Options 101
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Options 101. What are Options. An option is a contract sold by one individual (option writer) and bought by another individual (option holder).

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Options 101

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Options 101

Options 101


What are options

What are Options

  • An option is a contract sold by one individual (option writer) and bought by another individual (option holder).

  • This contract gives the options holder the right but not the obligation to buy (Call) or sell (Put) a the underlying security at the agreed upon price (Strike Price) during the allotted time period (Expiration Date)

  • Each option contract is worth 100 shares of the underlying security (except in mini-options where those are 10 shares)

  • Call options allows you to buy or (call) the underlying security from the option writer. (option holder wants the security to go up)

  • Put options allows you to sell or (put) the underlying security to the option writer. (option holder wanted the security to go down)


Need to know terms

Need to know terms

  • Bid – price someone is willing to buy the contract for

  • Ask – price someone is willing to sell the contract for

  • Call – chance to buy the underlying security

  • Put – chance to sell the underlying security

  • Strike Price – the price of the underlying security

  • Expiration Date – date on which the contract expires

  • Volume – the amount of contracts bought or sold the day

  • Open Interest – the total amount of open contracts

  • Theta – the amount an option value decrease over time

  • Delta – the amount an option value increase when the underlying moves by $1


Need to know terms cont

Need to know terms cont.

  • Option writer – entity that is selling the contract

  • Option holder – entity that is buying the contract

  • Premium – the amount paid for the contract

  • Exercise – the fulfilling of the contract

  • Option holder – entity buying the contract

  • Option writer – entity selling the contract

  • BTO – Bought to Open – bought an option (option holder)

  • STO – Sold to Open – sold an option (option writer)

  • STC – Sold to Close – sold and option (options holder)

  • BTC – Bought to Close – bought an option (option writer)


Need to know terms cont1

Need to know terms cont.

(THESE WILL BE EXPLAINED LATER)

  • In the Money – aka ITM

  • At the Money – aka ATM

  • Out of the Money – aka OTM


Option chain

Option Chain

  • The options chain is a listing of all the call and put option strike prices along with their premiums (bid & ask) for a given maturity period (Expiration Date).

  • Now lets take a look of the option chain.


Option chain1

Option Chain


Option chain cont

Option Chain cont.

  • Now lets examine the various parts of an options chain.

    • Expiration date

    • Strike Price

    • Calls

    • Puts

    • Bid & Ask

    • Volume and Open Interest

    • In the Money / At the Money / Out of the Money

    • Delta

    • Theta


Expiration date

Expiration Date


Expiration date cont

Expiration Date cont.

The expiration date is the date the contract expires.

As you see from that slide AAPL has many various expiration days listed.

AAPL has weekly options as well as monthly options. (In TDA the weekly options are represented in red). Not all securities have weekly options.

All options expire on Saturday. But since the markets are not open trading ends on Friday at 4:30P.M.

Weekly options expire each Saturday on the week they are listed for. Where as monthly options expire the 3rd Saturday of each month.


Strike price

Strike Price


Strike price cont

Strike Price cont.

  • The strike price is the price at which the underlying can be purchased (call) or sold (put)

  • The difference between strike prices is determined by the CBOE.

  • The difference in strike price can vary from a $10.00 difference do to a $.50 difference.

  • The difference in the strike price can also vary from expiration date to expiration date.

    In this example AAPL has a $2.50 difference between strike prices. (i.e. – 515 / 517.50 / 520 / 522.50 / 525)


Calls

Calls


Calls cont

Calls cont.

  • A contract that gives an entity the right but not the obligation to buy the underlying security at a specified price within a specific time period.

    If you a buying call options you are bullish on the underlying security and want the underlying to increase in price.


Options 101

Puts


Puts cont

Puts cont.

  • A contract giving an entity the right, but not the obligation, to sell the underlying security at a specified price within a specified time.

  • If you are buying a put then you are bearish on the underlying and expect the price to drop.

  • Where as a put is different from a call. A call you are buying the underlying; a put you are selling the underlying to the option writer.


Bid ask

Bid & Ask


Bid ask cont

Bid & Ask cont.

  • Just like the underlying security options also have a bid and ask. This is the price an entity is willing to buy (bid) the contract or sell (ask) the contract. The bid and ask price is for each share in the contract (100 shares)

  • The bid & ask is also known as the Premium. This is the amount you are paying for the contract to have the right to buy (call) or sell (put) the underlying at that strike price

    In the example:

    The 550 strike call entities are willing to buy that contract for $1.62 and entities are will to sell it for $1.63

    The 550 strike put entities are willing to buy that contract for $18.20 and entities are will to sell it for $18.90


Volume and open interest

Volume and Open Interest


Volume and open interest cont

Volume and Open Interest cont.

