Learn How to Trade Options
Learn leading strategies used by professional trader every day.
Learn to Trade Options
Introduction Part 1
the Basics of Buying Options
If you want to buy a stock because you think that the stock is going to move up, you simply buy the stock at the existing stock price. If the stock price is 100 dollars, then you will buy the stock for 100 dollars.
Buying an option is more complicated. Buying a call option requires you anticipate not only the directional movement of the stock, but you will have to anticipate a target price ( called the strike price ) and the time you think it will take to get there ( called the expiration date ).
If the stock you are interested in is 100 dollars, you might think to yourself that the stock will reach 120 dollars in the next month. More on this later, but you might be considering buying a call option contract for a 115 dollar strike with a March expiration. It is very important to know that you will be profitable as long as you get the direction correct.
While it is true that you are most profitable if your stock approaches your strike price by the March expiration, you don’t have to wait until expiration to cash in and close your trade. Read later about what happens if you get the direction wrong or don’t reach the strike price by expiration.
- Initial Steps in purchasing a call option:
- Anticipate the directional movement of the stock
- Anticipate a strike ( target ) price that you think the stock might reach by a given date ( expiration date )
Choosing a Strike Price:
Choosing a strike price requires more knowledge than simply understanding that it is the target price that you want your option to reach by expiration. While this is mostly true, it is not completely true. Choosing a strike price requires you to understand how option prices are determined ( the premium ), and how “time” elapsed and “volatility” in the stock influences the premium price. The option price is called the premium; it is the price that you have to pay to buy one option contract. The premium does not precisely correlate with the stock price. A 10% increase in your stock price does not translate to a 10% increase in the option premium. This is because “extrinsic” variables are incorporated into the premium price. For the most part, these extrinsic variables are time and volatility.
Understanding Option Premium Prices
- Intrinsic and Extrinsic Values
- In the Money or Out of the Money
- Option Calendar
- Time Decay
- Implied Volatility