Option Tips: Leverage Assets and Control Risk
You’ve probably heard the saying “Buy low, sell high” at one time or another. An ‘option’ is a contract that gives the buyer the right, but not the obligation, to sell the contracted asset at a specified time which is called the “Strike Price”, on or before a specified date. The seller, also has a corresponding obligation to complete the transaction if the buyer exercises their right to sell. The buyer of the option paid the seller a premium for the right to sell at a specific price and during a specific time frame. One of the most important things to learn before you begin to venture into the world of options, stocks, trades and money is learning the terminology.
Call Options give you the right, but not the obligation, to buy a specific stock at a specific price per share within a specific time frame. If you sell a call, you have the obligation to sell the stock at a specific price per share within a specific time frame. Put Options give you the right (but not the obligation) to sell a specific stock at a specific price per share within a specific time frame. If you sell a put, you have the obligation to buy the stock at a specific price per share within a specific time frame. In a business where money is literally everything, it will pay off to take some time to learn the difference. An Introduction to Stocks, Futures, Forex and Options Markets is a great place to start. Options contracts have been around for centuries and gained in popularity in 1973 when they began to be issued with standardized terms and traded through a guaranteed clearing house. In today’s day and age options are traded regularly through clearing houses.
Option trading is a way for savvy professionals to be able to turn a profit without having to rely on the “buy low, sell high” strategy. You see, with options you can sell when stocks are up, down, or stagnant. Options can be used to cut losses, protect gains, and control large amounts of stock with relatively very little cash outlay. Learn how to trade stock options and profit in an up and down market by enrolling in our Option Profit Mini course. However, there’s always a ‘but’, right? Options trading, just like stocks, can also be risky. So, before you begin to trade options, take a minute to think about the effects that variables can have on your selling and buying strategies.
Time for a brief history lesson. The New York Stock Exchange opened in 1791. In 1791 however, there was no centralized marketplace where options could be traded. Options in 1791 were traded over the counter with the assistance of broker-dealers whose job it was to match options-sellers with options-buyers. Every piece of the option had to be negotiated, strike price, expiration date, and cost. By the late 1800’s the market evolved and broker-dealers began to place sales ads in financial journals in the hopes that they would get a buyer to bite. Then, in 1929 the stock market crashed and things began to change with the intervention of the Government and the establishment of the Securities and Exchange Commission (SEC). There was more growth with the development of the Options Clearing Corporation (OCC) and the Chicago Board Options Exchange (CBOE) in the 1970’s. The market and how options are traded has changed drastically since their creation in 1791. The 1980’s saw the introduction of index options and the 90’s birthed Long Term Equity Anticipation Securities (LEAPS) and of course online trading.
The internet and online trading allows for instant options gratifications, quotes are available on demand with a wide range of strike prices and expiration dates. This makes it infinitely easier for an investor to place an option trade as well as research the market and their options before purchasing. Take advantage of our 3 course bundle and learn the Basics of Options Trading before you begin to risk yourself financially.
We’ve covered a brief history of options, what they are and how they started. Now, it’s time to talk some Greek.
Delta is the amount an option price is expected to move based on a $1 change in the underlying stock. Calls have positive delta, between 0 and 1. So, if the stock goes up and no other pricing variables change, the price for the call will go up in theory. Puts have negative delta, between 0 and -1. So, if the stock goes up and no other pricing variables change, the price of the option will go down. So, if a put has a delta of -.50 and the stock goes up $1, in theory the put will decrease in price $.50. If the stock goes down $1 however, the price of the put in theory will increase by about $.50.
Gamma is the rate that delta change based on a $1 change in stock price. Try and remember the difference this way, if delta is the speed at which option prices change, gamma is the acceleration. Options with the highest gamma are the most responsive to changes in the price of the underlying stock. Delta is an unset number that will change as the stock prices change. But, it’s important to keep in mind that delta doesn’t change at the same rate for every option based on a given stock.
Thing of theta as enemy number one, if you’re an options buyer. Time decay, or theta is the amount of the price of calls and puts will decrease in theory for a one-day change in the time to expiration. Take note that for out of the money options, theta will be lower than it is for at the money options due to the dollar amount of time value being smaller.
Vega is the amount call and put prices will change, in theory, for a corresponding one-point change in implied volatility. Vega does not affect the intrinsic value of options, it only affects the time value of an options price.
The amount an option value will change in theory based on a one percentage point change in interest rates. I’ve mentioned Rho to make you aware that he does exist. However, you probably won’t see him much or speak of him much until you become more experienced with options.
By nature, I’m a cautious person. I also like to know just how much money I will have in the bank at all times. So, whenever I begin to put money at risk I’m especially cautious. Buying and selling options can be very lucrative, but it can also be very costly and uncertain depending on the variables. The markets as we’ve all seen in the not so distant past can crash and burn from one day to the next. An entire life’s work and savings can vanish in an instant. Control your risk by leveraging your assets as much as possible by learning as much as you can before you begin to invest in options. Be a Smart Option Trader, learn how to maximize your gain and control your risk with this course. Don’t jump into something without knowing the risks that lie ahead. Be a smart trader, not a broke one.
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