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Introduction

This particular options overview is for you if you are unfamiliar with them or if you simply want a quick refresher.

What is presented below is not a comprehensive or sophisticated options training course. All we really need to get started are the fundamentals of option trading, which are covered in this report. Simply put, you don\’t have to be an experienced institutional trader to profit from options. Although successful strategies require a minimum level of comprehension, fortunately, we can get through that material quickly and painlessly.

You can always visit www.cboe.com for more comprehensive options for educational resources and tutorials.]

The key lesson here is that option trading is not at all as difficult as many individuals believe.

Although there are some fairly sophisticated uses and strategies available, do you really have to be an institutional trader to take advantage of options?

Obviously not.

And \”benefit\” is the key word here.

Options have improved my investing performance, assisted me in accelerating the process of accumulating wealth, and decreased my overall long-term risk. They have also changed my life.

and the techniques I use? Simply put, they aren\’t that difficult. In fact, I can give you all the information you need to finally comprehend the fundamentals of options and lay the groundwork for you to start enhancing your own investing performance.

As a full-time Trader/Investor, I highly recommend tastytrade as a broker to trade options

By taking advantage of tastytrade\’s $100 to $2,000 bonus, you can get started trading today with the best option trader broker

How to Approach Stock Options: The Crucial Steps

The main idea to keep in mind when it comes to trading stock options is that they are always about trading (i.e., buying or selling) risk. Options can be thought of as a risk-reward dial. Your potential reward and level of risk both rise the more one way you turn it. And the further you go the other way, the safer your portfolio becomes, but the more you restrict your potential gains.

Options allow you to transfer risk to a third party in exchange for money and/or a portion of your potential profits, and conversely, options allow you to take on someone else\’s risk in exchange for money and/or a portion of their profits. If you understand only one concept about options, understand this.

In addition there are several types of stock options risks that an investor needs to take into consideration when it comes to trade options, below are some of them:

Limited profit potential:

The profit potential of buying options is limited to the premium paid for the option, meaning that there is a limit to the amount of money that can be made.

Time decay:

Options have an expiration date, and the value of the option decreases over time as the expiration date approaches. This is known as time decay.

Volatility risk:

The value of options is highly dependent on the volatility of the underlying stock. An increase in volatility can result in a significant increase in the value of the option, but it can also result in a significant decrease in value.

Exercise risk:

There is a risk that the option will be exercised, which would result in the investor being obligated to sell or buy the underlying stock at the strike price.

Liquidity risk:

There may be a limited number of options available for a particular stock, which could make it difficult to exit the position if the market moves against the investor.

Credit risk:

There is a risk that the counterparty to the options trade could default on their obligation to buy or sell the underlying stock.

Systemic risk:

Options are often used to hedge against market risk, but a sudden and significant market downturn can result in a significant decrease in the value of the option.

Note: It is important to understand these risks and to have a clear investment strategy and a well-written trading plan before starting investing in stock option. Options trading is a high-risk leveraged product, and it is crucial to have a fully understanding the terms and the risks involved to it.

Stock Options Overview:

The following fundamentals are essential to understand if you want to delve into the world of stock options:

• 100 shares of the underlying stock or security are represented by each option contract, whether it be a call or a put (with rare exceptions)
• Every option contract has a month of expiration.
• The third Friday of every month is designated as the actual expiration date; technically, this should be the following Saturday, but since markets are closed on weekends, this Friday is considered to be the actual expiration date.
• There are currently options on some stocks in the US markets that expire weekly, but for the purposes of this report, we\’ll concentrate on the monthly options.

YOU MAY ALSO BE INTERESTED IN READING AND LEARNING ABOUT OUR 5 CONCEPTS OF ANALYZING A BUSINESS TO TRADE STOCK AND STOCK OPTIONS

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Stock Options Concepts:

Below are the four distinct stock options terms that any investor should know before pressing the trigger.

1. Options Order Types:

·         Calls

·         Puts

2. Options Position Type:

·         Long options

·         Short options

3. Options Execution Type:

·         Buy to open

·         Sell to open

·         Buy to clos

·         Sell to Close

4. Options Moneyness:

·         ITM – In the money

·         ATM – At the money

·         OTM – Out the money

Stock Options Order Type:

When it comes to trading stock options. We only have two types of stock options orders, calls and puts.

