Criterias to list stock options – Option Trading FAQ

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How to Trade Stock Options for Beginners – Best Options Trading Strategy

This simple, profitable trading guide teaches stock options trading for beginners. The strategy applies to the stock market, Forex currencies, and commodities. In this article, you will learn about what options are, how to buy Put and Call options, how to trade options and much more. If options trading isn’t for you, try our Harmonic Pattern Trading Strategy. It’s an easy step by step guide that has drawn a lot of interest from readers.

The Trading Strategy Guides team believes this is the most successful options strategy. When trading, we adhere to the principle of KISS: “Keep it simple, Stupid!”

With simplicity, our advantage is having enormous clarity over price action.

We’ll be focusing on BUYING Put and Call options through this options trading tutorial. Selling options is a different animal. It requires more experience to fully understand the inherited risks. Why? Because you can’t control the downside, the same way you do when you buy Put and Call options.

This is the most successful options strategy because it consistently provides profitable trade signals. Not because it doesn’t have losses. The preferred time frame best options trading strategy is the 15 minute time frame.

We will first define what buying a Put and Call options is. After that, we will give out the rules for the best options trading strategy. Here is another strategy called The PPG Forex Trading Strategy.

What are Options?

Options are a specific type of derivatives contracts . The underlying securities can be stocks, indexes, ETFs or commodities . With a derivatives contract, you do not directly own the underlying asset. Instead, you own a related asset whose value is affected by changes in price.

With an options contract, you have the right to buy or sell an asset at a predetermined price in the future. When that future point arrives, you will have the choice to exercise the option or let it expire.

Here’s an example. Let’s say the asset is selling for $110, a contract giving you the right to buy at $100 will have an intrinsic value. As the expiration date approaches, the value of the options contract will adjust.

There are two different types of options, call options and put options. When used correctly, options trading will make your strategy much more dynamic. Let’s dive into the next section.

What is a Call Option?

A Call Option gives you the right to purchase an asset in the future. If exercised, this purchase will occur on a predetermined date. It will also occur at a predetermined value. If you are unsure about the future value of an asset, a call option can offer some protection. Call options are commonly purchased by stock traders. However, they can also be found in many other markets. In fact, call options are the most commonly traded options contracts.

What is a Put Option?

A Put Option gives you the right to sell an asset in the future. Like call options, these contracts have predetermined prices and sell dates. Put options and call options are often purchased together in order to make a “hedged” position. Below, we will discuss the different types of options sales. We will then discuss how these sales can be introduced into your trading strategy. You may also enjoy this article about options vs futures.

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Different Types of Option Sales

It is necessary to remember that an option is a contract that allows you to purchase an asset at a specific price in the future. There are four different types of options sales that can possibly occur. The differences between short and long sales, and puts and calls will be very important.

  • A long call option will give you the right to buy an asset at a specific price in the future. Long call option holders will benefit from price increases over time.
  • A long put option will give you the right to sell at a specific price in the future. Contrary to call options, long put option holders are hoping that market prices will decrease.
  • A short call option gives you the right to sell not the underlying asset, but the option itself in the future. Because the “logic” of short positions is reversed, short call option holders are in similar positions to long put option holders.
  • A short put option will hope that long put options become less valuable over time—consequently, holders will be rooting for prices to go up.

Once you can understand the different varieties of options sales, you will be able to engage in more complex trading strategies. These strategies will usually involve purchasing multiple different options in order to manage risk and increase the possibility of earning high returns.

Why Use Options?

Options are used for speculation or hedging. Hedge fund managers are notorious for using advanced risk management strategies to hedge their market exposure.

Options offer high leverage, giving you the chance to trade big contracts and potentially make more money. This is the same for Forex. You need a smaller initial investment than buying stocks outright. When buying options, the risk is limited to the initial premium price paid.

When using options, the risk is limited, but the potential profit is theoretically unlimited. Obviously, we say theoretically unlimited profits. But options prices are going to be range-bound within certain parameters. There’s no stock price to rise to infinity. Also, read this article on Paper Trading Options – The Secret to Riches.

