Register for free to join our community of investors and share your ideas. You will also get access to streaming quotes, interactive charts, trades, portfolio, live options flow and more tools.
Register for free to join our community of investors and share your ideas. You will also get access to streaming quotes, interactive charts, trades, portfolio, live options flow and more tools.
I must admit I was a little shocked.
Yes you can choose which expiry you want... and what Chris said was correct. And your understand is correct too.
When they expire, you don't have to execute your contract (i.e.: have the bajillion dollars needed to own 1,000 shares of Apple stock). You can close that position out and have a cash settlement.
Sorry about the delay! I haven't forgotten about you guys! Been really busy since I was preparing for my presentation for Timothy Sykes' 5th Annual PennyStocking Conference, and then I got slammed with 80% worth of assignments due within the next week. Can't wait to finish school... six more months.
Anyway, after Thursday, I'm off for the next 12 days for mid-semester break, so expect it real soon. Within the next week.
+1
Very good resource, but it will take some time to digest everything. You realistically will not get through all his videos in only two weeks, so get started as soon as you can!
Yup! Sure thing!
Everything Chris said.
The reason why I went bearish was because 1466 is a pretty key resistance level on the S&P. We topped there exactly before coming down. On top of that, Apple's price action was weak.
Wow, why did you do that? I shorted calls today on Apple.
It's updated, but I won't be able to split it. I'd actually have to go through manually. Plus, my trades prior to the summer of 2011... can't verify because it didn't support my crappy Canadian brokers :P
Pretty much what Chris said.
Yes, you can't use margin (as in borrowed money from your broker) when trading options. However, there is still a 'margin requirement'. For example, if your only position was one short call on Apple, it may require you to put up $10,000. Hedging this position with a purchased call however can bring it down to only $500.
Does this make sense? Your long call needs to expire worthless if you wish to profit off of your short call.
It depends on a few things. Like I mentioned, options are very flexible so the reason will depend on their situation and current options position.
If, for example, they needed the long call or put in order to hedge against a short one (this is known as a spread), selling the long option before expiry will probably cause a margin inefficiency with their broker. You can think of it kinda like... the losing trade was a necessity in order for the winning trade to exist, and as long as you are net profitable, it does not matter.
Alternatively, if the only position they have is a long one, and it seems pretty inevitable that it will expire worthless, the trader might as well lock in whatever's left assuming the commissions do not outweigh the benefits.
If neither apply, perhaps they do not mind risking the $0.05 in premium in hopes of the option eventually going ITM.
Hope this makes sense.
How's everyone doing? I've been browsing but haven't had much time to write up an Options 201 yet for you guys. Anyone profit on PUNL?
Should be able to have something up this weekend :) any questions in the meanwhile about options?
Haha, that's me. Thanks for the warm welcome :)
Introduction to Options
Everyone's experience with options on this board is different. Some might have been burned in the past with them, others may have taken it as a course in college, and the rest might have no idea what the heck an option is. I'll be explaining the basics of options, what they are, and how they work.
If you already know what an option is however, this post probably won't help you in any way. I want to get everyone on the same page. Here we go.
Why trade options?
- You can control more stock for less money
---> One option contract is represented by 100 shares
---> The contract is usually only a fraction of the cost to actually purchase or short 100 shares of a company
- Leverage
---> Because your cost basis is lower, options are more sensitive to the price movements in a stock
- Income
---> There are a few option strategies that are considered "income generating"
---> These types of trades are my specialty and yields 5, 10, or even 20% safely and consistently on a regular basis
- Profit no matter which way a stock is moving
---> Up? Down? Rangebound? Volatile? Every price action can be profited from using options. Did you know that you can also make money if you don't know which way a stock will move, but you know it will move big?
- Hedge and protect your investments
---> You can use options to reduce your risk in an investment. Some may cost you money (like buying insurance), but there are others that won't cost you anything but the commissions
What is an option?
- An option is a derivative trading instrument
---> In other words, it derives its price from the underlying security
---> For example, an options on Netflix (NASDAQ: NFLX) derives its price from Netflix stock
- Options are contracts
---> Think of it as a transferable piece of paper with certain terms and conditions on it that the buyer and seller need to adhere to
---> You'll never know who your buyer or seller is, but a dollar gain in your account through options is a dollar loss in someone else's
What kinds of options are there?
- There are two types of option contracts
---> One is known as a call and the other is known as a put
- To put it simply, buying a call generally means you're bullish on the underlying security and buying a put means you're bearish on the underlying security
---> If I believe Apple stock were to go up in price, I could purchase a call option as an alternative to buying equity
Characteristics of an Option Contract
Each option has a few characteristics that differentiate themselves from one another.
