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Welcome to the exciting world of options, the purpose of this site is to share my wealth of knowledge and experience in the world of options trading. Options are a great way to reduce (or increase) the risk exposure of your portfolio and are an essential part of any serious investors trading strategies. Trading options is a little more complicated than trading stocks, but don't be discouraged learning how to trade options is an effort well spent.
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In the simplest term Options are rights to buy (call) or sell (put) a fixed amount of stock at a specified price within a particular period of time.
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There are 2 kinds of options a call and a put, the right to buy and the right to sell. Easy enough. An investor may buy or sell a call or a put option, In other words there are 4 positions that can be taken: buying a call, selling a call, buying a put and selling a put.
The next variable to add is time, each option contract has a time dimension associated with it. The option holder has the right to buy or sell the underlying stock within a particular period of time. After the time is over the holder no longer has that right.
The last variable is the strike price. This is the price that the contract is made at, in other words when you exercise a call option you may buy the underlying stock at the strike price or when you exercise a put you may sell the underlying stock at the strike price.
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Combining different combinations of buying/selling, calls/puts, with different time and strike price combined with owning or being short the underlying stock creates a wealth of different trading strategies.
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A call option is in the money when the strike price is lower than the market price of the underlying stock.
In this situation you have a right to buy a stock at a price that is lower than the market price.
A put option is in the money when the strike price is higher than the market price of the underlying stock.
In this situation you have a right to sell a stock at higher than the market price.
An option is at the money when the strike price is equal to the market price of the underlying stock.
In this situation you have a right to buy/or sell a stock at the market price.
A call option is out of the money when the strike price is higher than the market price,
In this situation you have the right to buy a stock at a price higher than the market price.
A put option is out of the money when the strike price is lower than the market price.
In this situation you have a right to sell a stock at a price lower than the market price.
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There are 2 components to the price of an option.
The intrinsic value, which is the amount the option holder can realise by exercising the option
The time value, the value over and above the intrinsic value The price that the market puts on this time value depends on a number of factors: time to expiry, volatility of the underlying product price, risk free interest rates and expected dividends.
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Time has value, since the longer the option has to go until expiry, the more opportunity there is for the underlying price to move to a level such that the option becomes in-the-money. Generally, the longer the time to expiry, the higher the option's time value. As expiry approaches, the value of an option tends to zero, and the rate of time decay accelerates.
The volatility of an option is a measure of the spread of the price movements of the underlying instrument. The more volatile the underlying instrument, the greater the time value of the option will be. This will mean greater uncertainty for the option seller who will charge a high premium to compensate. Option prices increase as volatility rises and decrease as volatility falls.
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There are 3 kinds of general option strategies:
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