's dividend is going to be massive and the stock will jump up in price to 40 or even 50mio isk and demand will be really high. However if you are wrong you don't want to have 10 or 20 shares of 30mio in your wallet that you will be unable to sell unless you try to sell for 25mio isk.

Without options you would have to buy 10 shares @ 30mio and wait for dividends. (300mio investment)
a) Dividends are massive: you get 3mio dividends, and resell your shares for 40mio making (300mio investment / 130mio profit / 43% profit)
b) Dividends suck: you get 1mio dividends and resell your shares for 26mio (300mio investment / 30mio loss / 10% loss)

With options you would have the option to buy 300 options: [Call AAAA @ 32 - 14th of July] for 1 mio isk.
a) Dividends are massive: you don't receive any dividends, but you exercise your option @ 32m and resell at 40m (300mio investment / 2400mio profit / 800% profit)
b) Dividends suck: you don't exercise your option (300mio investment / 300mio loss / 100% loss)

Of course to profit from the option in the case of a rise you need the isk to cover the buy and resell of the share, this could be done with a loan, or of course, you could offer EMFI to buyback your option for example 5mio / option (900mio profit).

2) Investing in an IPO carefully
Lets say there is a new IPO Ticker: ABCD and you would like to invest in it but you are not 100% sure it is save. the IPO offers shares at 10mio isk... you really want about 100 shares in this IPO but don't want to lose 1bil in about 3 days.

Normally you would have to buy 100 shares @ 10mio isk and invest 1b:
a) IPO turns out to be a scam: loss 1b
b) IPO runs really well and pays out dividend, share rises to 15m: invested 1b hold 1.5b in assets

In this case you could buy 100 options [Call ABCD @ 12m - 14th of July] for 1m per option.
a) IPO turns out to be a scam: loss 100m
b) IPO runs really well and pays out dividends, share rises to 15m: invested 1.3b hold 1.5b in assets

As you can see you can use call options to limit your risk in case of total failure, or to speculate on agressive price increases (using the leverage power of a call option)

I will update this post as questions arise and will use a separate post (on eve-o) for my price lists.

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