- An option is either a call or a put (it can't be both)
- An option contract has an expiry date
---> Monthly options expire on the 3rd Friday of every month
---> New weekly options have been introduced a bit more than a year ago that start trading on Thursday and expires the following Friday
---> Quarterly options expire on the 3rd Friday of March, June, September, and December
- An option has a strike price
---> The price a trade would occur at if a contract were to become exercised regardless of the current market price (more on this later)
- An option has a cost known as the premium
---> Note that a $0.50 option actually costs $50 per contract because every contract is for 100 shares of the underlying security
Following so far?
- An option is simply a contract that is publicly traded
- It is also a derivative instrument which means that it derives its price from the security that the contract is for
- An option is either a call or a put, has an expiry date, has a strike price, and costs a certain amount to purchase
- If you're bullish, you can purchase a call and if you're bearish, you can purchase a put (note that you can be bullish or bearish and still buy the opposite option contract, but more on that at a later date)
Call Options
- To put it technically, buying a call gives you the right to purchase the underlying security at the specified strike price at the specified expiration date
- If the market price of the underlying security is below an option strike price, that option is known as out-of-the-money or OTM
- If the market price of the underlying security is above an option strike price, that option is known as in-the-money or ITM
- If the market price of the underlying security is at an option strike price, that option is known as at-the-money or ATM
An Example Outside the Capital Markets World
- Today is January 15, 2012
- You are unsure of whether you want to purchase a piece of land today, so you buy a contract from the seller for $1,000 which gives you the right to purchase the land for $200,000 by January 31, 2012
- In this case, the option buyer is paying $1,000 (premium) to have the right to purchase the piece of land for $200,000 (strike price) by January 31, 2012 (contract expiry date)
- Since the option buyer has the right to purchase the piece of land according to the details on the contract, it is similar to a call option in the capital markets
- If by January 31, 2012 you decide to purchase the lot and you find out its market value is actually $250,000, the seller will be at a loss since you have the right to purchase the land at the strike price and the seller has the obligation to deliver/sell the land at the strike price
- If on the other hand you decide not to purchase the lot, your loss is the premium you have paid for the contract
Example From The Capital Markets
- At the close of the markets on January 17, 2012, the $450 strike February 2012 expiry call option on Apple was trading at $5.67 per share
- The market price of AAPL at this time was $424.70
- Because an option contract is for 100 shares, this contract will cost $567 to purchase
- This contract states that the buyer of this option has the right to purchase 100 shares of Apple (per contract) for $450 on February 2012 after paying $567 up-front
- Why would anyone do that? You can purchase Apple for nearly $25 less from the market today, and you can save an additional $5.67 per share if you don't purchase the contract
Let’s assume that Apple closed at $425 at the close of January 17th to simply things. The symbol delta simply means change in profits (as a percentage) from the purchase price. Have a look at the bottom row--the option appreciated 253% when the stock only moved 10.6%. This leverage is what attracts people to the options world... and this example is nothing. The weekly options which more aggressive traders play can appreciate 500% in a matter of minutes just because of a $1 or $2 move.
Unfortunately at expiry, that option will be worth nothing if it is below the $450 strike price. Intuitively if you were able to understand the past few slides, this makes sense. The purchaser of the contract has the right to purchase Apple at $450. Why would they exercise the contract when they can purchase Apple at the market price for less than $450?
This options leverage also allows you to control 100 shares of a stock at a much cheaper price. If you look in the second column, you can see that 100 shares of Apple at $425 will cost you $42,500, whereas the option will only cost you $567 up-front. That’s a huge difference, and you may not have $42 thousand dollars to play Apple bullishly.
Apple and the $450 Strike Calls at Expiry
- While Apple moved only 10.6% from $425 to $470, the $450 strike option moved 253% from $5.67 to $20
- This is the power and leverage options can provide you, but this of course works as a double edged sword
- If Apple does not reach $455.67 or higher at expiry, you may see a considerable loss in your trade
---> Note that you do not need to hold an option until expiry (which is what the calculations were for)
---> You can still realize a gain even if the underlying security does not reach a strike price
- Break-even for a call option (at expiry) = strike price + premium
This image is what's known as a risk profile graph. As you can see, buying a call option gives you limited risk and unlimited reward potential. You will never lose more than what you put into the option. Have a look at some key inflection points. The chart starts heading upwards at $450. The call option will have what is called intrinsic value once it passes $450. That contract has no real value until it surpasses the strike price. As you can also see visually, your breakeven price is the strike plus the premium you paid for it. So for this example, your breakeven point is $450 + $5.67 = $455.67. Depending on your brokerage platform, you may be able to outlay this graph yourself. ThinkorSwim does it. Note that although this risk profile is particularly for the $450 strike calls on Apple, all call risk profiles will look like this but will have different PnL values.
So far we've covered...
