Options Trading Tutorial
by Al Lewis
If you're considering trading options, you need to understand the
basics before you move further into trading strategies. This is just a
basic options trading tutorial that should be followed with more
education prior to trading options.
What is an option?
In simplest terms, an option is the right, but not an obligation, to buy
or sell an underlying asset at a stated price, by a stated date. The
underlying security is most often a stock, but can be a bond, an index,
an ETF, a futures contract, etc. There are two basic typed of options,
calls and puts.
Call Options
When you purchase a call option contract you have the right to buy the
asset at the strike price (a predetermined price) before or at the
expiration date. You are not obligated to buy the asset. You can sell
the option for a profit or a loss before expiration, or you can let the
option contract expire.
You want to buy a call option if you think the underlying security is
going to rise in value between the time you buy the option, and the
expiration date.
Put Options
When you buy a put option contract you have right to sell the asset at a
predetermined price by the expiration date. This is similar to shorting
a stock in that you are expecting the price of a share of stock to go
down in the value in the near term.
Contracts and Strike Prices
Each options contract gives you the right, but not the obligation, to
buy (call) or sell (put) 100 shares of the underlying stock at a certain
price. That certain price is called the "strike price". The strike price
is sometimes referred to as the exercise price.
In, Out, and At the Money
If you own a call option and the current price of the underlying stock
is above the strike price, this is known as being "in-the-money". If it
is trading exactly at the strike price, this is known as being
"at-the-money". If it is trading below the strike price, this is known
as being "out-of-the-money". For example, if you own 1 call contract of
xyz with a strike price of $100 and the stock is currently trading in
the market at $102.25, your contract is in the money by $2.25.
This works the opposite way for puts. To be in the money with a put,
you need the stock to be trading below the strike price. Again, when you
buy puts, you want the stock to drop in value.
The amount of money that a contract is in the money is called its
intrinsic value. In other words in the example above, your option
contract would have an intrinsic value of $2.25. Once you get into
options trading strategies, you'll see that options prices behave very
differently depending upon whether they are out of, at, or in the money.
Expiration
In addition to a strike price, each option contract will also have an
expiration date. Most stock options expire on the 3rd Friday of each
month, and will be quoted by their month of expiration. So, a June call
contract will expire on the 3rd Friday of June.
The expiration date is very important because option contracts suffer
from time decay. The number of days left until expiration is a big part
of an option contract's extrinsic value. Each day that goes by, if all
else stays the same, the contract will lose value.
To see a more complete options trading tutorial that will take you
to the point you can trade options and make money doing it, click on the
following link:
Options Trading Tutorial
About the Author:
Al is a professional options trader who has written a series of
options trading tutorials to help individual traders become more
proficient at
options trading.
