Last Update: August 2021
Hello, Tackle family!
My kids are back so I am super excited this week. They were on summer vacation in Kenya with their grandparents and one of the things I asked them was whether they learned any new words in Swahili while they were there. I must admit I got a kick listening to my son try to put together a few words. One of the words he learned was “kuja hapa” meaning “come here”. He said he didn’t know what he was being told to do but he guessed what it meant when the person also made a hand gesture as he was calling him. I’m sure if they had stayed a few more months their vocabulary of Swahili words would have been a lot more. This reminded me of when I was a new trader learning the options lingo. I could not wrap my brain around all the different terms that were coming at me. Trying to figure out what a bear call and bull put were let alone figure out which one was a bullish or bearish strategy was quite confusing. Just when I had one term figured, out another one was around the corner. When I first heard the term Iron Condor from fellow Tackle contributor Bob Shannon, he had to spell it out on a napkin and draw a risk graph in order for me even grasp what it was. I was in love with the Iron Condor and was determined to learn how it worked and to this day is one of my favorite strategies.
So, let us talk options, and let me try to help you make sense of it all. I love trading options contracts because they allow me to have control shares of stock without owning them.
There are 2 types of options:
- Call options
- Put options
The 4 ways to trade options are:
- Buy a call
- Sell a call
- Buy a put
- Sell a put
Combining them is what gives them the crazy names. Once you have the technical analysis of a stock and you determine a trend, you then pull the trigger using options contracts. The rules on which delta and expiration months vary with each strategy. Also, understanding the Greeks and OTM, ITM, and ATM options are an important part of the system and process but for now, let’s just focus on defining the common option strategies. Another way to categorize options is to determine if it is a debit trade – pay to get into the trade, or a credit trade receives a credit to get into the trade.
This is most simple to understand. You buy a call option with the expectation that the price of the underlying stock will move upwards. The trend is bullish and the maximum amount of money you risk without an exit strategy or stop loss is what you paid for that option and unlimited profits. This a debit trade.
Also a debit trade however in this case, the expectation is for the price of the stock to move downwards, therefore, the trend is bearish. Just like the long call, their limited risk which is the cost of the option and unlimited profits.
Also known as the naked put, is a credit trade that is a neutral to bullish trend with unlimited risk if the stock goes to zero and rewards are limited to initial credit or premium received. Since you do not have to pay to get into the trade, there is a margin requirement. In other words, your brokerage account needs to have a certain money or buying power set aside in order to able to cover the risk of the trade.
This credit trade is also known as the naked call has a neutral to bearish trend. The risk is unlimited without an exit strategy and has limited reward based on the initial premium received. A covered call is when you sell a call option to cash flow on a stock you already own. Note that you need to own at least 100 shares to sell 1 call option.
With that being said, having a visual can help you wrap everything together and learning to look at a risk graph before hitting the send button comes in handy. Focus on the profit and loss rather than why the risk graph is the way it is.
So now that we have defined the single call and put options, what fancy name shall we end up with when we add layers and combine these legs? For the sake of keeping it simple, I will just focus on the vertical credit spreads but understand there are many others that you will learn as you become more advanced in your trading journey.
Bear Call Spread
The trend is neutral to bearish and this is combining a short call and long call that expire in the same month. The strike price on the short call is a lower and the long call strike is higher. Limited risk and maximum reward is the credit received
Bull Put Spread
Bullish to neutral trend and consists of selling a higher strike put (short put) and buying a lower strike put (long put) in the same expiration month.
This is combining a bull put and bear call together to create an Iron Condor. This is a neutral trend trade whereby you receive credit and keep the maximum credit if the price stays inside the short call and the short put strike prices. This is why we love the cash flow condor strategy on the RUT because of the neutral trend.
For the new beginners I know it might seem difficult to think you will ever master the options lingo but it just takes time and practice. Paper trading and building out these spreads then utilizing the risk profile to analyze them will help you tremendously so keep at it. The more you paper trade you will become comfortable and soon enough you will be putting together back ratios, straddles, strangles, and butterflies but that’s for another day!
If you’re a new trader, stick to your rules and try to process these concepts as you go. You don’t have to know everything to be able to follow your rules and make a trade. Generally, playbooks—like our own Trading Playbook (for PRO Members only) —are invaluable resources for new traders so that you don’t get your head spinning too much on the definitions.
Options Trading for Beginners
Continue learning the basics of Options trading with this additional freemium content from Tackle Trading.
Options 101 [Free Content]
Access more free high-quality articles to improve your knowledge of Options Trading.
In this article, Gino Poore delivers a great lesson on understanding and using the Delta of an option.
In this tutorial video, Coach T shows how to manage a credit spread and how to set up a contingency in ThinkOrSwim.
In this Thinkorswim tutorial video, Coach T walks the team through how to use the risk graph for options trading.
In this video tutorial, Coach T walks the team through how to set a basic stop on a covered call or naked put position.
In this video tutorial, Coach Matt goes through the latest edition of the Options Research Spreadsheet explaining how to use it to find the best stocks to cash flow.
In this video, Tackle Trading’s Coach Tim explains when, how, and why a trader would buy a put option on a covered call position.
The Tackle 25 2016 Edition is up and better than ever. This list contains the best stocks to cash flow and compound your gains.
The assignment hobgoblin has been haunting the dreams of novice traders since the dawn of the options market.
In this video tutorial, Coach Tim Justice teaches how to find the best candidates to trade the Covered Call options strategy using the Theta Research tool.
The Tackle 25 2017 Edition is up and better than ever. This list contains the best stocks to cash flow and compound your gains.
What is the Black-Scholes Model and how to use it in your trading? This is what this video will cover.
Delta measures the probability of an option expiring in-the-money.
The Options Heuristic Series [Free Content]
How can we explain the basics of Options so that our students can really learn, without getting confused with so many concepts, terminologies, and strategies? That’s the idea behind the series.
Options Greeks Guide [Free Content]
The Options Greek Guide is a simple, powerful resource to help you better understand how to use the Greek’s.
As you build, enter, and manage Options Trades, it’s helpful to understand the math behind the Black Scholes Option Pricing Model. Using the Options Greek Guide will give you the information and training on how time, volatility and asset price changes impact options values.
What are the Options Greeks and how can you utilize them in your trading routine in order to perform better in the market? This is what you will be learning in this video series.
What is the Black-Scholes Model and how to use it in your trading? This is what this video will cover.
Options 101 Course [Premium Content]
The Options 101 Course is exclusive to PRO members. Try it for free for 15 days by clicking on the button below.
Options Report [Premium Content]
The Options Report is a weekly briefing delivered to Pro members of Tackle Trading. In this report, you will receive information and education that will help you develop as a trader. We will also highlight attractive trade setups for the coming week that you can add to your watchlist.
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