Calls:

A call option gives the holder the rights but NOT the obligation to BUY a stock (100 shares) at a certain price (strike price) at or within a specified time (expiration date).

Puts:

A put option gives the holder the rights but NOT the obligation to SELL a stock (100 shares) at a certain price (strike price) at or within a specified time (expiration date).

In order for us to have a better understanding how stock options order types works, let us have look at some examples:

Call Option Example:

Let\’s assume an investor buys a call option with a strike price of $100 and a premium of $5. The total cost of the option will be $500 (100 shares x $5 premium).

If the price of the underlying stock increases to $110 before the option expires, the investor have the rights but not the obligation to exercise the option and purchase the stock at $100, and then sell it in the market for $110. In this scenario, the profit would be $600 ($110 sale price – $100 strike price – $5 premium).

If the price of the underlying stock remains below $100, the option will expire worthless, and the investor will lose the premium paid for the option. In this scenario, the loss would be $500 (the cost of the option).

The break-even point for this trade would be $105, which is calculated by adding the strike price ($100) and the premium ($5).

Put Option Example:

Let\’s assume an investor buys a put option with a strike price of $100 and a premium of $5. The total cost of the option will be $500 (100 shares x $5 premium).

If the price of the underlying stock decreases to $90 before the option expires, the investor have the rights but not the obligation to exercise the option and sell the stock at $100. In this scenario, the profit would be $500 ($100 strike price – $90 sale price + $5 premium).

If the price of the underlying stock remains above $100, the option will expire worthless, and the investor will lose the premium paid for the option. In this scenario, the loss would be $500 (the cost of the option).

The break-even point for this trade would be $95, which is calculated by subtracting the premium ($5) from the strike price ($100).

Visual illustration on what happens to Long Call and Long Put options when the underlying stock goes up or down in price:

Underlying Stock	Call Options Value	Put Options Value
Increase	Increase	Decrease
Decrease	Decrease	Increase

Option Position Type:

Whether an investor is buying or selling options depends on the kind of options position they take. A trader has two options: long or short. If we refer to an investor as having a long position, it simply means that they have purchased some options, and if we refer to them as having a short position, it simply means that they have sold some options.

Buying Options:

By purchasing an option contract, one can start a long position in options. As a result, the investor can gain from a rise/drop in the underlying stock’s price. If the investor buy a call options the investor will benefit in an increase in stock price whilst the buyer of a put options will profit from a decrease in the stock price.

Short Call Option Example:

Let\’s assume an investor buys a call option with a strike price of $100 and a premium of $5. The total cost of the option will be $500 (100 shares x $5 premium).

If the price of the underlying stock increases to $110 before the option expires, the investor have the rights but not the obligation to exercise the option and purchase the stock at $100, and then sell it in the market for $110. In this scenario, the profit would be $600 ($110 sale price – $100 strike price – $5 premium).

If the price of the underlying stock remains below $100, the option will expire worthless, and the investor will lose the premium paid for the option. In this scenario, the loss would be $500 (the cost of the option).

The break-even point for this trade would be $105, which is calculated by adding the strike price ($100) and the premium ($5).

Long Put Option Example:

Let\’s assume an investor buys a put option with a strike price of $100 and a premium of $5. The total cost of the option will be $500 (100 shares x $5 premium).

If the price of the underlying stock decreases to $90 before the option expires, the investor have the rights but not the obligation to exercise the option and sell the stock at $100. In this scenario, the profit would be $500 ($100 strike price – $90 sale price + $5 premium).

If the price of the underlying stock remains above $100, the option will expire worthless, and the investor will lose the premium paid for the option. In this scenario, the loss would be $500 (the cost of the option).

The break-even point for this trade would be $95, which is calculated by subtracting the premium ($5) from the strike price ($100).

Selling Options:

Opening a short options position by selling an option contract is referred to as selling options. This enables the investor to profit from a drop/rise/sideways price action in the underlying stock’s price. If the investor sell a call options the investor will benefit in a decrease/sideways action in stock price whilst the seller of a put options will profit from an increase/sideway action in the stock price.