Types of Options Strategies

You can take your trading beyond basic call and put options. That is the beauty of options trading. Other trading strategies include covered call, married put, bull call spread, bear put spread, and more. They can help you better manage your risk and seek new trading opportunities.

If you’re a versatile trader, take advantage of the flexibility that options trading can give you. Study the top 10 stock options trading strategies below:

  • Covered Call Strategy or buy-write Strategy – implies buying stocks outright. At the same time, you want to sell call options on the same stock. The number of shares you bought should be identical to the number of call options contracts you sold.
  • Married Put Strategy – implies buying stocks outright. At the same time, you will buy put options for an equivalent number of shares. The married put works like an insurance policy against short-term losses.
  • Bull Call Spread Strategy – implies buying call options with a specific strike price. At the same time, you’ll sell the same number of call options at a higher strike price.
  • Bear Put Spread Strategy – it’s similar to the bull call spread but involves buying and selling put options. In this options strategy, you buy put options with a specific strike price. At the same time, sell the same number of put options at a lower strike price.
  • Protective Collar Strategy – implies buying an out-of-the-money put option. At the same time sell or write an out-of-the-money call option for the same stock.
  • Long Straddle Strategy – implies buying both a call option and a put option at the same time. Both options should have the same strike price and expiration date.
  • Long Strangle Strategy – implies buying both an out-of-the-money call option and a put option at the same time. They have the same expiration date but they have different strike prices. The put strike price will typically be below the call strike price.
  • Butterfly Spread Strategy – implies using a combination of the bull spread strategy and bear spread strategy. The classical butterfly spread involves buying one call option at the lowest strike price. At the same time, sell two call options at a higher strike price. And then sell one last call option at an even higher strike price.
  • Iron Condor Strategy – involves holding a long and a short position in two different strangle strategies.
  • Iron Butterfly Strategy – involves using a combination between either a long or short straddle strategy. At the same time, buy or sell a strangle strategy.

Now let’s turn our focus back to the most successful options strategy.

Let’s define the indicators you need for the best options trading strategy. And how to use stochastic indicator.

The only indicator needed is RSI or Relative Strength Index.

Options trading is constrained by the expiration date factor. So it’s important to select a technical indicator that is suitable for options trading. The RSI indicator is a momentum indicator which makes it the perfect candidate for options trading. This is because of its ability to detect overbought and oversold conditions in the market.

The RSI indicator’s location is on most FX trading platforms (MT4, TradingView). You will find it under the indicators library.

So, how does the RSI indicator really work?

The RSI uses a simple math formula to calculate the oscillator:

There is no need to go further into the math behind the RSI indicator. All we need to know is how to interpret the RSI oscillation. Basically, an RSI reading equal to or below 30 shows that the market is in oversold conditions. An RSI reading equal or above 70 shows the market is in overbought conditions. At the same time, a reading above 50 is considered bullish. On the other hand, a reading below 50 marks is considered bearish.

The preferred RSI indicator settings are the default settings with a 14 period.

Before we go any further, we always recommend taking a piece of paper and a pen and note the rules.

Let’s dive into the options trading tutorial….

Most Successful Options Strategy

(Rules for Buy Call Options)

Options Trading Tutorial Step #1: Wait 15-minutes after the stock market opens to establish your market bias.

The most successful options strategy isn’t focusing only on the price. But they also make use of the time element the same as we’re doing here.

The stock market opening price is usually the most important price. During the first minutes after the stock opening bell, we can note a lot of trading activity. This is because that’s the time when major investors are establishing their positions in the stock market.

Read Day Trading Price Action- Simple Price Action Strategy. You’ll learn about a strategy that isn’t restricted to the time element and focuses on price action. It’s one of the most comprehensive guides to successfully trade stocks or other assets by simply using price action.

Our team at Trading Strategy Guides wants to develop the best options trading strategy. In order to do that, we have to think smarter. We have to track how the smart money operates in the market.

The best options trading strategy will not keep you glued to the screen all day. You only have to know when the stock markets open.

The NYSE opens at 9:30 EST or 1:30 PM GMT time for those trading from Europe.

This brings us to the next step in our options trading tutorial…

Options Trading Tutorial Step #2: Make sure the 15-Minute candle after the opening bell (9:30 EST) is bullish.

