Category Archives: Options Trading
An option provides the owner the right to buy or sell an asset at a pre-determined price before or on a certain date. Trading Options can be very profitable for the owners. However, it is important to gain a proper knowledge and understanding of the terms used in the options market.
Options are very different from stocks. This article presents 10 very basic facts about options that every options trader should know. Don’t start trading of you don’t understand them.
- Right to Buy or Sell
Options are contracts giving the owner the right to buy or sell an asset at a fixed price (called the “strike price”) for a specific period of time.The seller of the option contract is obligated to take the opposite side of the trade if and when the owner exercises the right to buy or sell the underlying asset. Options are available on a variety of different underlying assets including stocks, futures, indices, commodities, Forex, Bonds etc. Today most assets have options.
- Calls and Puts
There are two types of Options: Calls and Puts. Understanding the difference between the two is absolutely crucial to getting started.
For each call contract you buy, you have the right (but not the obligation) to purchase 100 shares of a specific security at a specific price within a specific time frame. A good way to remember this is: You have the right to “call” stock away from somebody.
For each put contract you buy, you have the right (but not the obligation) to sell 100 shares of a specific security at a specific price within a specific time frame. A good way to remember this is: You have the right to “put” stock to somebody.
Generally speaking, you buy Call Option because you have Bullish Outlook and you buy Put Option when you have bearish outlook.
Though there are only two types of options, when you factor in other characteristics of options, there are endless trading possibilities.
- The Strike Price
That’s the pre-agreed price per share at which stock may be bought or sold under the terms of an option contract. Some traders call this the “exercise” price. You can choose any price at which you would like to buy or sell underlying instrument. These prices are called Strike Price and Options are available in several Strike Prices at, far or near the current market price of the underlying instrument.
Options can be In-The-Money (ITM), Out-of-The-Money (OTM) and At-The-Money (ATM).
- Options Symbols
The OCC option symbol consists of 4 parts:
- Root symbol of the underlying stock or ETF, padded with spaces to 6 characters
- Expiration date, 6 digits in the format yymmdd
- Option type, either P or C, for put or call
- Strike price, as the price x 1000, front padded with 0s to 8 digits
- SPX 141122P00019500: This symbol represents a put on SPX, expiring on 11/22/2014, with a strike price of $19.50.
- LAMR 150117C00052500: This symbol represents a call on LAMR, expiring on 1/17/2015, with a strike price of $52.50.
- Buying vs. Selling Options
If you buy an option, you are not obligated to buy the underlying instrument; you simply have the right to exercise the option. When you buy a Call Option, you have the right to BUY stocks at your option’s strike price.
Similarly, when you buy a Put Option, you have the right to SELL stocks at your Option’s price.
If you sell a Call Option, you are obligated to deliver the underlying asset at the strike price at which the Call Option was sold if the buyer exercises his or her right to take delivery. If you sell a Put Option, you have to buy the underlying if exercised.
Generally speaking, if you don’t take any action, your friendly broker will most likely do it for you if your Options are eligible for exercise.
- Options Strategies
There are about 72 options trading strategies. There are three most commonly used options strategies: bullish, bearish and neutral or non-directional. The top 10 options strategies: Covered Call, Protective Put, Long Call, Long Call Spread, Long Put, Long Put Spread, Long Straddle, Long Strangle, Collar and Iron Condor.
Options are good for a specified period of time after which they expire and the option holder loses the right to buy or sell the underlying instrument at the specified price. This specified period is called “Expiration”.The expiration date for listed stock options in the United States is normally the third Friday of the contract month, which is the month when the contract expires. However, when that Friday falls on a holiday, the expiration date is on the Thursday immediately before the third Friday.
Options are available for variety of expiration timings such as Weekly, Monthly, Quarterly and much longer durations (known as LEAPs).
- The Option Price
The price reflects a variety of factors including the option’s volatility, time left until expiration, and the price of the underlying asset. There are several Options Pricing Models that you can use to calculate theoretical Option Price by modeling various parameters.
There is no fixed price for an Options. It is dynamic and will keep on changing with respect to time to expiration and other variables.
- Debit vs. Credit
Options when BOUGHT are purchased at a DEBIT to the buyer. That is, the money is debited from your brokerage account. It’s exactly like buying a stock.
You can sell an Option, without owning the shares. Options when SOLD are sold at a CREDIT to the seller. Money is added to the brokerage account. You can’t withdraw this money until the trade has been closed. Usually, this money is used to offset the margin required for selling the options.
- What You Can Do With an Option
You have three choices when you own an option. And that’s true whether you own a call or a put. Each choice has its pros and cons. Each choice might lead to different profit outcome.
The choices are:
- Sell it. You do it by entering a sell order to close (eliminate) your position.
- Exercise it. Notify your broker that you want to do what the contract allows.
- Allow it to expire worthless.
Kim Klaiman is a full time Options Trader and founder of steadyoptions.com – options education and trade ideas, earnings trades and non-directional options strategies.
Read more from Kim on his Options Trading Forums.