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Demystifying Options

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Breaking news stories might rattle lesser traders, but by the time they unfold, they’re practically history for Pete Najarian. That’s because he trades options –and always has his ear to The Street, listening for whispers of takeovers, scandals, and buyouts. Well usually he’s listening – right now he’s talking.

(A little trade school first: An option is an agreement in which the buyer has the right, but not the obligation, to exercise buying a stock at a set price by some date in the future. Since the option gives the buyer a right and the writer an obligation, the buyer pays an option premium to the writer.)



Here's Pete Najarian's report.

I’m Pete Najarian, the “Pit Boss,” and I’m standing in front of the Chicago Board Options Exchange where it all began. If you think options are only for the experts or veteran traders like me, think again. Options are one of the greatest tools out there today and the reason is leverage.

A lack of options knowledge in 1987 during the crash, as well as during the 2000 dot com era, really hurt the options markets for an extended period of time. But options are back, and they’re back with a vengeance.

I’ll give you an example: In March this year, we have averaged 3.8 million contracts per day. That is a 58% increase since last year’s March.

So options are certainly back and the options markets with electronic trading have a lot more upside. We are just at the tip of the iceberg as to what is going on with options.

Dylan Ratigan explains that option traders watch volume closely – and asks the guys how to tell when an explosion in volume is worth trading?

Tim Strazzini says if a stock seems undervalued and then speculation surfaces that’s it’s being taken over.. that seems like an options trade to him. He adds one telling sign is when the stock isn’t moving, but the option price is exploding because of the option demand.

He also says there was speculation today that Pride International (PDE) is being taken over. But he cautions investors to understand the trade before they even think of buying options. It’s a difficult game to play and investors can lose a lot of money.

Dylan asks Pete Najarian for his best trade.

Pete says he’s watching Paychex (PAYX). He explains there’s currently a high volume of buying of the “April $37.5 calls”. Based on that buying, Pete believes there’s someone out there, who expects something positive will happen with this company in the future.

Symbol
Price
 
Change
%Change
PAYX
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Questions? Comments? fastmoney@cnbc.com

Trader disclosure:
On APR 4, 2007, the following stocks and commodities mentioned or intended to be mentioned on CNBC’s Fast Money were owned by the Fast Money traders Bolling Owns (DIS), (ICE), (NMX), Gold, Silver Najarian Owns (DNDN), (OI), (RIO), (PDE) Strazzini Owns (BOT), (DNDN), (SNDK), (WMT), (STM), (BRCM)