How to Trade Stock Options – Your #1 Guide to Success

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How to trade stocks in 3 steps (it’s easier than you think)

March 2, 2020 8:00 am

Learn how to trade stocks in just 3 steps. It’s really that easy. PLUS, our guide on how to choose the right stocks to make the most money.

Contrary to what Hollywood would have you believe, trading stocks isn’t a matter of putting on your favorite power suit, picking up a phone, and screaming “SELL! SELL! SELL!”

Pictured: Complete BS Instead of trying to buy and sell hot stocks in the hopes of striking it rich, I suggest you reframe: Investing is a long-term strategy to help ensure your financial future.

In fact, it’s the single most crucial thing you can do today to make sure you’re ready for retirement and other savings goals. The sooner you start, the easier it is to get rich.

But I get it. We’ve been led to believe a lot of different things about stocks. Some of them are positive (“you can get rich by trading stocks!”), some of them not so much (“stocks are risky, ESPECIALLY with the recession/depression/financial-crisis-of-the-week just around the corner!”).

Luckily, most all of that noise is just that. There’s more than 100 years of evidence in the stock market that suggests that by investing in the stock market, you’ll be able to grow your wealth consistently over time.

To do that, though, you need to understand the basics of stocks — and how to trade them.

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What is a stock?

Stocks are investments in a business. When you own a stock, you own part of the company that stock came from.

For that reason, stocks are also referred to as “equity,” since you own a small part of the company.

Stocks fluctuate in price depending on how the company is doing. For example, if Company A just released an amazing new product that is selling like crazy, the prices for Company A stocks are going to rise.

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Alternately, if Company A experiences falling sales, their stocks are likely going to fall as well.

Advantages: If your stock is good and the company is flourishing, you can really make a lot of money. The money is also liquid. This means that you can get it at any time by selling your stock.

Disadvantages: If a company does poorly, so does your stock. Because a stock isn’t diversified, that can mean disaster for you (although you can easily reduce your risk by picking bigger, solid companies). Also, it’s important to note it’s nearly impossible to game the market — so it’s not worth trying for the lay investor.

Those are the basics of what stocks are. Now let’s take a look at how you can actually trade stocks.

NOTE: You should only be trading stocks once you have the rest of your financial house in order. That means automating your personal finance system, maxing out your 401k and Roth IRA, and building an emergency fund. Once you’ve done that, it’s totally fine to invest 5% of your income into stocks.

What is stock trading?

“Trading” stock is a bit of a misnomer. All it really refers to is the buying and selling of stock for money. So whenever you purchase or sell your equity, that’s considered trading.

And there are two ways you can trade stocks:

  • Exchange floor trading. This is the kind of trading you see on movies and television with all the people shouting on the floor of the New York Stock Exchange. It’s a bit of a complex process, but at its core, here’s how it works: You tell your broker to purchase stock from a company, the broker sends a clerk to the floor to find a trader willing to sell you the shares, they agree on a price, and you get the shares.
  • Electronic trading. This is a much more intuitive process for individual investors. It most often comes in the way of online brokerage platforms that allow you to immediately issue a trade during trading hours. No more relying on screaming floor traders to pick up shares for you.

For our intents and purposes, we’re going to be focused on electronic trading. That’s how I trade stocks and that’s how the vast majority of individual investors should be doing it as well. It’s simple, it’s intuitive, and you can get started in a few easy steps — which brings us to …

How to trade stocks

Inevitably, whenever I’m teaching someone about the basics of stocks, someone will pipe up with myriad questions like:

  • “What stocks should I buy?”
  • “Is X company a good investment?”
  • “Is $XX too much for this stock?”

First thing’s first: SLOW DOWN.

Before you make an investment in any sort of stock, you’re going to want to stop and make sure you understand how to go about making a decision of what stock to buy — which brings us to how to trade stocks in just 3 steps:

  1. Set an investing goal
  2. Open a brokerage account
  3. Buy your first stock

Step 1: Set an investing goal

Before you even think to start investing, you should set some goals.

This is a crucial step psychologically and will help you stay focused on achieving your goals.

A good way to come up with an investing goal is to ask yourself why you’re investing. Do you want to save money for retirement? Are you trying to earn money for a big purchase down the road? Do you simply want to support whatever company/business you’re investing in?

