Expert: Biff - 2/22/2004

Question
Hello,
I have been reading a book on stock options and strategies for safer option investing, the author likes selling call and put options at the same time at 2 times standard deviation, i think he calls it a small sweep or something, and admit it confuses me a bit. but i am still mind twisted on the starting line,  The author describes how to make an order , he says to call the broker and sell so and so options, meanwhile I don't own any to sell, does he mean to tell me, to tell the broker, to sell options that the broker owns, or the company owns, i got lost in who is selling what.  In other words , sell something I don't have, or I guess these options are not like stocks in any way shape or form.   Where is my logic gone wrong here..
Thanx a bunch


Answer
Options are contracts that derive value from an underlying asset ie stocks.  If I have an option or contract to buy a stock at 5 and the stock is trading at 10 than the value of my contract or option is worth at least 5.  I could exercize my contract at 5 and sell the stock at 10.

Because options are not assets in the normal sense but contracts then there have to be two parties to the contract.  One is a buyer and one is a seller.  If you want to buy a contract at 5 than I would have to be willing to sell at 5.  Hence one person takes a long position and the other takes a short position, one buys one sells.  The beauty of options is that you take a position and not ownership.  I think the stock is going to decrease in value I will sell or take a short position.  If I think the stock will gain value I would take a long position.

I think where you are having trouble is seeing these as contracts and not as assets.

Here is an example from the futures markets.  A wheat grower wishes to borrow money.  The only asset he has is grain in the field.  A baker wishes to do some long term financial planning.  He can't do this without knowing the cost of wheat for the next year.  The farmer will sell the baker an option to buy his grain at a set price.  He now has an asset (the wheat) with a predetermined price.  He can go to the bank and show what he will have in cash several months from now.  He sold his asset now.  The baker has locked in a price for his raw materials and can develop pro forma financial statements for the next year.

Southwestern's CFO is a genious with futures contracts.  His airline pays much less in fuel costs than most other airline.  They are able to do this because of futures and options.  He locks in a favorable fuel price at opportune times.

Hope this helps.