Short Call Option Example:

Let\’s assume an investor owns 100 shares of a stock trading at $100 and sells a call option with a strike price of $105 and a premium of $3. The premium received for selling the call option will be $300 (100 shares x $3 premium).

If the price of the underlying stock remains below $105, the option will expire worthless, and the investor will keep the premium received for selling the call option. In this scenario, the profit would be $300 (the premium received).

If the price of the underlying stock increases to $110, the option will be exercised, and the investor will be required to sell the stock at $105. In this scenario, the profit would be $500 ($105 sale price – $100 purchase price + $3 premium received).

The break-even point for this trade would be $108, which is calculated by adding the premium received ($3) to the strike price ($105).

Short Put Option Example:

Let\’s assume an investor sells a put option with a strike price of $100 and a premium of $5. The premium received for selling the option will be $500 (100 shares x $5 premium).

If the price of the underlying stock remains above $100, the option will expire worthless, and the investor will keep the premium received for selling the option. In this scenario, the profit would be $500 (the premium received).

If the price of the underlying stock decreases to $90, the option will be exercised, and the investor will be required to purchase the stock at $100. In this scenario, the loss would be $900 ($100 purchase price – $90 sale price – $5 premium received).

The break-even point for this trade would be $95, which is calculated by subtracting the premium received ($5) from the strike price ($100).

Note: Call options and put options are the two popular types of options sold by investors.

Options Execution Type:

The simple difference between opening and closing an options position is a third area of contrast or distinction. As we\’ve already established, a long position is one you\’ve bought, and a short position is one you\’ve sold, whether we\’re discussing a call or a put.

The process of BUY TO OPEN, which is simple and makes sense, is used when you first buy a long position and similarly, it is known as SELL TO CLOSE if you close out that long position before expiration.

Short option positions follow the same logic and procedure. It is known as a SELL TO OPEN when you start one (i.e., sell or write a call or put), and a BUY TO CLOSE when you finish one before expiration.

Understanding the difference between buying and selling to open and closing is crucial, especially when placing an order. Think about the situation if you had a long put option and wanted to sell it. It needs to be marked as a SELL TO CLOSE order. If the order was accidentally submitted as a SELL TO OPEN, in addition to keeping the long put, you also have a second position, a short put. Correcting that error results in needless and expensive commissions.

To succeed as an options trader, one needs more than just a working knowledge of the trading principles we have covered. Before concentrating on the details of the buy to open, buy to close, sell to open, and sell to close parameters, you should be aware of a few important factors.

The last thing a trader wants to do is place the incorrect order, use excessive leverage, or miss out on current profits by failing to close an options position properly. An investor can both make and save a tonne of money by knowing which options order to use when.

Options Moneyness:

In stock options, the term \”moneyness\” describes whether an option is \”in the money (ITM),\” \”at the money (ATM),\” or \”out of the money (OTM).\” The intrinsic value of an option, or the value it would have if it were exercised today, is determined by the moneyness of the option.

Call Options Moneyness Examples:

ITM Call Options

Assume that a call option with a strike price of $90 is available to buy and that the price of a stock is $100. Because the stock price is greater than the strike price in this instance, this call option is \”in the money.\” In the event that the option were exercised, the holder would get paid the $10 difference between the stock price and the strike price.

ATM Call Options

Assume that a call option with a $100 strike price is available to buy and that the price of the stock is $100. Due to the stock price matching the strike price, this call option is \”at the money.\” The difference between the stock price and the strike price, which in this case is $0, would be paid to the holder if the option were exercised.

OTM Call Options

Assume that a call option with a strike price of $110 is available to buy and that the price of a stock is $100. Due to the stock price being below the strike price, this call option is \”out of the money.\” The difference between the stock price and the strike price, which in this case is -$10, would be paid to the option holder if it were exercised.

Put Options Moneyness Examples:

ITM Put Options:

Consider a situation where a stock is trading at $100 and a put option with a $110 strike price is offered for sale. Because the stock price is below the strike price, the option in this instance is \”in the money.\” If the option were exercised, the holder would get paid the $10 difference, or the difference between the strike price and the stock price.

