So… You want to learn the essentials to Option trading eh?
Look no further. In this blog here, I will go over all of the basics and essentials information you need prior to trading options. So, what are options? As defined by Investopedia, it is a contract that give buyers the right, but not the obligation, to buy or sell an underling asset at an agreed-upon price and date. Options are split between calls and puts. As for dates, each option contract have specific expiration dates, e.g. they can expire on 4/17, 4/24/, or 5/1.
So where do I go to trade options?
Most brokers already offer option trading on their platform. Personally, I prefer using Robinhood just for their options trading because their UI is so simple yet elegant. Plus $0 commission fee. Pictured below is an example of Robinhood’s UI.
Option contracts represent 100 shares, and a buyer will always pay a premium fee for each contract. For example as pictured above, for TSLA $485 CALL 4/17 EXPIRATION, the price is $30.35. No, that doesn’t mean you are allowed to buy it at $30.35 for Tesla. As mentioned before, contracts represents 100 shares. So in total, the price for 1 contract would be $3,035 ($30.35 x 100).
Strike Price = Set price at which a contract can be sold or bought when it has been exercised.
Calls = Buying in that if the speculation of a stock/ETF is to go up
Puts = Buying in that if the speculation of a stock/ETF is to go down
LEAPs = Long-term Equity Anticipation Securities. Essentially the same to regular options, but they just have a longer expiration date. Any expiration greater than a year is considered a LEAP, while those that expire within a year are short-term.
Straddle = Buying a call and put with the same strike price and same expiration date.
Strangle = Buying a call and put with different strike prices BUT with the same expiration date.
In the Money (ITM) = For a call option to be ITM, stock price has to be greater than current strike price. For a put option to be ITM, stock price has to be less than current strike price.
At the Money (ATM) = For both calls and puts option, stock price has to equal strike price.
Out of the Money (OTM) = For a call option to be OTM, underlying price has to be below strike price. For a put option to be OTM, underlying price is above the strike price.
- E.G. Stock A is trading at $17. OTM Calls would have strike prices above $17. OTM Puts would have strike prices below $17.
- DELTA = Measures change in option price when stock price moves. 0/1 for calls. -1/0 for puts. (If stock price of tesla goes up, option price increases by 0.49)
- GAMMA = Measures change in Delta when stock price moves.
- THETA = Price at which option price decays everyday as expiration is near.
- VEGA = Measures change in option price when volatility moves.
- RHO = Represented as rate of change to interest rate
Implied Volatility (IV) = Market’s forecast of a likely movement in security’s price. IV increases in bearish markets; while it decreases in bullish markets.
Volatility Crush = Describes swift reduction in IV of an option after underlying’s stock earnings are announced or other major news event. This occurs because the IV will usually rise before earnings, and fall once earnings are announced.