Once you have your why, I suggest framing a SMART goal around it.

SMART goals are the solution to vague goal setting that gets you nowhere.

SMART stands for specific, measurable, attainable, relevant, and time-oriented. Here are a set of questions you can ask yourself to frame out your goal:

  • Specific. What will my goal achieve? What is the precise outcome I’m looking for?
  • Measurable. How will I know when I’ve accomplished the goal? What does success look like?
  • Attainable. Are there resources I need to achieve the goal? What are those resources (e.g., gym membership, bank account, new clothes, etc.)?
  • Relevant. Why am I doing this? Do I really WANT to do this? Is it a priority in my life right now?
  • Time-oriented. What is the deadline? Will I know in a few weeks if I’m on the right track?

When it comes to your stock trading goals, you can have a goal as simple as “I want to earn $1,000 from my investments in two years to put towards a new car” or one that’s a little more complicated like, “I want to earn 30% more on my principal investment in one year.” See how you can set a SMART goal for your investments.

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Step 2: Open a brokerage account

An online brokerage account is going to be where you’ll do your trading and investing — and there are a LOT to choose from.

My suggestion: Get a self-serve site such as E*Trade or TD Ameritrade. They’ll offer you an intuitive platform to get you started trading stocks.

Signing up is easy too. Follow the steps below to open one up today.

That’s right. It’s steps within steps! STEPCEPTION.

NOTE: Make sure you have your social security number, employer address, and bank info (account number and routing number) available when you sign up, as they’ll come in handy during the application process.

  • Step 1: Go to the website for the brokerage of your choice.
  • Step 2: Click on the “Open an account” button.
  • Step 3: Start an application for an “Individual brokerage account.”
  • Step 4: Enter information about yourself — name, address, birth date, employer info, social security.
  • Step 5: Set up an initial deposit by entering your bank information. Some brokers require you to make a minimum deposit so use a separate bank account in order to deposit money into the brokerage account.
  • Step 6: Wait. The initial transfer will take anywhere from 3 to 7 days to complete. After that, you’ll get a notification via email or phone call telling you you’re ready to invest.
  • Step 7: Log into your brokerage account and start investing!

The application process can be as quick as 15 minutes and will put you on your path to a Rich Life.

Step 3: Buy your first stock

The simplest way to narrow down the universe of stock options is to think of companies you like and use.

Take some time right now to write down 15 companies you use and return to time after time.

Think of everything. For example:

  • Food: Whole Foods, Conagra, Shake Shack
  • Clothing: Under Armour, Limited Brands, Etsy
  • Services: IBM, UPS
  • Technology: Apple, Microsoft, Snap
  • Entertainment: Disney, Live Nation, Netflix
  • Transportation: Tesla, Ford, CSX Corporation

Instead of 5,000 stock options to choose from, you now have 15 companies you could possibly invest in.

Keep in mind that a good company doesn’t necessarily mean a good stock!

For any stock, you’re going to need a deeper analysis than “I think cars from Tesla are dope so I’m going to buy a bunch of stock from them.”

Instead, you’re going to want to look at five different areas:

  • Trends: Are sales increasing from this time last year? 2 years ago? 5 years ago?
  • Products: Is the future bright in terms of upcoming product development? What news have you heard about their future products?
  • Revenues/profits/growth/earnings per share: The real financial nuts and bolts of a stock. These are intimidating at first. Luckily, many sites will guide you through it.
  • Management: Is management good at the company? Or do they have bad press for unscrupulous practices like overworking their employees? What is the turnover? What is their philosophy and ability to execute?

Do as much research as you can. If you see a reason to doubt a company based on any of the areas above, avoid that stock.

At first all of the charts, earnings, and balance sheets will be incredibly confusing — but the more you look into them, the more you’ll start to get a good sense of what’s going on. It just takes practice.

Your investment future without bullshit

Remember what I said up top: Trading individual stocks is fine ONLY IF you have the rest of your financial house in order.

  • Automating your personal finances
  • Maxing out your 401k and Roth IRA contributions
  • Building an emergency fund
  • Getting out of debt

Only when you’ve done all those things is it fine to invest 5% to 10% of your income to individual stocks. That’s because you don’t get rich by investing in individual stocks. Instead, the best way to build a Rich Life is through low-cost, diversified index funds.