- The definition of a call option: buying a call gives you the right to purchase the underlying security at the specified strike price at the specified expiration date
---> Selling a call on the other hand gives you the obligation to sell the underlying security at the specified strike price at the specified expiration date
- Options give you leverage
---> You can make money really quick with options, but you can also lose it very quick
---> Buying a call gives you an unlimited reward, limited risk profile
A Strategy an Investor Can Use: Covered Calls
- Used by those who:
---> Want to gain some extra income off their (potentially slow moving) investment
---> Don't mind having to sell the investment and capping your gains at a particular price on the upside
For example...
- Apple is trading at $425 and the $450 strike call option is $5.67
- You own 100 shares of Apple as an investment and don't plan to sell it
- However, Apple has been a slow mover lately and it has been hovering around $425 for quite some time (obviously this is only a hypothetical situation)
- You decide to sell one contract of the $450 strike call
- You have now executed what is known as a covered call
What does this mean to you?
- As an option seller, you have the obligation to sell Apple at $450 by the third Friday of February to the contract buyer if it becomes exercised
- However, you get $5.67/share up-front
- If Apple never makes it to $450 by that date, the premium is all yours!
- If on the other hand Apple goes to $500, your stock gain will be capped at $450 unless you buy back the call you initially sold
As you can see, the covered call strategy will allow you to make additional income on your investment. However, your gains will be capped after $450 for as long as the covered call is in place. Again, the breakeven point is calculated by taking your strike price and adding it by the premium--so $455.67.
Put Options
- Buying a put gives you the right to sell the underlying security at the specified strike price at the specified expiration date
- Selling a put gives you the obligation to buy the underlying security at the specified strike price at the specified expiration date
Outside the Capital Markets World
- Say you own a piece of land and a prospective buyer comes along and tries to negotiate a price
- You don’t really want to sell the land, but you’re very tempted to because you’ve always wanted to move into the city and start your own business. This could be your opportunity!
- Worried that you would not find another buyer, who offered a very generous amount given these market conditions by the way, you decide to purchase a contract from the offerer
- The conditions were: the contract would expire a month from today, the selling price would be $400k, and the contract will cost $1,000 to purchase
- In this example, if the contract were to become exercised, the purchaser of the contract (the land owner) has the right to sell the land for $400,000 to the contract seller as long as it is before the expiry date--one month from today
- This contract is the exact same as a put option from the capital markets world
- If you decide to not sell the lot, you will lose out on the premium you have paid
Example From The Capital Markets
- Let’s say that on January 17, 2012, Netflix (NFLX) was trading at $100/share
- You’re bearish on this stock and you decide to purchase the $90 strike put for $5, expiring the month of February 2012
- Because an option contract is for 100 shares, this contract will cost $500 to purchase
- This contract states that the buyer of this option has the right to sell 100 shares of Netflix (per contract) for $90 on February 2012 after paying $500 up-front
Let's assuming Netflix's market price is at $100 at the close of January 17 and the February $90 strike put is $5. The chart is fairly self-explanatory.
And here's what the risk profile graph would look like. Again, similar to the calls, buying puts is an unlimited reward (technically limited though since stocks can only go to $0), limited risk trade and the shape will look the same for all put options.
Call/Put Options
- Buying a contract will always give you the right to do something
---> Buying calls will give you the right to buy a certain security at a certain price and buying puts will give you the right to sell a certain security at a certain price
- Selling a contract on the other hand will always require you to perform your obligation to do something if the situation arises
---> Selling calls requires your obligation to sell a certain security at a certain price and selling puts will require you to buy a certain security at a certain price
Buying Insurance: The Protective Put
- Perhaps you’ve bought a particular stock, let’s say Tesla Motors (TSLA) at $25
- You believe it to be a good company, however two people on management recently left before their electric car debut and now you’re a little worried about this
- You don’t want to sell your stock however
- What if the leave was justified and the car actually will take off? Will you hit yourself for missing the boat?
- As an alternative to selling, you could purchase a put option for every 100 shares you own
- Purchasing a put option in this case will act as insurance
- Remember, buying a put gives you the right to sell the underlying security at the specified strike price
- For instance, let’s say I decide to purchase the June $25 strike puts on Tesla for $5
- This is a little pricey to pay, but that’s because you’re paying for four months (if today January)
- You have now effectively capped your loss at $20 ($25 - $5)
- A 20% loss would be unfortunate, but you believe this pick to yield 100%+ in the future!
