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Creating a Portfolio Like Warren Buffett: A High-Return Investment Strategy by Jeeva Ramaswamy

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CHAPTER 30

Options

Options are not part ownership of a company. Buying options means you are betting on which direction the price of a stock will move in the short term or long term. We are not going too deep into the option techniques. But the following option basics are enough to enhance return.

Here are the basics of options.

Calls

The buyer of the call gets the right, not the obligation, to buy the stock before a specified time by paying a small fee. The small fee is called a premium. The specified time period means there is an expiration date, which is traditionally the third Friday of the month. Calls are used to bet that the stock price will increase above the strike price, which is the specified price.

Puts

Puts give the buyer the right, not the obligation, to sell an underlying asset before a specified time period at a set price by paying a small fee. The buyer of the put expects the underlying stock price to go lower than the strike price before the expiration date. This depends upon the relationship between the stock price and the excise price. Three kinds of options are:

1. In the money

2. At the money

3. Out of the money

In the Money

For a call option, the strike price is below the market price of the underlying stock. For this kind of in-the-money option, the premium will be higher than the other two options. For a put option, the strike price is above the market price of the stock. Even if the stock price goes down, you can sell the stock at a higher strike price ...

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