This is going to be a thread for anyone that would like a very rudimentary lesson on what options are and some of the terms you will hear. This article is strictly discussing American Style options and the basics for you to reference / research.
So “What are Options?” in the world of trading ? To start, think of options as another financial instrument for you to utilize just like margin on your favorite exchange, leveraged ETFs, or your go to crypto index ticker. Whatever the choice, “Options” are just another tool at your disposal to trade with.
On a technical sense Options are financial derivatives that you can buy or sell on a agreed upon date but are not obligated to. People most commonly tend to use options in a strategic way to generate passive income, speculate or hedge positions. Options are a from of leverage so as appealing as the strategies may seem, they hold risks that you should consider ahead of time.
Now the most common form of options are known as “Calls” and “Puts”, lets get into a bit of detail to explain what they are:
Call Option- This is when you are making a Bullish bet, you will be expecting the price to hit a certain price point or exceed it. Call options have bullish buyers and bearish sellers.
Put Option - This is when you are making a Bearish Bet, you will be expecting the price to fall to a certain point or go lower. Call options have bearish buyers and bullish sellers.
Options also have an “Expiration Date” that you decide on before you buy which is essentially you deciding when the last day to trade your option is. The following day your option(s) are deemed worthless. So when your selecting the expiration date you’ll want to keep in mind a few things:
When will the price of your Call or Put option will exceed or go to the expected price.
When will the asset produce favorable volatility or for how long.
In most cases you can “Exercise” a contract and purchase it out right, also keep in mind 1 single options contract is equivalent to 100 shares of whatever underlying asset, so if a trader chooses they can exercise all their contracts if they have the cash to cover it instead of letting the options expire or simply to buy out their options contracts for other strategies.
Lets give an example now:
“Trader Joe want take a trade to speculate on Ethereum’s price and how they believe that its going back to triple digits before Christmas according to their Technical Analysis and On-chain Data .”
If you wanted to play an Options play based off this thesis then you are wanting to do a PUT play as you are assuming ETH will go down to a certain price point and before an expected time period. Your expiration in this case would be a date close to, at, or beyond Christmas. It would also look something like this “600p 12/25 “ , this simply shows your strike price(600) followed by a P or C representing a Call or Put and finally the expiration date(12/25).
Another important factor to take into consideration is the Premium you pay, if you are buying a Call or Put , you will pay a base price of lets say $1000 for 10 contracts of the 12/25 600p on $eth , if they expire worthless you lose the $1000 premium . Premium is essentially the cost you paid for whatever expiration date and strike. Keep in mind when you are looking to buy a strike further out from the current date it will cost more and it will also cost more to buy a strike in the money vs out of the money .
ITM, ATM, and OTM are terms you will often hear and they just represent what I have written below. They each have their own trading strategies that can be used which I’ll discuss on the next options post.
ITM = In The Money: When you select a strike below the current price.
OTM = Out of The Money: When you select a strike further away from the current price.
ATM = At The Money: When you select a strike closest to the current price.
Lastly lets touch on “Options Decay” also know as Theta Decay as a factor you should focus on so you can manage your risk. Options contracts are affected by “Time Decay” , what this means is that as the expiration date approaches the price of your options changes due to that . This is why you want to make sure you manage your options before they expire (unless doing 0-DTE). The more time you have left on your options the less the decay will occur and the less time you have left the more decay will occur, with both also depending on how far they are from ITM. We didn’t touch on Greeks this lesson but I will next time, they are just ways to judge the decay, volatility, underlying price and rates of change.
I hope this was helpful, I will certainly get a detailed post out soon with some strategies, I’ll leave you with a visual example of the mechanics of a Call Option.
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*Linking a Options Profit Calculator you can mess around on which will give good examples on gains / decay once you plug in the ticker and select the parameters. Stocks only*
https://www.optionsprofitcalculator.com/
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