As we have established earlier, we only want to trade in the direction where the smart money is. If we’re looking for buying Call Options opportunity we want to make sure smart money is buying after the open. Conversely, if we’re looking to buy Put Options we want to see sellers appear right after the opening bell.

Important Note*: If we have an opening gap up it means the buying power is even stronger and we should put more weight on this trade setup.

Options Trading Tutorial Step #3: Check if the RSI is above 50 level – This is a bullish momentum signal.

We use the RSI indicator for confirmation purpose only. We want to make sure that once we have identified the bullish price action the momentum behind the move is confirmed by the RSI indicator. We’re not concerned with overbought and oversold conditions because the market can stay in these conditions longer than you can stay solvent.

In the chart above, we can note the RSI is well above 50 during the first 15-minutes of trading. The price action is confirmed by the RSI momentum reading.

Now, let’s jump and define where exactly we want to enter our buy a Call option.

Options Trading Tutorial Step #4: Buy a Call option right at the opening of the second 15-minute candle after the opening bell.

Now, that we have confirmation that smart money is buying we don’t want to lose any more time and we want to buy a Call option right at the opening of the next 15-minute candle after the opening bell.

As easy as it sounds this strategy only requires you to put 15-minutes of your time each day. You’ll either get a signal or not, but in order to take advantage of the best options trading strategy, you need to exercise discipline and don’t take any trades if you don’t have any signal.

So at this point, our trade is running and in profit, but we still need to define when to exercise our call option and take profit.

Options Trading Tutorial Step #5: Choose the nearest expiration cycle. For day trading choose the weekly cycle.

When you buy a Call option you also have to settle an expiration date, as part of that contract.

You might be asking yourself how to choose the right expiration cycle?

Well, because we’re most likely going to sell our Call option the same day as we have purchased it, it’s more appropriate to choose the weekly cycle.

Time to switch our focus to the most important part: Where to take PROFITS and sell your Call Options?

Options Trading Tutorial Step #6: Take Profit and sell the Call Option as soon as you have two consecutive 15-minute bearish candles.

Knowing when to take profit is as important as knowing when to enter a trade. We want to get out of our position as soon as we see the sellers stepping in. We measure this by counting two consecutive bearish candles as a sign of bearish sentiment presence in the market.

You don’t want to exercise your long Call option because you don’t want to own those share stocks, you just want to make a quick profit.

Note** The above was an example of a buying Call option using the options trading tutorial. Use the exact same rules – but in reverse – for buying a Put option trade. In the figure below you can see an actual Buy Put Options example using the options trading tutorial.

We’ve applied the same Step #1 through Step#4 to help us establish our trading bias and identify the Buy Put Option trade and followed Step #5 through Step#6 to identify when to sell your Call option.

Selecting the Options Contract that’s Right for You

Now that you understand how to successfully trade options, you will want to know how to choose the contracts that are right for you. All options contracts will have some degree of risk. This is especially true when trading binary options. This is due to the fact that options can potentially be worthless on their expiration date. The risk of trading options can be managed.

When selecting options, keep the following things in mind:

  • Your personal level of risk tolerance
  • Your desired trading timeframe (day trading, long-term trading)
  • The volatility of each prospective asset
  • Past returns on options contracts

Options contracts also have high levels of implied volatility . During the first 30 minutes of trading, options contracts experience large changes in value. When volatility is high, both the level of risk and potential reward will be higher. During this time, your trading strategy will need to be much more active. Risk can be managed by issuing stop orders. It can also be managed by hedging your position and diversifying your positions.

Both call and put options can be very rewarding. In order to prepare yourself as an options trader, it will be a good idea to practice. Fortunately, Trading Strategy Guides makes it easy to hone your skills and enter new markets. Carefully combining the steps mentioned above can help you unlock the best options trading strategy.

Conclusion – Options Trading Tutorial

This is one of the most successful options strategies because when trading stocks, it’s important to have a good understanding of the market sentiment and how the big players are positioned in the market. Another important reason why this is the best options trading strategy is that you’re not required to be glued to the screen all day long.