Let’s look at a real-world example.

Say you’re 25 years old and you decide to invest $500/month in a low-cost, diversified index fund. If you do that until you’re 60, how much money do you think you’d have?

$1,116,612.89.

That’s right. You’d be a millionaire after only investing a few thousand dollars per year.

Smart investments are about consistency more than chasing hot stocks or anything else:

If you are just starting out, it’s so awesome that you’re here.

For financial security, it’s more important than anything else to start early. That’s why my team created The Ultimate Guide to Personal Finance.

It’s a comprehensive guide that’ll introduce you to basic investing concepts that’ll best position you for a Rich Life. From mastering your 401k to automating your expenses, you’ll learn exactly what you need to do today to get the biggest financial wins.

Put your name and email below and I’ll send the guide straight to your inbox.

7 Binary Options

Here are some useful hints to get you in the proper mindset for successful binary trades:

1) Set a goal of 10% profit as it is both realistic and does not require more than 3 trades. (And yes a profit of 200-300% is possible, but this means you have to bid larger amounts and spend more time trading). Then 10% daily compound profit with a $250 deposit can easily turn into 10K, over three months time.

2) Set a “Stop” limit in place for trading such as “I’ll stop once I hit my 10% profit” or when losing “I’ll stop once my balance hits $_____”

3) Only trade in the 30 minute and 1 hour duration options. Although the 1 minute option is quite tempting, it’s where the biggest losses occur.

4) Be patient: It is important to that you know the lowest and highest points of your trade for that day. Always aim for the peak or low before placing your bid. You can bid more confidently when it is near the top or the bottom. Never bid when it’s in the middle.

5) Find the “guiding point.” Follow the trend of the 2 hour graph when bidding at the one hour option. Use the 1 minute graph as a guide to “bid” or “wait.”
For example, if the 2nd hour graph displays a downtrend, look at the 1 minute graph, if this is also down, go ahead and bit. Wait, if it’s uptrend. Wait til it starts to downtrend before bidding on the one 1 hour option.

6) Deposit only a minimum amount with which you feel comfortable. Feel free to ignore the bonus “bait” or broker’s threat. Set an amount; say $250 as a monthly deposit. When this starts making a profit, withdraw some of the profit per month as well. But always leave money for bidding. The initial aim is withdrawal the total you have deposited throughout the entire process.

Some of the above might seem a little too technical, but if you break it down, they are practical and will help you turn a profit.

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Profitable Stock Options Trading – A Beginner’s Guide: Lessons I Learned Losing $100,000 to Accelerate Your Trading Success

You need to read this book to find out more about Stock Options?

Some books provide a simple introduction to Stock Options.
Some books provide a more detailed framework for how to use Stock Options.

This book provides both!

In this book you will find a collection of eighty consolidated learnings from an experienced derivative trader, with over twelve years of trading You need to read this book to find out more about Stock Options?

Some books provide a simple introduction to Stock Options.
Some books provide a more detailed framework for how to use Stock Options.

This book provides both!

In this book you will find a collection of eighty consolidated learnings from an experienced derivative trader, with over twelve years of trading experience.

You can use Stock Options as Insurance for your long term stock portfolio.

You can use Stock Option Trading as a stand-alone business venture.

Here’s just some of the information that you will find inside this frank, informative compilation:

An explanation of basic Call Options and Put Options in layman’s terms.

An introduction to using Stock Options as insurance for your stock portfolio.

Discussions and explanation of candlesticks bar charts and the display of financial information.

A breakdown on liquidity and market makers.

The benefits of trend trading and optimizing your profits during price movements.

The importance of Psychology in profitable trading.

Criteria for choosing the best Mentors and the training that suits you.

Your Trading should be an investment so this book covers:

Money management and capital preservation tools.
A realistic focus on the time commitments and the opportunity costs of trading.
Emphasis on the importance of your own written trading rules.

Recognition that trading is a business and help in defining your own trading business plan.

An introduction to more advanced Options trading strategies plus the use of strategic action plans to reduce your reaction times.
This is not a book about making millions of dollars, trading for only ten minutes a day.The Author frankly talks about his $100k losses during his early trading career.
Invest in this book for the price of a cup of coffee and save yourself a fortune! . more

Get A Copy

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About Ged Cusack

As a child of the sixties, I’ve always had a thirst for learning and knowledge.

