Welcome to the world of option trading. This is a way to leverage your money to get bigger returns, hedge your current security position, generate stable income to your portfolio, or limit your losses. We will cover the following topics to get you prepared for option trading.
All of the strategies seen below require that your account allows you to trade on margin; though you can trade using cash and not borrow margin
Options can be risky, due to the leveraged play, but is similar to trading securities
Consider establishing your trading with securities first before venturing into options
CALLS
PUTS
Premiums
Dollar Cost Averaging
Share Price
Options
Strike Price
Intrinsic Value
Extrinsic Value
Bid
Ask
In the Money (ITM)
At The Money (ATM)
Out of The Money (OTM)
Days to Expiration (DTE)
Spread (Difference between bid and ask)
Delta
Gamma
Theta (Time)
Vega (Volatility)
The Wheel
Cash Secured PUT
Options are derivatives of the underlying security.
Purchasing one contract is the equivalent of 100 shares (leverage)
You can buy or sell Calls or Puts
Buying Calls - Bullish
Selling Puts - Bullish
Buying Puts - Bearish
Selling Calls - Bearish
People will often use the CALL to PUT ratio as an idea about the future sentiment or direction of a stock in the short and long term
If there are more calls than puts
People purchase options to hedge their positions or to gain exponentially on moves within the stock market
Since a contract represents 100 shares, the contract will increase based on Delta
Each contract represents the opportunity to buy or sell 100 shares
Contract costs 13.20 = 13.20 x 100 shares = $1,320/contract
Contract costs 3.50 = 3.50 x 100 shares = $350/contract
Contract costs 0.45 = 0.45 x 100 = $45/contract
This is cheaper than purchasing 100 shares of the stock (AAPL $163/share)
$163 x 100 shares = $16,300
Options Facts
All options have an expiration date and this could mean that you could lose the entire cost of a contract
Options increase and decrease using a multiplier (Delta) for every $1 movement
If delta was 0.40 or 40 delta, the option price would move $40 for every $1 it goes up or down
Example 1: Increase in Share Price
AAPL increases from $160 to $165/share, your purchased an option of 3.50 at a 40 delta prior to increase in price
40 x ($165 - $160) = 40 x $5 = $200 or 2.00 gain
You new contract value would be worth approximately 3.50 + 2.00 = 5.50 or $550
Example 2: Decrease in Share Price
AAPL decreases from $160 to $155/share, your purchased an option of 3.50 at a 40 delta prior drop in price
40 x ($155 - $160) = 40 x -5 = ($200) or -2.00 loss
You new contract value would be worth approximately 3.50 - 2.00 = 1.50 or $150
Why Options can be better
If a share continues to go down in price, it could continue down until the share price is zero
AAPL shares drop from $160 to $150 = ($10)/share
AAPL shares drop from $160 to $100 = ($60)/share or 100 x 60 = ($600.00)
If an option contract goes down, it will hit zero, but it is capped at the contract cost
AAPL shares drop from $160 to $150, contract of 3.50 with a 40 delta
40 x (10) = (400)
Contract Value is 3.50 - 4.00 = 0.00
You cannot lose more than the contract cost
***Note: numbers in parenthesis represent negative numbers. We also highlighted them in red to help with visualizing the negative amounts
Call
Buying a Call - Bullish
Selling a Call - Bearish
Put
Buying a Put - Bearish
Selling a Put - Bullish