Stock options trading course could be highly complex and therefore, should be carefully dealt with. It requires a trader to make three distinct choices viz. Deciding the direction in which the stock would move, how low or high the stock price would go, and the time frame in which all of this would occur. With our simple and effective options trading course, you can learn everything you need to know about stock options trading. The course will cover the different aspects of options trading, including long and short put and call, price patterns, options terminologies, and options market concepts, among others.
The course will reveal more about successful or profitable options trading strategies as well as the advantages and disadvantages of options trading. Continue reading to find out more.
Options Markets Concepts Explained
A stock option is an instrument, which falls in the category of derivatives. Options are categorized as derivatives as their price is intrinsically related to some other amount. They are necessarily contracts, which provide the rights to, instead of the obligation of buying or selling underlying security at a specific price before or on a particular date. This right to purchase is referred to as call option whereas the selling right in is known as a put option.
An option is an instrument for trading that is traded by individuals who are not interested in investing heavily in stocks. It is essentially an agreement that is established between 2 distinct parties for selling or purchasing the rights to a stock. For instance, the one who buys options is required to pay a premium amount to the seller, thereby hoping or speculating that the price of the stocks might go up right before the agreement expires or vice versa. Options enable individuals to adopt several trading strategies/techniques with unlimited/limited profit/risk potential in addition to creating speculative and hedging related opportunities.
Options Trading Terminology
Before proceeding further, take a look at the options terminologies below:
Call: An options contract that gives the purchaser the rights, instead of the obligations, for purchasing a specific commodity or asset or for entering into a long position.
Put: An option that provides the holder of the option with the rights and no obligation for selling a specific quantity of a commodity or any other interest at any given, future or before the date.
Premium: A payment made by the option purchaser to the writer of the option after he/she has granted the option contract. It is also defined as the amount by which a price would increase for purchasing a commodity of better quality.
Exercise: To choose to sell or buy, using the rights provided to the options contract owner.
Expiration: The expiry date of the options contract.
Time Value: The portion of a premium of an option, which is more than its intrinsic value, thereby indicating that the stock option may move into the money.
Grantor: The writer, maker, issuer or seller of the options contract who is willing to buy the commodity/ forex, in return for the premium duly paid for the stock option, where put option is concerned, or for selling the commodity/ forex where a call option is related.
Conversion: This is a position, which comes into existence due to the selling of a call option, buying of a put option as well as purchasing the instrument (for instance, the futures contract), wherein the options has the similar striker expiration and strike price.
Delta: This is the change that is expected at the price of an option, because of a single unit change within the cost of the futures contract or commodity.
At The Money: This refers to the point or level where the strike value of an option is similar to that of its current trading value of the commodity.
In The Money: The option contract’s state wherein its value is positive when exercised.
Out Of the Money: The state wherein the options contract has no intrinsic value.
Spread: The purchasing of a futures contracts delivery month as opposed to the selling of another futures contract delivery month of the underlying commodity.
Straddle: The purchase of one delivery month of one commodity against the sale of that same delivery month of a different commodity.
Strangle: A position of the option that consists of the buying of call and put options that have similar expiry dates but very different strike prices.
Synthetic Futures: The position which mimics a contract, which is duly created by way of combing put and call options.
Option Writer: The grantor, seller, or issuer of an options contract.
Advantages and Disadvantages
Needless to mention, options are versatile and unique instruments for trading, which can easily be traded on a number of instruments like the stock, currencies, stock indexes, futures, ETFs, bonds, and commodities. Following are the advantages and disadvantages of options trading.
Options are a great source of generating passive income, and they offer scope for leverage. In addition to this, options provide traders with the opportunity to profit from a bear, bull as well as sideways markets. They can also be for hedging against different types of risk exposure.
Options come with an expiry date, which means they can expire worthlessly. Also, if a trader holds onto a trade, which goes against him/her and when the options run out of money at expiry, then the trader could lose all the money they may have invested in it. In the case of an option, an investor could make wrong forecasts with regard to the timing and direction of the price of the stock.
Long and Short Positions Characteristics
As far as stock options are concerned, traders can take two distinct positions, including long and Short positions. Continue reading to find out more:
LONG Position Characteristics: When a trader buys a call option, he expects that the price of the underlying asset will rise. The long position is bullish in nature as well as expects the price to go up, and purchases call at a low strike price. Investors can easily hedge their long position through a long put position, thereby granting him the rights to sell the stock at a definite price.
SHORT Position Characteristics: Traders are in Short position when they purchase a right for selling (putting). They speculate that the price of the asset would drop and thereafter profits by selling at a pre-decided option pricing, which is more than the prevailing market price.
Volatility: measures the magnitude and rate of the changes in the prices (both down and up) of the asset. When the volatility is higher, the option premium will also be higher and vice versa. If a trader manages to measure the SV (Statistical Volatility) for an underlying, then he/she can input the same within a standard options model for the purpose of calculating the option’s FMV (Fair Market Value).
Historical VS Implied Volatility
It is crucial for traders who deal in options to understand that changes in volatility affect the options trade either negatively or positively. Below find out more about historical vs. implied volatility:
Traders can utilize implied and historical volatility for assessing whether the options are costly or not very costly. It also helps them in determining whether the options are under or overvalued. Historical volatility checks the changes in the securities by simply measuring the changes in price over a definite time period. This particular calculation could be owing to intraday changes; however, often calculates the movements on the basis of the changes from one particular closing value to another one. Historical volatility could be calculated in increments that range from ten to hundred and eighty days of trading.