Moving to New Zealand at the end of 2004 (After 22 years as British Military Engineer),I am enjoying the different pace of life.

Since moving to New Zealand I have pursued many ventures including Business Coaching, Trading Stock Options, Trading CFDs, Trading Foreign Exchange, Trading Futures and project
Hello

As a child of the sixties, I’ve always had a thirst for learning and knowledge.

Moving to New Zealand at the end of 2004 (After 22 years as British Military Engineer),I am enjoying the different pace of life.

Since moving to New Zealand I have pursued many ventures including Business Coaching, Trading Stock Options, Trading CFD’s, Trading Foreign Exchange, Trading Futures and project management.

I realized early on in my life, that I have a busy brain. Detailed notes and systems allow me to constantly move between projects.

Realizing that other people can benefit from my systems and guides, I have begun to consolidate information for other busy minds.

I previously spent 4.5 years working in post-earthquake Christchurch where my roles played to my strengths of project management, problem solving and systematization.

At the end of that last contract I decided to have a break from the corporate environment and focus on e-commerce and trading.

I had several friends and former colleagues ask what I was doing and how they too could start an Amazon business.

After many hours of guiding those people (Involving providing schedules and identifying where these people where at) I decided to systematize this guidance.

My Systems eventuated into my first book:
“FBA – Building an Amazon Business – The Beginner’s Guide: Why and How to Build a Profitable Business on Amazon.” myBook.to/booklinkerFBAlink

Spurred by that first success I have begun writing a series of Beginner’s Guide including:

“A Beginner’s Guide Profitable Stock Options Trading: Lessons I learned losing $100,000 to accelerate your trading success”.
myBook.to/StockOptions

and my most recent addition

“How to Choose a Writing Coach – A Beginner’s Guide: Ensuring your best chance for publishing success.” getBook.at/Chooseawritingcoach

I have also started writing an inspirational series of books, beginning with:

“Gratitude for Happiness: How to exercise your gratitude muscles.” myBook.to/GratitudeforHappiness

I hope you enjoy reading the books as much as I enjoyed writing them.

Essential Options Trading Guide

Options trading may seem overwhelming at first, but it’s easy to understand if you know a few key points. Investor portfolios are usually constructed with several asset classes. These may be stocks, bonds, ETFs, and even mutual funds. Options are another asset class, and when used correctly, they offer many advantages that trading stocks and ETFs alone cannot.

Key Takeaways

  • An option is a contract giving the buyer the right, but not the obligation, to buy (in the case of a call) or sell (in the case of a put) the underlying asset at a specific price on or before a certain date.
  • People use options for income, to speculate, and to hedge risk.
  • Options are known as derivatives because they derive their value from an underlying asset.
  • A stock option contract typically represents 100 shares of the underlying stock, but options may be written on any sort of underlying asset from bonds to currencies to commodities.

Option

What Are Options?

Options are contracts that give the bearer the right, but not the obligation, to either buy or sell an amount of some underlying asset at a pre-determined price at or before the contract expires.   Options can be purchased like most other asset classes with brokerage investment accounts. 

Options are powerful because they can enhance an individual’s portfolio. They do this through added income, protection, and even leverage. Depending on the situation, there is usually an option scenario appropriate for an investor’s goal. A popular example would be using options as an effective hedge against a declining stock market to limit downside losses. Options can also be used to generate recurring income. Additionally, they are often used for speculative purposes such as wagering on the direction of a stock. 

There is no free lunch with stocks and bonds. Options are no different. Options trading involves certain risks that the investor must be aware of before making a trade. This is why, when trading options with a broker, you usually see a disclaimer similar to the following:

Options involve risks and are not suitable for everyone. Options trading can be speculative in nature and carry substantial risk of loss.

Options as Derivatives

Options belong to the larger group of securities known as derivatives. A derivative’s price is dependent on or derived from the price of something else. As an example, wine is a derivative of grapes ketchup is a derivative of tomatoes, and a stock option is a derivative of a stock. Options are derivatives of financial securities—their value depends on the price of some other asset. Examples of derivatives include calls, puts, futures, forwards, swaps, and mortgage-backed securities, among others.