Don’t forget also to read our Support and Resistance Zones – Road to Successful Trading one of the most comprehensive guides to successfully trade stocks or other assets by simply using support and resistance levels.

Thank you for reading!

Please leave a comment below if you have any questions on How to Trade Stock Options!

Also, please give this strategy a 5 star if you enjoyed it!

(16 votes, average: 4.44 out of 5)
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Criterias to list stock options – Option Trading FAQ

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Options Trading Beginners Guide for 2020

Posted by Mark Wolfinger | Last updated on Jan 7th, 2020 | Published May 11th, 2009

Why trade options? If you have the skill (or luck) to know when a stock is going to move higher or lower, why not just buy or short the shares? The same can be said for commodities – why trade options when you can trade futures contracts?

Too many people look at options as tools for speculation. Sure, options provide leverage, giving you the possibility of turning a few hundred dollars into several thousand dollars. And yes, that possibility is attractive. But do you play the lottery – just because the prize is huge? Everyone knows the lottery is a bad bet and that the chances of winning are terrible.

But options cost more than lottery tickets and the payoff is smaller. The probability of success is small because so much must go your way when you buy options: price change, timing of that change, size of the change. It’s a tough road.

Options were not designed as tools for speculation, and if you want to get the most out of options, consider using them as they were designed – as risk-reducing investment tools.

Options, when used properly, allow an investor to reduce risk and provide an improved chance to profit from stock market investments.

First, it’s necessary to understand the basic principles behind options trading. It is important to understand how options work before you consider trading them. Let’s dive in.

Options Trading Beginner Points

Here’s what new investors need to know about options:

  1. An option is an agreement, or contract, between two parties: a buyer and a seller.
  2. Exchange traded option contracts are guaranteed by the Options Clearing Corporation (OCC). There has never been a default in the 40+ year history of the OCC.
  3. There are two types of options: calls and puts.
  4. The option buyer pays a premium to the seller.
  5. In return for receiving the premium, the seller grants specific rights to the buyer and accepts specific obligations.
  6. A call option grants its owner the right to buy a specific item (contract) at a specified price (called the strike price) for a limited time.
  7. A put option grants its owner the right to sell a specific item (contract) at the strike price for a limited time.
  8. Each contract represents 100 shares of stock. The generic name is the, “underlying asset.”
  9. The limited time ends on the option expiration date. Equity options expire on the third Friday of the month, after the market closes for trading (technically expiration is the following morning, but the last time you may sell or exercise an option is the third Friday).
  10. An option seller may become obligated to honor the conditions of the contract – i.e., sell stock to the call owner or buy stock from the put owner. If the option expires worthless, then the option seller is relieved of his/her obligations.

As the owner of the option, you can either A. sell it on the open market like you would shares, B. you can exercise it, or C. Allow it to become worthless (if expiration day arrives and the option has neither been sold, nor exercised, it expires worthless).

Exercising is the process by which an option owner does what the contract allows. Thus, a call owner can exercise the option, and buy 100 shares of the specified stock at the strike price per share – as long as the option has not yet expired. A put owner may sell 100 shares at the strike price. In practice, it’s more efficient to sell an option, rather than exercise.

Options Versus Stocks Differences

While obvious, it is important to emphasize: options are not stocks. With stocks, you are holding shares or ownership in a company. Contrarily, options are time restricted contracts that represent shares (100 shares per contract).

Option prices depend on far more than supply and demand. When markets are generally calm, option prices tend to decrease. When markets are volatile, option prices tend to increase. And that’s true for puts and calls.

Here are the three most important differences between stocks and options:

  1. Options expire while stock shares last forever (unless the company goes bankrupt or gets acquired).
  2. Options are derivative products. Their value is derived from the value of another asset. Stocks are assets, and have an intrinsic value based on the company they represent.
  3. Option owners have rights, but do not own anything tangible. Stock owners are entitled to dividends and own a voting share of the company.

Reasons to Trade Options

If you are a typical stock market investor, you adopted a buy and hold philosophy and own stocks, ETFs, or mutual funds. If you are a hands-on investor, you likely do research and carefully select stocks to buy. It’s difficult to beat the market, and most professional money managers underperform.

