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I read an article in the NY Times, but I don't understand what this statement means:

“The 16 puts on Cisco are offered at 71 cents. We should buy 1,000,” he says to a trader sitting across the desk, referring to the options bought when investors think a stock will fall. After a brief pause, the trader responds: “Done. 1095.”

From: http://www.nytimes.com/2011/03/18/business/global/18volatility.html

Would someone please explain what it means?

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The trader has purchased 1095 options, each of which is a contract which entitles him to sell 100 shares of Cisco stock for $16 a share. He paid $71 for each contract (71 cents a share x 100) which is roughly $78k total.

He will get $109,500 for each dollar below $16 Cisco's stock is when he exercises it (he can buy the stock for the going rate and then sell it for $16 immediately), or he can sell the option itself to someone else for a similar gain (usually a little more, especially if the option has a long time until it expires).

If the option expires when the stock is over $16/share, he gets nothing; i.e. the original $78k is lost.

For reference, Cisco's stock was trading at $17.14/share as of market close on March 18, 2010. The share price had recently been boosted by the recent news that they would be paying a quarterly dividend. It has been heading mostly downward since February 9, after they announced that they're not expecting profits to be as good as the analysts thought they would be: they claim that people aren't buying too much networking equipment just now, and they're also facing mounting competition from the likes of HP and Juniper for switches, and Aruba / HP / Motorola for wireless devices. They may lose market share or need to cut prices, hurting profits. Either way, there's certainly a real possibility of their stock going below $16 in the next few months, so people are willing to pay for those options.

(Disclosure: I work for Aruba, who competes with Cisco. I also own shares of Aruba, possess assorted stock options and similar equity grants, and participate in the employee stock purchase program. I also own shares in Cisco indirectly through various mutual funds and ETFs.)

  • +1. Note that the date of expiration is unspecified in the article. – mbhunter Mar 20 '11 at 1:42
  • Also note that he doesn't actually have to wait until it's below $16 to sell the option to someone else for a profit. There just needs to be someone else who suspects the price is headed down and willing to buy the options for more than $0.71 each. (And it's not necessarily all day-traders; perhaps the purchaser owns a lot of Cisco's stock, and just wants insurance against it losing value.) – user296 Mar 20 '11 at 1:58
  • Cisco puts increase in value when Cisco's stock falls (even if doesn't go below $16) OR when Cisco's volatility increases. Of course, puts decrease in value as time passes. These three changes are called delta, vega, and theta. – barrycarter Mar 20 '11 at 7:10
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    Since the NYT article is fresh, and the LEAPs have no $16 strike, it's safe to say these are the July '11 puts, bid .68 ask .71. – JTP - Apologise to Monica Mar 20 '11 at 16:34
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    How did he end up buying 1,095 when he asked for 1,000? – James McNellis Mar 21 '11 at 2:09
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fennec has a very good answer but i feel it provides too much information. So i'll just try to explain what that sentence says.

Put option is the right to sell a stock. "16 puts on Cisco at 71 cents", means John comes to Jim and says, i'll give you 71 cent now, if you allow me to sell one share of Cisco to you at $16 at some point in the future ( on expiration date).

NYT quote says 1000 puts that means 1000 contracts - he bought a right to sell 100,000 shares of Cisco on some day at $16/share.

Call option - same idea: right to buy a stock.

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