  • Volume is the amount of contracts traded on an individual day (BTO or STO).

  • Open Interest is the total amount of open contracts (bought or sold). This number is a rolling number, and calculated at the end of each trading day.

    In our example:

    The 550 calls had 10900 contracts traded and had an open interest of 45289

    The 500 puts had 2360 contracts traded and had an open interest of 20933


Itm atm otm

ITM / ATM / OTM


Itm atm otm cont

ITM / ATM / OTM cont.


Itm atm otm cont1

ITM / ATM / OTM cont.


Itm atm otm cont2

ITM / ATM / OTM cont.

  • What is meant by term ITM (In the Money), ATM (At the Money), and OTM (Out of the Money) is in reference to the strike price in connection to the underlying price.

    In our example AAPL at the time was trading at 532.94 which mean the strike price of 532.50 are ATM (At the Money).

    For the calls any strike price above 532.50 (535 – 550) are considered OTM where as the strike price below 532.50 (515 – 532) are considered ITM

    For the puts any strike price above 532.50 (535 – 550) are considered ITM where as the strike price below 532.50 (515 – 532) are considered OTM

    This is where it does confuse some people but hopefully in the end it will make more sense when I show examples.


Delta

Delta


Delta cont

Delta cont.

  • Delta is the amount the option value will increase or decrease for each point the underlying moves.

  • This is not a static number the closer the option gets to ITM the higher the delta will go. As well as the further the option goes OTM the lower the delta will go.

  • Most entities use delta .99 options as stock replacements as they will move penny for penny with the underlying.

    In our example:

    The 550 calls have a delta of .18 this means for every point the underlying rises or lowers the option value will increase or decrease .18

    The 550 puts have a delta of .83 this means for every point the underlying rises or lowers the option value will increase of decrease .83


Theta

Theta


Theta cont

Theta cont.

  • Theta is the amount a option will “decay” each day.

  • This is not a static number and this number increases the closer the option gets to expiration as well as the closer or further away it gets from being ITM

    In our example:

    The 550 calls value will drop .36 every day the contract is open

    The 550 puts value will drop .31 everyday the contract is open


Examples

Examples

  • Now lets see if I can explain it in terms with words an examples. I myself just trade options like most trade securities. I do not expect to exercise the options when it comes expiration time. Exercise is where you actually buy or sell the underlying fulfilling the contract.

    Example of exercising calls.

    Say I bought one AAPL 520 call and paid $15.30/share (premium for the contract $1530 cash outlay) and come Jan 18 when the option expires AAPL is trading @ 545 and I want to own APPL. I would exercise the option buying 100 shares of AAPL from the option writer @ 520/share ($52,000). Keep in mind I paid the premium ($1530) to buy those shares @ 520 even with AAPL trading @ 545 on the close of Jan 18th. So my total cost per share for AAPL would be $535.30


Examples cont

Examples cont.

Example of exercising puts:

I bought 1 AAPL 535put @ $8.90 (cash outlay $890). I think AAPL is going to keep dropping till expiration, and I currently do not own AAPL. So come Jan 18th when it times for the option to expire AAPL dropped and now trading @ 510.

So you want to exercise that option. Here is where some brokers very. Keep in mind a put means you are “putting” it to the option writer, which means you are selling it to him. And remember I did not own AAPL so what am I selling to him? Some brokers will go out on the open market and buy the shares floating you the amount of the cost ($51,000 – 100X 510) and then sell them to the option writer for ($53,500 -100X535). Some brokers will require you to have the $51K in your account even if you are just using it for a few seconds.

Most entities who buy option are using them as a “stop loss hedge” to a long position they are holding.


Examples cont1

Examples cont.

Example of buying call options: (what I do)

On Friday I bought (BTO)10 AAPL 520calls @ 15.30. My cash outlay for that trade is $15,300. (10 contracts = 1000 shares underlying @ 15.30 (premium per share)) and the underlying price of AAPL is @ 532.50

Come Monday AAPL gaps up to 536.60 (4 point move). If you look at the delta those 520calls had a delta .76. So that means in minimum those option would now be worth $3.04. Granted they would be higher due to the fact they went even deeper ITM, but you can use the delta as a reference number.

So I place an order to sell (STC) 10 AAPL 520calls for $18.34

So profit on that trade is $3,040


Option chain online

Option Chain Online

  • Each brokers option chains will looks different. As well each brokers Delta and Theta will vary due to the way they calculate their Greeks. The example I used can be found at:

    Option Monster


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