Investors tend to be long. They own stocks. They don’t know how to hedge, or reduce the risk of owning, investments. That’s why options are so important. To me, it’s unfortunate that so few brokers help clients to adopt risk-reducing strategies with options.

Here are seven great reasons why you should take time to learn how options work:

  1. Hedging – Options allow you to reduce the risk of investing in the stock market. Imagine how investors everywhere would feel if they learned that the giant losses they suffered were unnecessary. By using appropriate hedging strategies, losses can be reduced significantly.
  2. Insurance – You can buy insurance that protects the value of your portfolio – just as you buy insurance to protect the value of your home or car. Using options, there are strategies that allow you to own insurance for little, or no, cost.
  3. Income – By selling someone else the right to buy your stock at a predetermined price (selling a call option), you are paid a premium that you can consider to be a special dividend.
  4. Leverage – With options, you have the ability to avoid trading shares of stock altogether. Options also allow you to take a position with far less capital invested than buying shares outright.
  5. No Need to Always Be Bullish – Options allow you to create positions that prosper when the market moves higher, lower, or trades in a range. Traditional long investors only profit when stocks move higher.
  6. Limited risk – You can adopt strategies with limited loss, but with high probability of success. The trade off is that profits are also limited. The limited loss nature of so many option strategies is one important factor that makes them so attractive.
  7. Indexing – If you prefer to trade a diversified portfolio rather than individual stocks, the major indexes (e.g., S&P 500, DJIA, Russell 2000, etc) have options you can trade.

Basic Types of Options Trades

Beginner options traders often get stuck when entering an order because they have not yet learned which of the four choices applies.

When you trade options, there are four ways in which each trade can be described:

Buy to Open

A. An order to buy a specific option
B. You are initiating a new position, or increasing an existing position

Buy to Close

A. An order to buy a specific option
B. You are buying an option that you previously sold
C. You are reducing or exiting (closing) an existing position

Sell to Open

A. An order to sell a specific option
B. You are writing (selling) an option you do not own
C. You are initiating a new position, or increasing an existing position

Sell to Close

A. An order to sell a specific option
B. You are selling an option you bought earlier
C. You are reducing or exiting an existing position

Note: When you trade options spreads (multiple options contracts in combination), you are entering an order to trade at least two different options simultaneously. When you initiate the trade, the appropriate boxes to check are: ‘Buy to open’ for the option you buy and ‘sell to open’ for the option you sell.

Some online brokers require that you specify into which of the four categories your trade falls. Others don’t ask because it’s a simple matter for their computers to gather the information.

Option rookies are often eager to begin trading – too eager. It’s important to get a solid foundation to be certain you understand how options work and how they can help you achieve your goals – before trading.

Here’s a list of my favorite methods. Note: this list contains strategies that are easy to learn and understand. Each is less risky than owning stock. Most involve limited risk. For investors not familiar with options lingo read our beginners options terms and intermediate options terms posts.

1. Writing covered calls

Using stock you already own (or buy new shares), you sell someone else a call option that grants the buyer the right to buy your stock at a specified price. That limits profit potential. You collect a cash premium that is yours to keep, no matter what else happens. That cash reduces your cost. Thus, if the stock declines in price, you may incur a loss, but you are better off than if you simply owned the shares.

Example: Buy 100 shares of IBM
Sell one IBM Jan 110 call

2. Writing cash-secured naked puts

Sell a put option on a stock you want to own, choosing a strike price that represents the price you are willing to pay for stock. You collect a cash premium in return for accepting an obligation to buy stock by paying the strike price. You may not buy the stock, but if you don’t, you keep the premium as a consolation prize. If you maintain enough cash in your brokerage account to buy the shares (if the put owner exercises the put), then you are considered to be ‘cash-secured.’

Example: Sell one AMZN Jul 50 put; maintain $5,000 in account

3. Collars

A collar is a covered call position, with the addition of a put. The put acts as an insurance policy and limit losses to a minimal (but adjustable) amount. Profits are also limited, but conservative investors find that it’s a good trade-off to limit profits in return for limited losses.

