Why do we work with options?
The vast majority of traders trade in the exchange markets, be it stocks, SFDs (margin-covered contracts for differences) on various financial instruments, or Forex, where our company carries out 70 percent of all our trading activities – as standard. It “STANDARDLY” looks like this;
Entered the market and opened a spot position. I bought, say, 100k EUR\USD, using or not using margin leverage (99,9 percent of traders use this credit) at the rate of 1,1050 in the hope that the EURO will strengthen, closed the position at the rate of 1,1120, and earned $700.
If the calculations and hopes (oh, these hopes))) did not come true and the rate moved in the opposite direction, the Stop Loss was triggered, closing the position at 1,1000, losing $500. Everything is extremely simple and clear.
Everyone has heard this word – OPTION. And this word, this concept has a rather sophisticated formulation that repels a significant number of traders from options trading, even those who can afford it. Here it is, this explanation:
“An agreement under which the buyer of an option (a potential buyer or potential seller of an underlying asset – a commodity, a security) receives the right, but not the obligation, to purchase or sell this asset at a pre-agreed price or at an unfixed price, but calculated according to a pre-agreed formula, at a time specified in the contract in the future or over a certain period of time, subject to the occurrence of a specified event or without it; the number of payments and frequency can also be established by the terms of the contract. In this case, the seller of the option bears the obligation, respectively, to sell the asset or buy it from the buyer of the option in accordance with its terms.”
Wise, right?
Let’s decipher it using a simple example. I’m sure you’ve heard something like this in the press.
“The shareholders (Board of Directors) of the public company “Big boy” (provisional name), California, USA, on August 22.08.2021, XNUMX, appointed the company’s executive director (CEO) Thomas Crazy, known as the “market shark,” a crisis manager with the talent to “make shit candy.” Details of the contract have not been disclosed, but our source knows that Mr. Crazy’s salary is one and a half million dollars a year, as well as an option for a million shares of the company.
From this publication it becomes clear to us that the Big Boy company is going through hard times, and also that the company’s shares are present on some exchange (public), which means they have quotes, a specific daily price.
Everything is clear with Thomas’s salary, but how do you understand the “option for a million shares”? Why all this? What kind of option is this?
In order to incentivize Thomas to work to bring the company out of crisis, the contract stipulates that the company gives Thomas the RIGHT to exercise an option on up to one million shares at the PRICE at the time of signing the contract under CERTAIN conditions.
At the time of signing the Contract on August 22.08. 2021, in the evening after the close of trading on the stock exchange, one share of the Big Boy company cost 2,95 USD. This price is fixed in the option. The company’s board assigned Thomas the right to buy a million shares at this price (the right, not the obligation) upon the occurrence of certain conditions or the performance of any actions by Thomas that lead the company to success. For example:
- Thomas doubles his cash flow
- Thomas increases profitability by so many percent
- Thomas is taking the company to such and such new markets.
There may be any number of conditions, but all these successes have a specific ending – the stock exchange quotes of the company’s shares soar. Any success, and preferably stable and successful activity of the company, inevitably leads to an increase in the value of shares and the capitalization of the issuer.
The contract with Thomas may indicate that Thomas will exercise his option no earlier than a certain period of time (for example, 2 years) and/or not earlier than the stock price reaches a certain price (for example, $8,00 per share), There may be many such conditions.
The option in this case means that Thomas uses his talent, organizational abilities, skills and knowledge, as well as agility, cunning, toughness and generally any means to achieve the goal – increasing turnover and profitability.
But we can leave all this fiction “overboard,” since the shareholders and the board of directors of the company absolutely do not care in what ways Thomas will increase profitability, dividends, and capitalization. The main thing is that the company is not taken “by the ass” for Thomas’s actions on the path to success, and all these “moralities” are bullshit (according to the “damn” capitalists)).
And now two years pass, Thomas brought the company out of the crisis. Success, stability. The shares cost $9. Thomas can exercise his option, according to the contract. And he says that he wants to EXERCISE his right to the option. No problem,” they answer him on the Board of Directors, “according to the contract and the CONDITIONS of the option, you have the right.
A million shares belonging to the company are sold on the stock exchange, in a “special account” of 9 million dollars. Thomas pays, roughly speaking, “at the cash desk” – 2mio 995 thousand dollars – the value of the block of shares at the time of signing the contract with him, and calmly “puts” the difference in his pocket – six million and 5 thousand dollars. Of course, he will then pay taxes on this amount.
And if the option condition had not been met and Thomas had not succeeded, would the shares have been worth $9 instead of $7?
If the terms of the option state that Thomas can exercise his right to exercise the option only when the price reaches $9,00 per share, then he cannot exercise his right until the shares reach $9,00. Let him work more intensely😊
In the next publication we will discuss specific financial options that we use in our business.
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