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Saturday, 27 August 2005
A Reader Writes "Would you be so kind to explain?" continued....
I went to sleep last night realizing I hadn't probably fully explained the Options question raised by Josie. But then again, I truly am an amateur and am not well versed on options strategies...I like to trade stocks but not the options contracts associated with them.

One of the things I enjoy doing on this website is to use questions like the one posed by Josie to better understand investing myself! Honestly!

So let's see if we can examine options a bit more and understand the particular situation that Josie is describing. (Again if you are a professional options trader/advisor and would like to help out here, that certainly would be appreciated....just leave a comment here on the blog or email me at bobsadviceforstocks@lycos.com and I will add your comments to the discussion.)

First of all, Graftech International (GTI) closed yesterday at $5.41, down $(.23) or (4.08)% on the day.

You wrote that you wanted to "buy the call .gtila", but Scottrade wouldn't allow you to do this in your IRA....and would only allow you to "sell to open". Apparently you already own the underlying Graftech stock in your IRA.

Let's take a look at what a ".gtila" option means.

As explained in Yahoo "Finance":
Options quotes follow a pattern that enables you to easily construct and interpret symbols once that formula is understood.

The basic parts of an option symbol are:
Root symbol + Month code + Strike price code
So in your case, the "root symbol" is "gti" indicating the company, the "Month code" is "l" which works out to be a "call" for the month of December, and the "Strike price code" is "a" representing $5 or $105, $205, $305, $405, or $505. Since GTI is trading at $5.41, I assume the strike price for this stock is $5.00.

You write that Scottrade wouldn't allow this. I do not believe, if you read the previous post, that buying a call option is necessarily illegal in an IRA, because the 'exposure' one has to loss is limited only the cost of that option. This is very different from writing an option contract which you did execute in your IRA.

O.K....let's see what happened next. You write:
It said that I can only “Sell to Open” my position – the complete opposite of what I wanted to do. Out of curiosity, I went ahead and did it. I bought 1 .gtila “Sell to open” call option at ask price of $1.15, $5 strike price, Dec 2005.
Apparently, the brokerage house communicated to you that you could only "sell to open" this .gtila call contract. And you report that you "bought" a .gtila option. I don't think you "bought" anything at all. Please check your statement. It is my (amateur) impression that what you did was SELL a contract on your underlying stock. That is why it is called "sell to open". Scottrade allowed you to do this because the underlying stock is sitting in your IRA account, and what you did was write a "covered call". That is you sold somebody the right to purchase a 100 share position of GTI at $5, by December, 2005. Since you own the stock, it is not a "naked call", that is you aren't writing a contract guaranteeing that you will deliver up 100 shares of GTI that you don't own but that you would be liable to purchase so that you could deliver those shares to the contract purchaser. If the shares rise above the $5 strike price, and the possibility of purchasing the GTI shares at $5 is profitable for the purchaser of the contract, your liability is the potential delivery of those shares at the $5 price. Nothing more. If it were a "naked call" then, for instance, if the stock rose to $10, and this anonymous contract holder might "call" the stock at $5, and you would have to scramble to buy some shares at a higher price so that you could deliver these shares to him or her at the $5 price that you specified. Thus, you would be exposed to an unlimited financial risk...in a limited IRA setting....thus, disallowing this type of transaction in that setting. I hope you are following.

Finally, you conclude with this:
Now what happens? Do I now “Buy to Close” my position? This whole thing confuses me. Would you be so kind as to explain this please?
This time you are correct. You need to "buy to close" to get out of a contract that you have written. This one is a bit trickier, but from my (amateur) view, if somebody now holds a contract to buy shares from you at a specified price, you don't actually buy the contract back from that individual who might or might not want to sell at the same time you want to buy it back :), but by purchasing the same contract 'on the market' you will have neutralized your risk and have exited the option. I assume that your brokerage account would delete the contract from your account at that time.

Anyhow, I think that is a bit of a better explanation, after doing my own homework on this...than the prior entry. Again, if there are some professional options traders, please feel free to critique and correct what I have written.

I don't need to remind you that I am an amateur investor, so please consult with your professional investment advisors!

Thanks again for visiting. I hope the above discussion was helpful even though I am learning about this as I write as well. I have traded a few options (unprofitably) in the past and since then have avoided that end of the business and stick to my current strategy.

Bob


Posted by bobsadviceforstocks at 8:26 AM CDT | Post Comment | Permalink

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