Example: Buy 100 shares of IBM
Sell one IBM Jan 110 call
Buy one IBM Jan 95 put

4. Credit spreads

The purchase of one call option, and the sale of another. Or the purchase of one put option, and the sale of another. Both options have the same expiration. It’s called a credit spread because the investor collects cash for the trade. Thus, the higher priced option is sold, and a less expensive, further out of the money option is bought. This strategy has a market bias (call spread is bearish and put spread is bullish) with limited profits and limited losses.

Example: Buy 5 JNJ Jul 60 calls
Sell 5 JNJ Jul 55 calls

or Buy 5 SPY Apr 78 puts
Sell 5 SPY Apr 80 puts

5. Iron condors

A position that consists of one call credit spread and one put credit spread. Again, gains and losses are limited.

Example: Buy 2 SPX May 880 calls
Sell 2 SPX May 860 calls

and Buy 2 SPX May 740 puts
Sell 2 SPX May 760 puts

6. Diagonal (or double diagonal) spreads

These are spreads in which the options have different strike prices and different expiration dates.

1. The option bought expires later than the option sold
2. The option bought is further out of the money than the option sold

Example: Buy 7 XOM Nov 80 calls
Sell 7 XOM Oct 75 calls This is a diagonal spread

Or Buy 7 XOM Nov 60 puts
Sell 7 XOM Oct 65 puts This is a diagonal spread

If you own both positions at the same time, it’s a double diagonal spread

What about buying naked calls or puts?

Note that buying calls or puts is NOT on this list, despite the fact that the majority of rookies begin their option trading careers by adopting that strategy. True, it’s fun to buy an option and treat it as a mini-lottery ticket. But, that’s gambling. The likelihood of consistently making money when buying naked options is very small, and it’s not a strategy I endorse.

How to Value Options

While stock prices depend primarily on supply and demand (buyers versus sellers), option prices depend on many factors, each of which affects the price of an option in the marketplace. Here are some of the most important factors:

1. Price of the underlying

If you own a call option, you have the right to buy stock at a specific price (strike price). For example, if you own one Nov 40 call, you can buy 100 shares at $40 per share. Wouldn’t you pay more to own that call if the stock is $39 than if it’s $35? Would you pay even more if the stock price is $43? I hope you replied ‘yes.’ That’s why calls are worth more as the stock rises.

2. Option type

A call gives you the right to buy shares and a put gives you the right to sell shares. Thus you cannot expect put and call prices to move in tandem. When the stock moves higher, call options increase in value and put options decrease in value.

3. Time to Expiration

When you own an option, you want to see the stock move higher (call option) or lower (put option). The more time that remains before an option expires, the greater the chance that a favorable more will occur. Thus, more time makes all options more valuable. It’s true that more time allows the stock to make an unfavorable move, but that’s not the significant factor in determining a price of an option. It’s the potential payoff, and the probability of receiving that payoff, that determines an option’s value.

4. Interest Rates

Call options can be used as an alternative to owning stock. When you buy stock, you must use cash, and that cash could be invested to earn interest. Thus, the more interest you earn on your cash, the more you should be willing to pay for a call option. This is not a significant factor in determining an option’s value.

5. Strike Price

When you buy stock, you want to pay the lowest possible price. Thus, the right to buy stock at $25 per share is more valuable than the right to buy stock at $30 per share. For that reason, call options increase in value as the strike price decreases.

When selling stock, you want to receive the highest possible price. Thus, it’s more valuable to own the right to sell shares at $60 than the right to sell shares at $55. Puts are worth more as the strike price increases.

6. Dividend

When a stock pays a dividend, its price declines by the amount of that dividend. That occurs when the stock ‘goes ex-dividend’ (the buyer is not entitled to receive the dividend). The higher the dividend, the more the price declines. Because a lower stock price is not good for the call owner, as the dividend increases, the value of a call option decreases. Similarly, the value of a put option increases.

These options do not suddenly change price when the stock goes ex-dividend. The model (modified Black-Scholes) that determines the fair value of an option ‘knows’ that the stock has a dividend in its future, and the effect of that dividend is already priced into the option when you buy or sell it.

