Reddit Is Letting Power Users In on Its IPO. Not Everyone’s Buying::Reddit says it wants to reward users by letting them buy into the company’s public listing. Some say it’s too risky—others say they won’t pay a company they’ve already given hours of free labor to.
But they said they’ll only do a small amount, so they’ll only risk losing a small infinite amount of money.
Options contracts for strategies like this typically cover 100 shares minimum though, so if Reddit’s stock goes public at say $10.00 per share and they buy 1 contract, they’re going to need $1000 just to buy the contract, and if the share price ends up going up to say $11 instead of going down, that $1000 is gone and they now owe their broker $100.
That’s not how options work.
There’s calls, which are contracts where the buyer can buy a number of shares (typically 100) at the specified strike price at any time between purchase and its expiry. Then there’s puts, contacts that allow the buyer to sell a number of shares for the specified strike price between purchase and the expiry.
The maximum loss of buying an option contract is the initial purchase price (though with bad luck, you can lose more from buying calls if they are in the green when exercised but then the piece drops before the shares are delivered).
The option with infinite potential loss is selling naked calls, which require you to purchase 100 shares to sell them at the strike price if they are exercised (which they will be if the price is above the strike).
Also, options are priced based on the intrinsic value (difference between the share price and strike price when the option is “in the money”) plus potential value over time (statistics based, basically the odds that it will end up in the money based on the difference to strike price, volatility, and time to expiry).
If the 100 shares are worth $1000, options will generally only be priced that much if they have that value. Like puts with $20 strike could be exercised immediately for $1k profit, so the price will be higher than $1k. But $11 puts only have an intrinsic value of $100, plus some time value. If you buy one of those contacts and the price goes up to $10.50, the contract would still have an intrinsic value of $50. If volatility also increases, the time value can increase more than the intrinsic value decreases.
Short selling, which also exposes you to infinite potential risk, is when you borrow shares to sell, expecting the price to go down so you can rebuy at a lower price to return those shares. You pay interest in the meantime, too. There are no options involved, but similarly to naked calls, you have an obligation to buy those shares at whatever price they end up at to close that position.
Btw, please don’t assume that because losses are capped for options at the original purchase price (if you’re buying), it means options are safe. You’re betting completely on price movements, if you’re wrong, you lose all of the money you bet. If you bet by buying shares, the price needs to go to 0 to lose the full investment. Holding shares has infinite potential growth and maximum loss of the original purchase price, too, but you can hold them for years and be wrong about them the whole time but still hold some value.