Pave Your Way to Trading Stock Options

Physician's Money Digest, June15 2003, Volume 10, Issue 11

Physician-investors can find options tobe a valuable, risk-reducing investmenttool. Before plunging into tradingoptions, though, you'll need to take somepreliminary steps, which aren't involved intrading stocks, to open an optionsaccount with your broker.

UNDERSTANDING FUNDAMENTALS

Your broker will probably tell you thatusing options is not for everyone. That's atrue statement. Your broker may also tellyou that options are dangerous and areonly used by speculators. That's false. It is,however, a common misconception.Options can be used as risk-reducing,profit-enhancing tools. Anyone intelligentenough to become a physician can easilymaster the concept of stock options.

Wanting to be certain all investors areaware of certain risks when using options,the SEC and the Options Clearing Corprequire that every potential optionsinvestor receive the following 2 educationalpamphlets before being allowed toenter an options order:

  • Characteristics and Risks of StandardizedOptions, and
  • Understanding Options.

These brief pamphlets contain valuableinformation for new optionstraders, and it is advantageous for newtraders to read them. Your broker willsend you a copy when you open youraccount, but if you prefer not to wait,you can obtain a copy from any optionsexchange, or by calling 800-678-4667.

ESTABLISHING MARGINS

You must have a margin account withyour broker to trade options, and youmust open the margin account. However,you're not required to trade on margin(ie, borrow money from your broker).

If you already own stocks, it's better todeposit those stock certificates with yourbroker. This step is not mandatory, but it isnecessary if you want to sell a covered call(ie, option contract backed by the sharesunderlying the option).

After you have received, and hopefullyread, the pamphlets and after themargin account is open, you're ready tomake your first option trade. You enteran order in the same way you enter astock order—either online or on thephone with a live broker.

MAKING THE FIRST TRADE

Your order is sent to an optionsexchange, where an attempt is made tofill the order. There are professionaltraders called market makers or specialistsat 4 of the 5 US exchanges, while theother exchange is purely electronic (ie,computers only). Prices are constantlydisplayed, showing the bid prices (ie, theprice that traders are willing to pay tooption sellers) and ask prices (ie, pricesthey ask option buyers to pay). Theseprofessionals buy and sell options fromeach other and from public investors likeyou. They take those options into theirown accounts as inventory, and hope toprofit later. When your order is filled,your broker notifies you.

These are the basic mechanics of openingan account and trading options.Physician-investors interested in usingoptions in a conservative manner tohedge (ie, reduce the risk of) their stockmarket investments should take the preliminarysteps outlined here.

Mark D. Wolfinger, author of

The Short Book on Options: A

Conservative Strategy for the Buy

and Hold Investor, is an educator

of public investors. He was a

professional options trader at

the Chicago Board Options Exchange for over

20 years. He welcomes questions or comments

at mark@mdwoptions.com. For more

information visit www.mdwoptions.com.