- No matter what price Tesla is at by June (let’s say $0), the puts will allow you to sell those shares for $25 (but costing you $5/share)
- The put you have purchased can be sold at any time
- Sometimes it will be for a profit and other times it will be for a loss (but never greater than the total amount it cost you)
- Options will lose value over time
- This is known as time decay or theta
- Intuitively, this should make sense because as time goes by, your ‘insurance’ covers less days
- Insurance will be more expensive during volatile markets
- Again, this should make sense because there is now a greater probability that you will exercise your ‘insurance policy’
Waiting For A Good Company To Go On Sale: Selling Naked Puts
- Selling naked puts is simply selling a put, but think about why someone would want to do that
- A put seller has the obligation to buy the underlying security at the specified strike price
- What if you actually wanted to own the stock?
- Let’s take Apple for instance that’s currently trading at $425
- You would like to purchase 100 shares of Apple, but you’d only do it at $400
- Instead of placing a limit order to buy 100 shares at $400, you can opt to sell one $400 strike put contract for $5
- If by expiry Apple never reaches $400, you get to pocket $500 instead of waiting to get your limit order filled
- If by expiry Apple does reach $400 and perhaps fall below, you’ll be at an unrealized loss, but this shouldn’t bug you if you were going to buy Apple at $400 anyway
To those that are new with options? Please don't tell me that you don't think that these strategies are damn cool.
Thanks Chris. You made a good point but I didn't realize people were going to start analyzing my past trades.
If I were to win 100% of the time with my bread-and-butter strategy, my win rate would probably read as 52%. Even though I am net profitable from the trade, it takes into account the other legs which might not be profitable (but was required for the trade to work).
They are not selective. I just did not update my trades yet.
I can't disagree on anything you have said. You are very correct.
Nonetheless, I wish to share with the people here what I do. Because of your concern, I will give extra attention to clearly stating the risks involved so they know what they are getting into.
I started options very early and I loved it. This risky perception of options is what deters many people from ever attempting to learn it, but it really does not have to be the case. Everyone needs to find their own strategy which works with their personality. Maybe this is the right one for them.
Again, my strategy does not simply involve buying calls and puts. In my opinion, that will cause an inexperienced trader to lose money faster. The combos you can create with them are absolutely amazing. It's unfortunate that not everyone is aware of them.
Thanks Garyst.
Options does sound like the wrong way to go, but when I started trading when I was 17, I started with options. I'm still around four years later. The strategy I use does not simply involve long calls or puts. That would be introducing a faster way to lose money to you guys.
Options are incredibly flexible and the different kinds of strategies you can make when you combine various calls and puts together? You can make some really good, high probability trades that can be repeated over and over.
And if there are any investors here, they can make money on their stock that they never realized was possible, or even decrease the risk on their position for free.
I'm an options trader and a friend of Chris. Like I mentioned in my first post, I love helping people and he told me that there's a good group of ya that got burned recently. I want to help alleviate some of that pain and share what I've been doing successfully with you guys.
Thanks for the warm welcome everyone! I'll get you your first lesson written up shortly. Expect it sometime tonight or tomorrow :)
In the meanwhile, I wrote a blog post on making new networks online, specifically on how to write a proper e-mail when introducing yourself. I hope you guys will find it useful.
Hi there. My name is Alex Vo and I’m here to tell you about what we all have planned here for you guys.
First, a bit about myself. I started trading the markets when I was 17 years old with only a thousand dollars. Like many aspiring traders, I started with very little money but built it up exponentially over the past few years (see trades here). I am currently up over $100,000 since I started verifying my trades a year ago and I achieved this while being a fulltime student at a very competitive business school in Canada.
Now, there are many reasons why I got into trading and you probably have the same idea. You get to be your own boss, you can work where you want, when you want, you get paid based on your performance, and success and profits are usually correlated with effort. Trading can also bring you more money into your life than you know what to do with. It's one of the only careers where you can become a millionaire overnight and not be known. Imagine how much better your life would be with complete financial freedom and independence.
Again, I am currently a fulltime student. This means that you too can achieve profits like I have even if you are a fulltime parent, 9 to 5 worker, part-time trader, student--my strategy is very flexible which you can fit into your schedule as long as you can spare an hour or so at the minimum once you obtain the skill set required.
There is a famous quote by author and motivational speaker Zig Ziglar. “You can get everything in life you want if you will just help enough other people get what they want.”
I have always wanted to help other people in my life, starting with my family and particularly my younger brother. Due to my family situation, I think it's safe to say that I had more opportunities than him. For example, I was able to grow up in a house with a backyard to play in for my entire childhood. My little brother on the other hand, who's currently nine and a half years old, does not have the same privilege I had. I plan to use my success from trading very shortly to buy my loving mother and brother the house they deserve.
In the same fashion, I want to help every single one of you achieve your financial goals and make your life better, whether it's by paying off your mortgage, car payments, student debts, a family vacation, and so on.
The first thing I will be doing with you guys is giving you all a few "courses" on the basics of option trading so that everybody is on the same page. I look forward to chatting with all of you, and best of luck.
Up next, Options 101.
Thanks!
Alex Vo