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IX. Option Basics

I consider myself an options trader. It is probably 90% of the positions I will take outside of my longterm portfolio. Options are a great tool to add to your trading arsenal whether you want to trade them independently or add them as a nice hedge to your other positions. I recommend everyone use options, to what degree is your choice.

Options are the right to buy or sell stock at a certain level known as the strike price. It gives you the right to buy/sell 100 shares of stock in the future. The best part of options are they they give you a great bang for your buck, especially for expensive stocks. If a stock lets say cost $100/share , it would take $10,000 of your money to get that long position. An option will allow you to do that for much cheaper, in this scenario probably around $1,000 . So essentially, your dollar goes further while still maintaining the same delta , or the dollar value per 1 tick of movement in a stock.

  1. Call Options- are the right to buy stock in the future at a certain level, making you long the stock. So if you have a view that at the end of expiration the stock will be higher than it currently is (minus the premium you pay) then you would buy a call option and either sell before expiration or execute

  2. Put Options- are the right to sell a stock at a certain strike price of the stock . This takes on a short view or a view that the stock will be lower at expiration ( minus the premiums you pay). Again , you will either buy back the put before expiration or execute.

  3. Strike Price- The price you are buying or selling the stock . It is important to note this is independent or not related to the stock price. There are multiple strike prices you can choose for a stock. Some being closer to the current stock price or further away.

  4. Premium- This is the value you pay if you are buying an option .It is essentially the price you pay to hold the right to own the option.

  5. Break Even - for options your break even is your Strike price-premium -+ stock price. So for example if you bought a call at a strike price of $10, the premium was $2 dollars and the stock is now $10, you essentially will need the stock to reach $12 to break even ( you strike of $10 plus the $2 premium). If the stock price ends at $14 dollars, you have made a $2 profit.

  6. Selling Options- if you sell a call or put you are essentially taking the opposite view of buying. If you sell a call you are predicting the stock will go down and if you sell a put you are saying the market will go up. Unlike buying options, the value you can make on selling is fixed, and the value you can make is just the premium that you sell the option for. Also the other draw back is you have unlimited risk when you sell an option, so I don’t recommend selling options for beginnings.

  7. Naked Options- is just buying either a call or put for our purposes. It is just taking one leg or side of a position and following it. This is what I recommend for most begginers

  8. Expiration- when the option for a certain month expires and must be either sold/bought or executed. It is the third Friday every month. One benefit of U.S. options is you can buy back or sell back at anytime time during the month. It is one thing first trades usually overlook, but buying and selling an option way before expiration if it is making money is a good strategy. * Majority of options expire worthless

  9. ITM- when an option is in the money or ITM it just means that between the strike and premium, you are profitable on the trade for our purposes.

  10. Greeks- the mathematical values to gauge how an option moves : delta, theta, gamma rho

I will get into more detail on how to trade options, encompass them into your other strategies, and go over more option techniques and valuations in the future. I just wanted to give a brief over view of how they work, and I really don’t recommend many trades or combination when you first trade options. I think you should just buy a call or put to start out.

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