Call and Put Options

Options are a type of derivative security. An option is a derivative because its price is intrinsically linked to the price of something else. If you buy an options contract, it grants you the right, but not the obligation to buy or sell an underlying asset at a set price on or before a certain date.

A call option gives the holder the right to buy a stock and a put option gives the holder the right to sell a stock. Think of a call option as a down-payment for a future purpose. 

Call Option Example

A potential homeowner sees a new development going up. That person may want the right to purchase a home in the future, but will only want to exercise that right once certain developments around the area are built.

The potential home buyer would benefit from the option of buying or not. Imagine they can buy a call option from the developer to buy the home at say $400,000 at any point in the next three years. Well, they can—you know it as a non-refundable deposit. Naturally, the developer wouldn’t grant such an option for free. The potential home buyer needs to contribute a down-payment to lock in that right.

With respect to an option, this cost is known as the premium. It is the price of the option contract. In our home example, the deposit might be $20,000 that the buyer pays the developer. Let’s say two years have passed, and now the developments are built and zoning has been approved. The home buyer exercises the option and buys the home for $400,000 because that is the contract purchased.

The market value of that home may have doubled to $800,000. But because the down payment locked in a pre-determined price, the buyer pays $400,000. Now, in an alternate scenario, say the zoning approval doesn’t come through until year four. This is one year past the expiration of this option. Now the home buyer must pay the market price because the contract has expired. In either case, the developer keeps the original $20,000 collected.

Call Option Basics

Put Option Example

Now, think of a put option as an insurance policy. If you own your home, you are likely familiar with purchasing homeowner’s insurance. A homeowner buys a homeowner’s policy to protect their home from damage. They pay an amount called the premium, for some amount of time, let’s say a year. The policy has a face value and gives the insurance holder protection in the event the home is damaged.

What if, instead of a home, your asset was a stock or index investment? Similarly, if an investor wants insurance on his/her S&P 500 index portfolio, they can purchase put options. An investor may fear that a bear market is near and may be unwilling to lose more than 10% of their long position in the S&P 500 index. If the S&P 500 is currently trading at $2500, he/she can purchase a put option giving the right to sell the index at $2250, for example, at any point in the next two years.

If in six months the market crashes by 20% (500 points on the index), he or she has made 250 points by being able to sell the index at $2250 when it is trading at $2000—a combined loss of just 10%. In fact, even if the market drops to zero, the loss would only be 10% if this put option is held. Again, purchasing the option will carry a cost (the premium), and if the market doesn’t drop during that period, the maximum loss on the option is just the premium spent.

Put Option Basics

Buying, Selling Calls/Puts

There are four things you can do with options:

  1. Buy calls
  2. Sell calls
  3. Buy puts
  4. Sell puts

Buying stock gives you a long position. Buying a call option gives you a potential long position in the underlying stock. Short-selling a stock gives you a short position. Selling a naked or uncovered call gives you a potential short position in the underlying stock.

Buying a put option gives you a potential short position in the underlying stock. Selling a naked, or unmarried, put gives you a potential long position in the underlying stock. Keeping these four scenarios straight is crucial.

People who buy options are called holders and those who sell options are called writers of options. Here is the important distinction between holders and writers:

  1. Call holders and put holders (buyers) are not obligated to buy or sell. They have the choice to exercise their rights. This limits the risk of buyers of options to only the premium spent.
  2. Call writers and put writers (sellers), however, are obligated to buy or sell if the option expires in-the-money (more on that below). This means that a seller may be required to make good on a promise to buy or sell. It also implies that option sellers have exposure to more, and in some cases, unlimited, risks. This means writers can lose much more than the price of the options premium.   

Why Use Options

Speculation

Speculation is a wager on future price direction. A speculator might think the price of a stock will go up, perhaps based on fundamental analysis or technical analysis. A speculator might buy the stock or buy a call option on the stock. Speculating with a call option—instead of buying the stock outright—is attractive to some traders since options provide leverage. An out-of-the-money call option may only cost a few dollars or even cents compared to the full price of a $100 stock.

Hedging

Options were really invented for hedging purposes. Hedging with options is meant to reduce risk at a reasonable cost. Here, we can think of using options like an insurance policy. Just as you insure your house or car, options can be used to insure your investments against a downturn.