7. Volatility

This is the crucial factor in determining the price of an option. Each of the other factors involved in an option’s price is known with certainty. But the volatility estimate used to calculate the value of an option refers to the future volatility. Specifically: how volatile is the stock going to be between the time the option is purchased and the time it expires? Because the future is unknown, the volatility component of an option’s price can only be estimated. Different people make different estimates, and thus, each has a different idea as to the value of an option. If you notice options changing price when the stock doesn’t move (or vice versa) it’s likely due to a change in the volatility estimate.

To provide even more clarity here, when you own an option, you want the stock price to change by a large amount because when the stock moves far beyond the strike, the value of your option increases. When stocks are not very volatile and undergo daily price changes of just a few pennies, a big move is unlikely. But when the stock price frequently changes by 5% in a single day, a few of those moves in the same direction can provide a handsome profit. Thus, the options of more volatile stocks are worth a great deal more than options of non-volatile stocks.

Options Greeks

When dealing with options, it’s possible to measure and modify the risk of any stock market investment. You can take steps you deem necessary to offset as little, or as much, of that risk as desired. When calculating various risks, a set of Greek letters, collectively known as ‘the Greeks,’ are used to measure (or quantify) specific risks associated with an investment.

Let’s take a quick look at a few of the more important, and commonly used, Greeks: delta, gamma, theta, and vega. NOTE: Vega is not a Greek letter, but apparently that’s not an issue.

  • Delta measures the rate at which the price of an option changes when the underlying asset (stock, ETF or index) moves one point. Delta is not constant.
  • Gamma measure the rate at which delta changes as the underlying moves one point.
  • Theta measures the amount by which the value of an option decreases as one day passes. Thus, theta is ‘time decay.’
  • Vega measures the sensitivity of the option’s price to a change in the implied volatility (IV), and represents the amount by which the option value changes when IV moves higher or lower by one point.

By calculating the delta, gamma, theta and vega of a position, specific risk parameters are measured, and thus, can be adjusted to suit the risk tolerance of the investor. And don’t worry, every online broker will calculate the Greeks for you.

How to Read an Option Chain

It’s good to understand specific option strategies and the reasons for adopting them, but for true rookies, something else is needed – and that’s an understanding of how to read an option chain to place a trade. Each broker has its individual trading platform, but if you learn to use one platform, the general principles should transfer to another.

Let’s look at a typical option chain from the Chicago Board Options Exchange (CBOE). Below is information for some IBM options.

1. Calls. This is a (partial) list of call options that are listed for trading at the various options exchanges. The next six columns refer to specific call options.

  • The first row contains: “09 Apr 90.00 IBM (IBM DR – E)”
  • “09” refers to the year in which the option expires, or 2009
  • “Apr” is the expiration month. For all options on individual stocks, expiration day is Saturday, one day after the 3rd Friday
  • “90.00” is the strike price, or the price at which the owner of this call option has the right to buy 100 shares of IBM. It is customary to ignore the decimals when they are ‘00’
  • “IBM” is the ticker symbol for the underlying stock
  • “IBM DR” is the symbol that describes the specific option. “D” represents the expiration month (April). “R” represents the strike price (90). The last letter is not part of the symbol. It’s used to designate the exchange from which market data is taken, and “E” stands for CBOE

2. Last sale. The most recent price at which the option traded. This number is seldom useful because you cannot tell whether the last trade occurred 5 seconds or 5 hours ago.

3. Net. This column shows today’s price change. It’s the difference between the last price and yesterday’s last price. This column serves no practical purpose. Red numbers indicate today’s price is lower, and green means higher.

4. Bid. The highest advertised price anyone is willing to pay for this option at this time. Be aware that the ‘real’ bid is often not published and that there’s a reasonable chance you can sell the option at a higher price.

5. Ask. The lowest advertised price that anyone is willing to accept when selling this option at this time. Be aware that the ‘real’ ask price is often not published and that there’s a chance you can buy the option at a lower price. When the bid/ask spread is wide, the chances of obtaining a better price (when you enter an order) are excellent.

6. Vol. (Volume) The number of option contracts that traded today on this exchange. If no exchange is specified, then it’s the total volume on all exchanges.