On the other hand, implied volatility indicates the fluctuations that are expected in underlying security or index over a specified frame of time. The demand and supply level that drives the implied volatility metrics is impacted by a number of factors, including market-related events as well as the news pertaining to a single organization.
Traders who trade options refer to the gamma, delta, theta, and vega of their options positions. Together, these terminologies are referred to as Greeks. They offer a method for measuring the option price’s sensitivity. These terminologies may appear intimidating and confusing to new traders, but they when understood in the right manner, these concepts can aid traders in understanding the reward and risk of the position of an option.
Delta: Delta is an important Greek. The delta value of the option indicates how its theoretical price would move in terms of price change within the security, with the assumption that all the other factors are the same. It is expressed in the form of a number ranging between -1 as well as 1.
Theta: Theta is another important Greek, which is associated with the impact that decay in time has on the option price. As a result, the extrinsic price of the option begins to diminish right from the time it’s written to until the expiry time, and eventually, the extrinsic value diminishes.
Gamma: Gamma measures the delta value’s sensitivity of the option in comparison to the pricing movements of the security. The option’s delta value is not fixed and changes by the conditions of the market. The cost of gamma indicates the rate as per which the value of delta moves about those very changes.
Vega: Vega is indicative of the extent to which the sensitivity of the price of the option is to the volatility changes within the security. It indicates the extent to which the option’s price would move in relation to the movements within the implied volatility of the security.
Rho: The value of rho is utilized for measuring the extent to which the option’s price is sensitive to the changes in the rate of interest.
Understanding chart (Candlestick): Candlestick charts displays the emotions by representing the price size movements visually in different types of colors. Traders utilize the candlesticks for making trading-related decisions on the basis of patterns that occur regularly that further help in forecasting the price’s short term direction. Candlestick charts are ideal for gauging market sentiments. The candlestick displays the options market’s high, open, close, and low prices for a given day.
Trend trading is all about trading in accordance with the flow. In order to read the price patterns, trends as well as the trend’s direction, a trader must use the following strategies. Traders must understand that the markets can either go down or up or sideways. Most of the traders utilize candles and bars for observing the chart patterns, but it is better if they use the line graph. The line graph helps in identifying the trend’s direction and helps in identifying the market’s overall direction. Apart from this, traders can also use the high and low to check if it is an uptrend, downtrend, or range. Moving averages are another important tool for identifying the direction of the market. The moving average’s length has an impact on the signals when the market turns. A small or fast-moving average may provide a number of false or early signals, as it does not react too much to the minor movements in the price. A slower moving average may provide late signals, or it may help the trader in riding the trends longer. Finally, trend lines and channels are another quick way to identify the trend’s direction since they help in understanding the range markets in a much better way.
Option pain is also referred to as Max Pain or Max Option Pain and is revolves around the theory that given that most of the options purchasing traders end up losing while options trading, the underlying security’s price should be duly manipulated to close at the time of options expiry at a given price. This results in the expiring of most of the options as they are out of the money. If the Option Pain theory is to be believed, it actually is possible to predict the exact value at which the stock shall close during the options expiry via charting the call as well as put options open interest. This price is referred to as the Option Pain or Max Pain.
Short straddle: The short straddle also known as the naked straddle or sell straddle is a neutral options strategy, which revolves around the selling of a call and out of the similar underlying security, expiry date, and striking price. A short straddle is a limited profit and unlimited risk options strategy for trading, which are utilized when the trader assumes that the security will witness limited volatility in the short term.
Iron Condor: The iron condor is a non-directional, limited risk strategy for trading, which is created for having a huge probability of earning a small and limited profit at a time when the security is expected to have lower volatility.
Iron Butterfly: The options offer traders with several methods to earn money, which can’t be duplicated using securities like bonds or stocks. Not every type of option trading is a highly risky venture. There are several ways in which the losses can be minimized. One such way is by utilizing the iron butterfly. This strategy outlines a specified limit on the amount that a trader can lose or gain.
Calendar spread: In financial terminology, the calendar spread is spread-based trading involving the purchase of options or futures that expires on a specific date as well as the selling of that very instrument, which expires on another date. The calendar spread can be easily created using either all the puts or calls, which is also referred to as the horizontal spread or time spread. Utilizing calls, the calendar spread can be easily set up by purchasing the long-term calls. The calendar comprises of a short option (put or call) in a near term expiry cycle as well as a long option (put or call) in a long term expiry cycle. Both types of options are similar to each other and utilize the similar strike price.
Strategies (Bullish Strategies)
The bullish options trading strategies are used at a time when the trader of the options hopes that the underlying security price will move up. It is essential to understand the extent to which the cost of the stock will go higher as well as the frame of time within which the rally would occur if one needs to pick the best strategy for trading options.
Long Call: It refers to the single position trading strategy, which involves just one simple transaction. It is suitable for newbie traders and includes an upfront cost.
Short Put: This requires one transaction and produces upfront credit. It is ideal for beginners.
Bull Call Spread: This strategy involves two transactions for creating a debit spread.
Bearish Strategies: The bearish options trading strategies are used at a time when the trader hopes the security price to move down. The put buying strategy is one of the most prevalent bearish strategies for trading options. Usually, the cost of the stock does not go down. However, the bearish options traders typically set the target pricing expecting a decline and use bear spreads for reducing risk.