ATM Put Options

Let\’s say a stock has a price of $100 and a put option with a $100 strike price is offered for sale. Due to the stock price matching the strike price, this option is \”at the money.\” The difference between the strike price and the stock price, which in this case is $0, would be paid to the holder if the option were exercised.

OTM Put Options

Let\’s say a stock has a price of $100 and a put option with a strike price of $90 is offered for sale. Because the stock price is greater than the strike price in this instance, the option is \”out of the money.\” The difference between the strike price and the stock price, which in this case is -$10, would be paid to the holder if the option were exercised.

Visual illustration on what happens to Long Call and Long Put options moneyness when the underlying stock goes up or down in price:

Status	Call Option	Put Option
In-the-money (ITM)	Stock Price > Strike Price	Stock Price < Strike Price
At-the-money (ATM)	Stock Price = Strike Price	Stock Price = Strike Price
Out-of-the-money (OTM)	Stock Price < Strike Price	Stock Price > Strike Price

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Option Greeks:

Option Greeks are a set of metrics used to measure various factors that can affect the price of options. The main Greeks include:

• Greek Delta

• Greek Theta

• Greek Gamma

• Greek Vega

• Greek Rho

Options Greek Definition and example:

Greek Delta:

measures the sensitivity of the option price to changes in the price of the underlying asset. A call option delta will be between 0 and 1, while a put option delta will be between -1 and 0.

Example Delta:

Let\’s assume that a stock is trading at $100, and a call option with a strike price of $110 is available for purchase. The delta of this call option is 0.6, which means that for every $1 increase in the price of the underlying asset, the option price is expected to increase by $0.6.

Greek Gamma:

Measures the rate of change of delta with respect to changes in the price of the underlying asset. A high gamma means that the delta will change rapidly as the underlying asset price changes, which can result in large profits or losses for the option holder.

Example Gamma:

Let us assume that a stock is trading at $100, and a call option with a strike price of $110 is available for purchase. The gamma of this call option is 0.1, which means that for every $1 increase in the price of the underlying asset, the delta of the option is expected to increase by 0.1.

Greek Theta:

Measures the sensitivity of the option price to the passage of time. A high theta means that the option is losing value quickly as time passes, which can be an issue for option holders.

Example Theta:

Let us assume that a stock is trading at $100, and a call option with a strike price of $110 is available for purchase. The theta of this call option is -0.05, which means that for every day that passes, the option price is expected to decrease by $0.05.

Greek Vega:

Measures the sensitivity of the option price to changes in the volatility of the underlying asset. A high vega means that the option price is more sensitive to changes in volatility, which can result in large profits or losses for the option holder.

Example Vega:

Let us assume that a stock is trading at $100, and a call option with a strike price of $110 is available for purchase. The Vega of this call option is 0.2, which means that for every 1% increase in the volatility of the underlying asset, the option price is expected to increase by $0.2.

Greek Rho:

Measures the sensitivity of an option\’s price to changes in interest rates. It represents the change in the option\’s price for a one percent change in the risk-free interest rate.

Example Rho:

For example, let\’s consider a call option with a strike price of $100 and a time to expiration of one month. The current risk-free interest rate is 2%. The rho of this call option is 0.05, which means that for every 1% increase in the risk-free interest rate, the call option price is expected to increase by $0.05.

So, if the risk-free interest rate increases from 2% to 3%, the call option price is expected to increase by $0.05. This is because an increase in interest rates increases the cost of carrying the option and results in a higher price.

Note: that the hypothetical examples given above do not correspond to actual results from trading options. The price of the underlying asset, the amount of time until expiration, volatility, and other variables can all affect the value of the Greeks.

Options Pricing & Volatility:

Pricing

Finally, it\’s critical to understand the components that go into determining an option\’s price. An option is made up of intrinsic and extrinsic value at its most basic level.

The degree to which the price of a stock or other underlying asset fluctuates is measured by its volatility. Volatility is a significant factor that impacts the price of options in the context of options trading. The price of an underlying asset\’s options is more likely to increase the more volatile it is because there is a higher likelihood that the option will expire in the money.

Typically, the standard deviation of the underlying asset\’s daily returns is used to calculate volatility. The standard deviation and option price increase in proportion to how volatile the underlying asset is. Since it increases the likelihood of large price swings and can make the price of options more unpredictable, high volatility can be viewed as a risk factor for options traders.

