Last update: July 2021
Welcome back to the Options 101 series presented to you by Tackle Trading! In this segment, we are going to explore the basic question: what is an option? During this segment, we will also dive into the basics of strike prices and expiration. This series will be a blog series originally and then supplemented with videos and quizzes down the road. If you like the series, please post in the chat and let me know.
Options are contracts
Options are contracts. They were designed and created so that institutions and investors could control the risk of their core positions. Speculation and direction were a bi-product of this creation. Options are always tied to an underlying instrument. That product can be stocks, futures, ETF’s and indices. The contract itself is independent and can be traded with or without ownership (long or short) in the underlying product. Options can be exercised by the buyer or assigned to the seller.
Options expire. Like the milk in your fridge, there’s a date printed on the options contract that after that point they no longer exist. Most options expire on a Friday and settle on Saturday. Index options expire on Thursdays and then settle on Friday mornings based on the settlement value of the index. If you’re going to trade index options you need to check the expiration date. Some index options expire on Friday as well. A simple phone call to your broker or help request can give you any clarity you need.
Calls & Puts
Options come in two types: calls and puts. As a trader, you have the opportunity to buy and sell the options. You can buy one option and sell another option to create a spread. Spread trading, whether in vertical, calendar or ratio spread versions, are very popular strategies in the options market. We’ll examine these strategies in upcoming sections of the options 101 series.
When you buy options, you are considered as an owner of the option. Some traders call this going long or purchasing a debit. Both are true. Buying an option has a set risk, higher reward and can be done in any basic account qualified for options trading. To trade options, you generally need to request permission with your broker by submitting a form either when you set your account up or after the fact by communicating with them. You can buy options in IRA, Margin, and Cash accounts. If you have a margin account you will be subject to the SEC rules on day trading if you have an account less than $25,000. If you plan on day trading options you may want to talk to your broker about account alternatives that don’t have these restrictions.
Option sellers are taking on a credit trade that is generally part of combining the sale with other positions they own – like stock ownership in the example of a covered call. You can sell options naked. A naked put position is one of the most popular options strategies used in the market – and one of the most proven to work. Options sellers need to set up a brokerage account with an appropriate trading level. You can sell options in a portfolio margin account, margin account or IRA. Your margin or buying power requirements will change depending on your account type. Options selling is a fantastic type of options trading and will benefit from time decay. If you’re going to sell options, you need to understand the risks of assignment, margin changes and leverage.
On any given underlying equity, there are strike prices available for you to choose from. There are many reasons why a trader chooses an In, Out- or At-the-money options. As you develop your strategies, you will learn why you choose to use one type of strike over another. Strike prices come in increments of 1.00, 2.50, 5.00, and other non-standard increments. To find out what strike prices are available for the options you want to trade, simply open an options chain inside your broker and look at them. The strike you choose will define the nature of the contract. If you buy a 20 strike call, it will determine that you have the right to buy at 20.00 specifically. If you buy a 20 strike put. It will determine that you have the right to sell the underlying at 20.00 specifically. If you sell a 25 strike call against a stock you own, you are giving the rights up to the market that the market can take your stock at 25.00. The strike price determines your exact contract obligation or rights.
Next in our series of options 101 we will examine the symbols themselves, quotes for an option chain and the bid/ask spread. We will also discuss Open Interest and Volume. Thank you for reading, and as a team member of Tackle Trading – Get in the Game!
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