Overview
This lecture provides an in-depth introduction to options trading, covering basic concepts, key terminology, option types, risk profiles, factors affecting option prices, trading mechanics, and platform navigation for beginners.
What Are Options?
- Options give the right, not the obligation, to buy or sell 100 shares of stock at a set price before a specific date.
- There are two types: call options (profit when stock goes up) and put options (profit when stock goes down).
Key Option Components
- Every option has a strike price (fixed buy/sell price), expiration date (last day to trade/use), and contract multiplier (usually 100 shares).
- The price you see is per share; total cost = option price × 100.
Call and Put Option Strategies
- Buying a call allows profit if stock rises above strike + option cost; max loss is the price paid.
- Buying a put allows profit if stock falls below strike - option cost; max loss is the price paid.
- You can close an option before expiration to realize gains/losses; most traders do not exercise options.
Intrinsic and Extrinsic Value
- Intrinsic value: built-in profit from exercising the option (calls: stock price – strike; puts: strike – stock price).
- Extrinsic value: remaining value due to time left and expected volatility; decays as expiration approaches (time decay).
- At expiration, option price = intrinsic value only; options with no intrinsic value expire worthless.
Factors Affecting Option Prices
- More time to expiration and higher stock volatility increase extrinsic value.
- High-volatility stocks have more expensive options than low-volatility stocks with similar prices.
- Implied volatility reflects market expectations of future stock price movement and directly impacts option premiums.
Moneyness: ITM, ATM, OTM
- In the Money (ITM): Option has intrinsic value.
- At the Money (ATM): Strike price is very close to current stock price.
- Out of the Money (OTM): Option has no intrinsic value, only extrinsic value.
Shorting Options
- Sell to open: initiate a short option position, aiming for the option price to fall.
- Short calls: unlimited loss potential if stock surges; short puts: large loss potential if stock crashes.
- Shorting options carries high risk unless hedged with spreads or cash-secured (for puts).
Option Greeks
- Delta: measures estimated price change per $1 move in stock (calls have positive delta, puts negative).
- Theta: measures daily loss of option’s extrinsic value due to time decay.
- Position Greeks scale with number of contracts and contract multiplier.
Exercise and Assignment
- Exercising means using the option to buy/sell shares at the strike price.
- Assignment: option seller may be required to fulfill contract if buyer exercises.
- In-the-money options are auto-exercised at expiration; early assignment risk rises if little extrinsic value remains, especially near dividends.
Trading Platforms and Tools
- Trading platforms show watchlists, position details, option chains, and order entry features.
- Use tools like OptionNet Explorer for backtesting and option pricing calculators to model scenarios.
- Trade liquid options (high volume/open interest, tight bid-ask spreads) to minimize slippage.
Key Terms & Definitions
- Call Option — Right to buy 100 shares at strike price before expiration.
- Put Option — Right to sell 100 shares at strike price before expiration.
- Strike Price — Fixed price to buy/sell asset via option.
- Expiration Date — Last day to trade or exercise the option.
- Contract Multiplier — Number of shares per contract (usually 100).
- Intrinsic Value — Built-in value if exercised now.
- Extrinsic Value — Additional value from time and volatility.
- Implied Volatility (IV) — Expected magnitude of future stock movements.
- Delta — Sensitivity of option price to $1 stock move.
- Theta — Estimated daily loss from time decay.
- Liquidity — Ease of entering/exiting trades with low slippage.
- Buy to Open / Sell to Open — Initiating long/short option positions.
Action Items / Next Steps
- Review recommended beginner videos on core strategies, Greeks, and volatility.
- Practice using an options pricing calculator and backtesting tools.
- Trade only highly liquid options with narrow bid-ask spreads.
- Avoid shorting naked options unless cash-secured or using spreads.
- Always consider risk, time decay, and assignment before entering positions.