How to explain Options in simple terms to friends?

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professorkev

How do you explain options to people who have never heard of them? THe other day someone asked me if I was worried about a market crash again? I explained to them I do worry about that and thats why I choose solid compnaies and less risky ones and that I trade in options and use those options to insure any losses. THe I explained options are like small insurance policies that are tradable and whose value goes up and down and their values are based on several factors. They were still confused!
 
Quote from professorkev:

THe I explained options are like small insurance policies
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Good analogy. You pay a little "insurance" premium for a policy that guarantees you get a certain price for your stock even if it loses all its value.

Quote from professorkev:

that are tradable and whose value goes up and down and their values are based on several factors.
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This is where you'll lose them every time.
:D
 
Just say that it's option that gives you the right, not the obligation to buy something. Everyone in their real life has dealt with real options: the options to buy a property; an option is exactly that, "an option to do something"

Quote from professorkev:

How do you explain options to people who have never heard of them? THe other day someone asked me if I was worried about a market crash again? I explained to them I do worry about that and thats why I choose solid compnaies and less risky ones and that I trade in options and use those options to insure any losses. THe I explained options are like small insurance policies that are tradable and whose value goes up and down and their values are based on several factors. They were still confused!
More...
 
If you start using big phrases like "the right, not the obligation" you'll just draw blank stares.

I tell them:

1) A put is like an insurance policy for stock I own.

2) A call is like the rain check you get when an item is out of stock but is on sale. (You have the right to buy it at a discounted price at a future date.)

These analogies usually make the questions go away. I don't bother explaining that I don't own stock at all (at least not overnight) and only trade option spreads longer term. That seems to make them angry for some reason. :cool:
 
I think the "insurance" analogy is the best. Keep it simple simple simple. "An option is price insurance. A call insures against the price of something going up, a put insures against the price going down."

If anyone asks why you would need to insure against the price going up, you can give them an example of airlines worried about the price of jet fuel going up, or General Foods insuring against a rise in the price of wheat, etc.
 
If this is a big phrase, you need better friends.

Quote from stevegee58:

If you start using big phrases like "the right, not the obligation" you'll just draw blank stares.
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it is a down payment for a contract for a house. And if the house increase in its value then you can sell your contract for a better price.
 
Quote from stevegee58:

If you start using big phrases like "the right, not the obligation" you'll just draw blank stares.

I tell them:

1) A put is like an insurance policy for stock I own.

2) A call is like the rain check you get when an item is out of stock but is on sale. (You have the right to buy it at a discounted price at a future date.) <b>[for a limited time]</b>
More...

These are the analogies I use in my book, The Rookies Guide to Options.

They are easy to understand.

Mark
 
I don't know about options themselves, but I really liked how Sheldon Natenberg discusses volatility behavior, comparing it to weather, in his book.

He also describes the garch model, which has some pretty involved math, through weather.

Weather, definitely weather . . .. Everyone understands weather :cool:

RandomZen
 
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