Although the two ideas are related, it\’s crucial to understand that volatility and risk are two different things. While risk refers to the uncertainty of those fluctuations and the potential losses that could result, volatility refers to changes in the price of the underlying asset. Understanding the volatility of the underlying asset as well as any potential risks is crucial when trading options.

The margin by which an option is in the money is its intrinsic value. A long call with a $50 strike price that you own if XYZ is trading at $55 per share has an intrinsic value of $5. In the same way, if you hold a long put with a $60 strike price in the same scenario, it also has $5 worth of intrinsic value.

There is absolutely no intrinsic value in an option if it is not in the money. Logically, everything else that affects an option\’s pricing is considered to be extrinsic value or time value of the option. It can also be viewed as time value in that an option\’s remaining value, if any, will be limited to its intrinsic value once it expires.

Option Greeks, or the mathematical formulas that compare particular risks to the value of the option, are associated with extrinsic value and it is crucial that you do understand how the value of each optiohs Greek will impact th value of an option

Volatility

Two indicators of the price volatility of an underlying asset are historical volatility (HV) and implied volatility (IV).

Historical Volatility:

The price volatility of an asset in the past is measured by historical volatility. It is determined by taking the standard deviation of the asset\’s price\’s daily log returns over a predetermined time frame, such as the previous 60 or 252 trading days. This measure of volatility helps determine the risk involved in holding an asset by giving an estimate of how much the price of the asset has fluctuated in the past.

Consider the stock XYZ, for instance, whose historical volatility over the previous year was 20%. This indicates that over the past year, the stock\’s price has fluctuated by an average of 20%.

Implied Volatility

Implied volatility, which is derived from the asset\’s option prices, is a measurement of the anticipated future volatility of the asset\’s price. Option traders use it to calculate the cost of options because it represents the market\’s expectation of how much an asset\’s price is likely to fluctuate in the future. Using option pricing models, such as the Black-Scholes model, which considers the option\’s strike price, expiration date, value of the underlying asset, and risk-free interest rate, implied volatility is calculated.

Think about the ABC stock, which is currently trading for $100. The implied volatility for the $100 strike price and one-month expiration call options is 30%. This indicates that the market anticipates a 30% swing in the stock price over the next month.

Note: that the hypothetical examples given above do not correspond to actual results from trading options. The market\’s expectation of future volatility, changes in the price of the underlying asset, the amount of time until expiration, and other variables can all affect the value of historical volatility and implied volatility.

FAQ

Q: Why do some people believe trading options is complicated?

A: The perception of complexity in options trading comes from its numerous strategies, price factors, and the use of financial jargon. However, with education and practice, it becomes manageable.

Q: Can a beginner trade options?

A: Absolutely. Many platforms and resources can help beginners understand and get started with options trading.

Q: What are some basics to know before starting options trading?

A: A beginner should understand basic terms like Call, Put, Strike Price, Expiration Date, and understand how options pricing works.

Q: Is options trading riskier than stock trading?

A: While options trading can be risky, it is also a way to hedge against risk. The risk in options trading can be controlled more than in stock trading because you know in advance the maximum you can lose.

Q: Are there any courses or books you recommend for learning options trading?

A: There are many online courses, books, and tutorials available for learning options trading. Look for resources that match your learning style and pace.

Conclusion:

We hope that after reading this article on fundamental stock options, you now have a firm understanding of what options are and how they work. As promised, they are not really that complicated.

Also, do not worry if you are still a little confused about some aspects of your options. You can always review this information at a later time. In addition, no matter what it is that we hope to learn; learning never truly begins until we act and begin putting what we have learned into practise.

To put it another way, knowledge is like a key that unlocks a door. To actually have a first-hand, direct experience is like opening a door and walking through it.

I sincerely hope this was helpful, though. It has been enjoyable for me to arrange this information in a straightforward and useful way.

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Although, here at Unison Trading we don’t trade looking for excitement neither for having fun, we are very aware of the Law of Large Numbers (Number of Occurrence’s), as we always make sure that our number of occurrences are in place so the probabilities can play out. Remember that the maths doesn’t lie.

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