#OptionsMarket
The Options Market: Where Fortunes Are Won and Lost.
Options can minimize the downside potential and reduce the amount you risk to an exact figure, while also amplifying the potential gains. But, with other types, they will limit the upside potential (albeit with a higher win rate) while leaving you exposed to unlimited losses.
For them to be effective, you must learn the basics first!
Disclaimer: Trading Options without a full understanding of how they work, what the different types of contracts are, what they do or how they work is dangerous and you will likely wipe out your entire account. This is not financial advice, and you should always seek out a professional before making any investment decisions.
You should probably consult with your significant other before engaging in Opinion Trading as well. If not, you’ll likley find yourself the victim of a homicide (maybe it was them, maybe not — I plead the fifth) for losing your combined savings on a botched Options play that you knew nothing about.
That being said, let’s see if trading Options can help you make some money in 2021.
What you can expect from this article
This isn’t going to be a complicated tutorial about advanced Options Strategies like Iron Condors, or even basic ones such as Debit Spreads or Credit Spreads.
Rather, this will be an article about the basics of what Options are, along with four key concepts you should understand before attempting to trade them.
That being said, I’ve broken this down into a few short sections that will get you to the level where you should be able to navigate the Options Market and make sense of what you’re seeing.
That’s not to say that you’ll be ready to trade them when you’re done reading this, but you’ll be 90% of the way there.
After reading this I suggest you dive a little deeper into the Greeks section. Understanding The Options Greeks (this will make sense further in) is one of the fundamental factors for making a good choice when buying an Option.
Let’s begin.
A Brief Overview of The Options Market
Chicago Board Options Exchange, or simply the (CBOE), is the largest Options Exchange in the US. The volume of contracts that are traded and passed through this exchange is remarkable, being well over 1 billion contracts every year since at least 2014.
The CBOE is regulated by the SEC, which is worth mentioning for anyone who doesn’t know much about the options market. I know it’s not comforting to many people having the government involved with their finances, but at least you can be comforted by the fact your money is insured.
The Options Market is regulated and bound to the same standard that governs the Stock Market.
What are Options & how are they priced
Options Contracts are a form of derivatives. To keep it simple, each contract represents 100 shares of an underlying stock. For example, one Call Contract for Apple would give you the leverage of 100 shares of Apple stock. You have the right, not the obligation to buy the 100 shares though. That’s important to understand.
We’ll get into that in more detail in the next section.
The pricing of Options reflects the leverage they give you and will probably confuse the shit out of you in the beginning.
At least they confused me.
That’s why I wanted to make it clear that each contract is essentially 100 shares of the stock it represents. The easiest way to remember how Options are priced is to multiply everything by 100.
If you see a Call selling for $1.25, then it’s worth $125.
If a Put is currently trading at $0.23, then its real value is $23.
That’s a very simple explanation but remember it. That’s how I learned to price options. I took an example like that one, (one I could easily understand and reference), then applied it whenever I got confused or uncertain of how much an option cost.
Now let’s move on to the four concepts. It will make this section easier to digest as well.
The four key concepts to know about an options contract
First, we’ll go through four concepts and their definitions. You must understand them in order to trade Options. If you don’t, then you’ll have a hard time moving past the basics, and it will become ever more difficult for you as you move on.
Obviously, this guide is geared towards brand new and beginner Options Traders. If you already know the basics, then you can skip forward but I suggest you read through it anyway. Options Trading is confusing and complex. You can never be too certain that you know all there is to know.
So, with that being said, here are the four key concepts to understand about Options.
1. Option types
- There are two types of options you can buy or sell.
- Call: An options contract that gives you the right to buy stock at a set price within a certain time period.
- Put: An options contract that gives you the right to sell stock at a set price within a certain time period.
- With these two contracts you can form more advanced trades, like Debit Spreads, Iron Condors, and even being the writer of the contract. Although, at the core of every option trade, lies either a Call or Put.
2. Expiration date
- The date when the options contract becomes void.
- It’s the due date for you to do something with the contract, and it can be days, weeks, months, or years in the future.
- When that date arrives, you have a few choices: You can sell the contract, exercise it for the right to buy (or sell) 100 shares of stock that the contract represents, or you can roll your position to another expiration date.
Rolling your position isn’t something that I’m going to go in-depth about in this article.
But, for the overly curious, here’s a short video I found on YouTube that does a good job explaining it.
Now, let’s move on to the next one before I go off on a tangent that lasts for half the article!
3. Strike price, or exercise price
- The price at which you can buy or sell the stock if you choose to exercise the option.
- The strike price is very important, not only because it’s the price that you can buy or sell the stock at, but if you plan to simply day/swing trade the Option Contract itself, (as most contracts are never exercised), then the closer (or further if it’s a put) to the strike price the underlying stock is, the more valuable it will be.
- An in-the-money call option means the option holder has the opportunity to buy the security below its current market price.
- An in-the-money put option means the option holder can sell the security above its current market price.
- I'm sure you can imagine what an out-of-the-money option is. AKA: all bad.
- Then there’s an at-the-money, which means the contract is right at the strike price. This can be good or bad depending on which contract type you have.
4. Premium: The per-share price you pay for an option.
- The premium consists of two values:
- Intrinsic value: The value of an option based on the difference between a stock’s current market price and the option’s strike price.
- Extrinsic value: The value of an option based on the amount of time before the contract expires.
- Time is valuable to investors because of the possibility that an option’s intrinsic value will increase during the contract’s time frame.
- As the expiration date approaches, the time value decreases. This is known as time decay or “Theta,” after the options pricing model used to calculate it.
I was thinking about something while editing this, and honestly, I should have included one more concept. The fifth concept, you could call it.
The reason I didn’t bring it up is that those four above are all you need in order to be able to look at an Options Chain and understand what you’re seeing.
But, as a quick bonus section, (for lack of a better phrase) here’s another important topic you should consider researching.
The Greeks
There are many different strategies for pricing Options, but using the The Greeks is by far one of the most effective ways to do so. Out of all the greeks, (and there’s a lot of them), a few are essential. Here are the Key Greeks:
As I said, this is just a basic guide for the new Options trader, so for now, I’ll leave it there. If you’d like to learn more about The Options Greeks check out this in-depth guide on them.
The Options Market is a tricky one. It’s a place where you can limit your risk and maximize your gains. At the same time, if you don’t understand them or how to properly value a contract, you can lose all the money you invest in a trade overnight.
Knowledge is the key to success in all financial markets, but that is especially true when it comes to Options.
Yet, if you take the time to learn, you can and will make more money with less capital by trading options than you can with ordinary stocks. The only market I know of where you can make more money in less time (but comes with extreme risks involved) is the Altcoin Markets.
If you’re unaware of what Altcoins are and would like to learn about them, consider reading this piece I wrote about them a few days ago:
The Crypto fanatics call it Altseason. . . A time when you can make a vast amount of money, but comes with an extreme amount of risk. I warn you, beware if you choose to delve into it.
That article will provide you with information about Altcoins and how the crypto market works, but should not be misconstrued as financial advice.
I am not a financial advisor. These articles I write are for educational purposes only.
Thanks for reading. If you enjoyed this article and want to read more about the options, stock, and crypto markets, consider checking out my Publication: The Self Hack
Sources and references:
NerdWallet
Investopedia