Imagine that you want to buy technology stocks. But you also want to limit losses. By using put options, you could limit your downside risk and enjoy all the upside in a cost-effective way. For short sellers, call options can be used to limit losses if wrong—especially during a short squeeze.

How Options Work

In terms of valuing option contracts, it is essentially all about determining the probabilities of future price events. The more likely something is to occur, the more expensive an option would be that profits from that event. For instance, a call value goes up as the stock (underlying) goes up. This is the key to understanding the relative value of options.

The less time there is until expiry, the less value an option will have. This is because the chances of a price move in the underlying stock diminish as we draw closer to expiry. This is why an option is a wasting asset. If you buy a one-month option that is out of the money, and the stock doesn’t move, the option becomes less valuable with each passing day. Since time is a component to the price of an option, a one-month option is going to be less valuable than a three-month option. This is because with more time available, the probability of a price move in your favor increases, and vice versa.

Accordingly, the same option strike that expires in a year will cost more than the same strike for one month. This wasting feature of options is a result of time decay. The same option will be worth less tomorrow than it is today if the price of the stock doesn’t move. 

Volatility also increases the price of an option. This is because uncertainty pushes the odds of an outcome higher. If the volatility of the underlying asset increases, larger price swings increase the possibilities of substantial moves both up and down. Greater price swings will increase the chances of an event occurring. Therefore, the greater the volatility, the greater the price of the option. Options trading and volatility are intrinsically linked to each other in this way. 

On most U.S. exchanges, a stock option contract is the option to buy or sell 100 shares; that’s why you must multiply the contract premium by 100 to get the total amount you’ll have to spend to buy the call.

What happened to our option investment
May 1 May 21 Expiry Date
Stock Price $67 $78 $62
Option Price $3.15 $8.25 worthless
Contract Value $315 $825 $0
Paper Gain/Loss $0 $510 -$315

The majority of the time, holders choose to take their profits by trading out (closing out) their position. This means that option holders sell their options in the market, and writers buy their positions back to close. Only about 10% of options are exercised, 60% are traded (closed) out, and 30% expire worthlessly.

Fluctuations in option prices can be explained by intrinsic value and extrinsic value, which is also known as time value. An option’s premium is the combination of its intrinsic value and time value. Intrinsic value is the in-the-money amount of an options contract, which, for a call option, is the amount above the strike price that the stock is trading. Time value represents the added value an investor has to pay for an option above the intrinsic value.   This is the extrinsic value or time value. So, the price of the option in our example can be thought of as the following:

Premium = Intrinsic Value + Time Value
$8.25 $8.00 $0.25

In real life, options almost always trade at some level above their intrinsic value, because the probability of an event occurring is never absolutely zero, even if it is highly unlikely.

Types of Options

American and European Options

American options can be exercised at any time between the date of purchase and the expiration date. European options are different from American options in that they can only be exercised at the end of their lives on their expiration date. The distinction between American and European options has nothing to do with geography, only with early exercise. Many options on stock indexes are of the European type.   Because the right to exercise early has some value, an American option typically carries a higher premium than an otherwise identical European option. This is because the early exercise feature is desirable and commands a premium.

There are also exotic options, which are exotic because there might be a variation on the payoff profiles from the plain vanilla options. Or they can become totally different products all together with “optionality” embedded in them. For example, binary options have a simple payoff structure that is determined if the payoff event happens regardless of the degree. Other types of exotic options include knock-out, knock-in, barrier options, lookback options, Asian options, and Bermudan options.   Again, exotic options are typically for professional derivatives traders.

Options Expiration & Liquidity

Options can also be categorized by their duration. Short-term options are those that expire generally within a year. Long-term options with expirations greater than a year are classified as long-term equity anticipation securities or LEAPs. LEAPS are identical to regular options, they just have longer durations.

Options can also be distinguished by when their expiration date falls. Sets of options now expire weekly on each Friday, at the end of the month, or even on a daily basis. Index and ETF options also sometimes offer quarterly expiries. 

