Home Investments While Cocooning

People are definitely skittish about the stock market right now. House market predictions are still a bit shaky, with many people losing their homes to foreclosure. Those that are not underwater are digging into their homes, like it was a safety bunker in World War I. Instead of upgrading and trading a home at a time when few homes are selling, many have chosen to take a different route: Maintaining the value of their current homes.

Out With Large Remodeling In With Small Fixes

Contractors are still out of work because many people are putting off those large house remodeling projects. However, companies that specialize in fixing small items like plumbing, roof leaks, drafty windows, and all manner of small home repairs are seeing a jump in business. That’s because people are spending more time in their homes cocooning and want to maintain them in the best condition possible, for when the market finally turns around.

Home Gardens Are Hot

Investing in a few fruit trees and edible landscaping, or a vegetable garden, are very hot trends right now. People have a bit more time to tend a garden and it can be a worthwhile investment in learning how to feed a family on a budget for less. It can also be a great selling point when the market does turn around and people start to trade up.

Greening Their Homes

If you aren’t aware of it, now’s the time to find out about the perks for homeowners in the stimulus package. If you are replacing an old furnace, adding some solar panels, or learning how to conserve water, there are a multitude of savings being offered by utility companies and the Federal government. Investing to green your home can return money in savings in utilities and taxes at the end of the year.

SOME EXAMPLE OPTIONS

Consider some call and put options on Sun Microsystems (SUNW). The date is 13 June OF and Sun is selling for $16.25.  The July options expire on 20 July and the October options expire on 18 October. In the parlance of the profession, these are referred to as the July 15 calls, July 17.50 calls, October 15 calls, and October 17.50 calls, with similar terminology for the puts. These particular options are American style.
Consider the July 15 call. This option permits the holder to buy SUNW at a price of $15 a share any time through 20 July. To obtain this option, one would pay a price of $2.35. Therefore, a writer received $2.35 on 13 June and must be ready to sell SUNW to the buyer for $15 during the period through 20 July. Currently, SUNW trades above $15 a share, but as we shall see in more detail later, the option holder has no reason to exercise the option right now.3 To justify purchase of the call, the buyer must be anticipating that SUNW will increase in price before the option expires. The seller of the call must be anticipating that SUNW will not rise sufficiently in price before the option expires.
Note that the option buyer could purchase a call expiring in July but permitting the purchase of SUNW at a price of $17.50. This price is more than the $15.00 exercise price, but as a result, the option, which sells for $1.00, is considerably cheaper. The cheaper price comes from the fact that the July 17.50 call is less likely to be exercised, because the stock has a higher hurdle to clear. A buyer is not willing to pay as much and a seller is more willing to take less for an option that is less likely to be exercised.
Alternatively, the option buyer could choose to purchase an October call instead of a July call. For any exercise price, however, the October calls would be more expensive than the July calls because they allow a longer period for the stock to make the move that the buyer wants. October options are more likely to be exercised than July options; therefore, a buyer would be willing to pay more and the seller would demand more for the October calls. Suppose the buyer expects the stock price to go down. In that case, he might buy a put. Consider the October 17.50 put, which would cost the buyer $3.20. This option would allow the holder to sell SUNW at a price of $17.50 any time up through 18 October.
He has no reason to exercise the option right now, because it would mean he would be buying the option for $3.20 and selling a stock worth $16.25 for $17.50. In effect, the option holder would part with $19.45 (the cost of the option of $3.20 plus the value of the stock of $16.25) and obtain only $17.50.~
The buyer of a put obviously must be anticipating that the stock will fall before the expiration day.
If he wanted a cheaper option than the October 17.50 put, he could buy the October 15 put, which would cost only $1.85 but would allow him to sell the stock for only $15.00 a share. The October 15 put is less likely to be exercised than the October 17.50, because the stock price must fall below a lower hurdle. Thus, the buyer is not willing to pay as much and the seller is willing to take less.
For either exercise price, purchase of a July put instead of an October put would be much cheaper but would allow less time for the stock to make the downward move necessary for the transaction to be worthwhile. The July put is cheaper than the October put; the buyer is not willing to pay as much and the seller is willing to take less because the option is less likely to be exercised.
In observing these option prices, we have obtained our first taste of some principles involved in pricing options.

BASIC CHARACTERISTICS OF OPTIONS

The fixed price at which the option holder can buy or sell the underlying is called the exercise price, strike price, striking price, or strike. The use of this right to buy or sell the underlying is referred to as exercise or exercising the option. Like all derivative contracts, an option has an expiration date, giving rise to the notion of an option’s time to expiration. When the expiration date arrives, an option that is not exercised simply expires. What happens at exercise depends on the whether the option is a call or a put. If the buyer is exercising a call, she pays the exercise price and receives either the underlying or an equivalent cash settlement. On the opposite side of the transaction is the seller, who receives the exercise price from the buyer and delivers the underlying, or alternatively, pays an equivalent cash settlement. If the buyer is exercising a put, she delivers the stock and receives the exercise price or an equivalent cash settlement. The seller, therefore, receives the underlying and must pay the exercise price or the equivalent cash settlement. As noted in the above paragraph, cash settlement is possible. In that case, the option holder exercising a call receives the difference between the market value of the underlying and the exercise price from the seller in cash. If the option holder exercises a put, she receives the difference between the exercise price and the market value of the underlying in cash.There are two primary exercise styles associated with options. One type of option has European-style exercise, which means that the option can be exercised only on its expiration day. In some cases, expiration could occur during that day; in others, exercise can occur only when the option has expired. In either case, such an option is called a European option. The other style of exercise is American-style exercise. Such an option can be exercised on any day through the expiration day and is generally called an American option.
Option contracts specify a designated number of units of the underlying. For exchange-listed, standardized options, the exchange establishes each term, with the exception of the price. The price is negotiated by the two parties. For an over-the-counter option, the two parties decide each of the terms through negotiation.
In an over-the-counter option–one created off of an exchange by any two parties who agree to trade-the buyer is subject to the possibility of the writer defaulting. When the buyer exercises, the writer must either deliver the stock or cash if a call, or pay for the stock or pay cash if a put. If the writer cannot do so for financial reasons, the option holder faces a credit loss. Because the option holder paid the price up front and is not required to do anything else, the seller does not face any credit risk. Thus, although credit risk is bilateral in forward contracts-the long assumes the risk of the short defaulting, and the short assumes the risk of the long defaulting-the credit risk in an option is unilateral. Only the buyer faces credit risk because only the seller can default. As we discuss later, in exchange- listed options, the clearinghouse guarantees payment to the buyer.