7. Open Int. (Open Interest) The total number of this specific option that exists. In other words, the open interest equals the number of options written (sold) that have not yet been bought back or exercised. This number is not ‘live’ and is published once per day, prior to the opening. Notice that the open interest tends to be highest for options whose strike price is nearest the stock price.

8. Puts. The same data is repeated for the put options.

  • Note: The option symbol has one major difference: The letter used to represent the expiration month is not the same as the letter used to represent the call expiration month. That’s convenient because you can determine whether an option is a call or put by its symbol. The letters A to L represent Jan thru December for calls. The letters M to X represent Jan thru Dec for puts. Thus, the first row contains the IBM Apr 90 put, symbol IBM PR. Where P = April expiration for puts
  • The letter representing the strike price is the same for calls and puts. IBM PR is the IBM put, expiring in Apr, strike price 90.

Your First Options Trade: Writing a Covered Call

If you are an investor who has experience buying and selling stocks, then it should be easy for you to make the transition to writing covered calls. Why? Because this option strategy begins with the purchase of stock – and you are already familiar with that process and the decisions required.

Writing covered calls is neither the best nor safest strategy available, but it’s safer than owning stocks outright and it gives you experience using options. Writing a basic covered call is my recommended first option trades.

Here are three reasons why writing covered calls makes sense as an introduction to the world of options:

Covered calls are an easy to understand strategy.

  1. You sell someone else the right to buy your stock at a specified price (strike price)
  2. You collect cash for making that sale
  3. The agreement has a limited lifetime
  4. If the other person declines to buy your stock by the deadline, the agreement expires and you are no longer obligated to sell your shares.

Covered Calls can lead to many more profitable trades when compared with buying stock.

  1. If the stock declines, you lose less than the person who did not write a covered call.
  2. If the stock declines by less than the premium you collected, you earn a profit.
  3. If the stock is relatively unchanged when expiration day arrives, you have a profit while the buy and hold investor breaks even.
  4. If the stock moves beyond the strike price by less than the premium collected, you earn more than the buy and hold investor.
  5. If the stock undergoes a significant price increase, that’s the only scenario in which you earn less than the buy and hold investor

Bottom line, covered calls provide options traders more frequent profits and overall reduce risk. By collecting cash for selling the call, you are effectively reducing your cost basis for the shares of stock you own. Thus, covered calls do not remove risk altogether, but they do reduce risk from holding shares long without any protection.

9 Easy Tips for Option Trading Success

Most investors who are looking for ‘tips’ for option trading success have the wrong perspective. They seek tricks, special strategies, or ‘can’t-miss’ gimmicks. There are no such things.

Options are the best investment vehicles around. They allow investors to take long, short, or neutral positions. They allow you to manage risk far better than any other investment method. Use them wisely and they will treat you well.

Here are nine easy tips for new options traders to follow if they want to be successful:

1. Options are best used as risk-reducing investment tools, not instruments for gambling.

2. Use the options Greeks to measure risk.

3. Manage risk carefully. Do not hold any position than can – in the worst case scenario – cost more than you are willing to lose.

4. Be careful about the number of option contracts you trade. It’s easy to over-trade with inexpensive option contracts – especially when selling.

5. Don’t go broke. Never allow an unexpected event to wipe out your account.

6. Do not expect miracles. Do not buy options that are far out of the money just because they are ‘cheap.’ The chances of success are tiny. Not zero, just tiny.

7. Selling naked options is less risky than buying stock. But, like stock ownership, there is considerable downside risk. Exception: It’s reasonable to sell naked puts – but only if you want to buy the shares, if assigned an exercise notice.

8. Limit losses. The most effective way to accomplish that is to buy one option for every option you sell. That means selling spreads, rather than naked options.

9. Hope is not a strategy. When a position goes bad, consider reducing risk. Doing nothing and hoping for a good outcome is nothing more than gambling.

Additional Options Resources

To wrap this guide up, here is a list of excellent articles across the web to help you learn options trading and trade successfully:

Mark Wolfinger, @MarkWolfinger, is a 20 year CBOE options veteran and is the author of the book, The Rookie’s Guide to Options.

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