Reading Options Tables

More and more traders are finding option data through online sources. (For related reading, see “Best Online Stock Brokers for Options Trading 2020”) While each source has its own format for presenting the data, the key components generally include the following variables:

  • Volume (VLM) simply tells you how many contracts of a particular option were traded during the latest session.
  • The “bid” price is the latest price level at which a market participant wishes to buy a particular option.
  • The “ask” price is the latest price offered by a market participant to sell a particular option.
  • Implied Bid Volatility (IMPL BID VOL) can be thought of as the future uncertainty of price direction and speed. This value is calculated by an option-pricing model such as the Black-Scholes model and represents the level of expected future volatility based on the current price of the option.
  • Open Interest (OPTN OP) number indicates the total number of contracts of a particular option that have been opened. Open interest decreases as open trades are closed.
  • Delta can be thought of as a probability. For instance, a 30-delta option has roughly a 30% chance of expiring in-the-money.
  • Gamma (GMM) is the speed the option is moving in or out-of-the-money. Gamma can also be thought of as the movement of the delta.
  • Vega is a Greek value that indicates the amount by which the price of the option would be expected to change based on a one-point change in implied volatility.
  • Theta is the Greek value that indicates how much value an option will lose with the passage of one day’s time.
  • The “strike price” is the price at which the buyer of the option can buy or sell the underlying security if he/she chooses to exercise the option. 

Buying at the bid and selling at the ask is how market makers make their living.

Long Calls/Puts

The simplest options position is a long call (or put) by itself. This position profits if the price of the underlying rises (falls), and your downside is limited to loss of the option premium spent. If you simultaneously buy a call and put option with the same strike and expiration, you’ve created a straddle.

This position pays off if the underlying price rises or falls dramatically; however, if the price remains relatively stable, you lose premium on both the call and the put. You would enter this strategy if you expect a large move in the stock but are not sure which direction.   

Basically, you need the stock to have a move outside of a range. A similar strategy betting on an outsized move in the securities when you expect high volatility (uncertainty) is to buy a call and buy a put with different strikes and the same expiration—known as a strangle. A strangle requires larger price moves in either direction to profit but is also less expensive than a straddle. On the other hand, being short either a straddle or a strangle (selling both options) would profit from a market that doesn’t move much.   

Below is an explanation of straddles from my Options for Beginners course:

Straddles Academy

And here’s a description of strangles:

How to use Straddle Strategies

Spreads & Combinations

Spreads use two or more options positions of the same class. They combine having a market opinion (speculation) with limiting losses (hedging). Spreads often limit potential upside as well. Yet these strategies can still be desirable since they usually cost less when compared to a single options leg. Vertical spreads involve selling one option to buy another. Generally, the second option is the same type and same expiration, but a different strike.

A bull call spread, or bull call vertical spread, is created by buying a call and simultaneously selling another call with a higher strike price and the same expiration. The spread is profitable if the underlying asset increases in price, but the upside is limited due to the short call strike. The benefit, however, is that selling the higher strike call reduces the cost of buying the lower one.   Similarly, a bear put spread, or bear put vertical spread, involves buying a put and selling a second put with a lower strike and the same expiration. If you buy and sell options with different expirations, it is known as a calendar spread or time spread. 

Spread

Combinations are trades constructed with both a call and a put. There is a special type of combination known as a “synthetic.” The point of a synthetic is to create an options position that behaves like an underlying asset, but without actually controlling the asset. Why not just buy the stock? Maybe some legal or regulatory reason restricts you from owning it. But you may be allowed to create a synthetic position using options.   

Butterflies

A butterfly consists of options at three strikes, equally spaced apart, where all options are of the same type (either all calls or all puts) and have the same expiration. In a long butterfly, the middle strike option is sold and the outside strikes are bought in a ratio of 1:2:1 (buy one, sell two, buy one).

If this ratio does not hold, it is not a butterfly. The outside strikes are commonly referred to as the wings of the butterfly, and the inside strike as the body. The value of a butterfly can never fall below zero. Closely related to the butterfly is the condor – the difference is that the middle options are not at the same strike price. 

Options Risks

Because options prices can be modeled mathematically with a model such as the Black-Scholes, many of the risks associated with options can also be modeled and understood. This particular feature of options actually makes them arguably less risky than other asset classes, or at least allows the risks associated with options to be understood and evaluated. Individual risks have been assigned Greek letter names, and are sometimes referred to simply as “the Greeks.” 

Below is a very basic way to begin thinking about the concepts of Greeks:

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