Options trading is very unique and often difficult to learn for beginners.
In this free 2-part Options Trading video series, we will give you the foundation and step by step guide on how to trade options, learn option strategies and how you can generate income trading options.
Welcome to our Options Trading Course for Beginners.
(Transcript for the video is below Part 2)
In Part 2 of our free Intro to Options Trading course, you’ll learn how and why to buy call and put options, and how they can benefit your trading.
Call and put options are the basic building blocks of all option strategies, so getting this down is crucial. This is our in-depth beginner’s guide to options trading.
Part 1 Transcript:
Hey, traders. Welcome to The Best Option Trading Course For Beginners. This is Part 1 in a 2-part series. My name is Chris Capre with 2ndSkies Trading.
If you’re completely new to option trading, or just getting your basics down and want to learn how you can generate income with options trading, then you’ll want to grab your coffee and a notepad, as we’re gonna lay a foundation for you in this video on how to make money trading options.
In today’s video, I’m gonna begin with “What is option trading?”. Then I’m going to share with you the advantages and disadvantages to trading options.
From there, we’re gonna give you the basic building blocks of options and types of options you can trade. After this I’ll introduce you to what is called the option chain, which is a critical aspect of understanding options and how to read and trade them.
Next, I’ll share with you how to read Option P&L Diagrams, and then I’ll end with giving you some homework to build your option trading skills.
So, let’s dive into this free course on how to trade options as a beginner.
Now first off, if you’ve been just trading stocks, or forex, or crypto, don’t be intimidated by the inherent complexity of options. When I first started trading options, it was confusing. I didn’t understand it, but with time and practice, it has become one of my best weapons for trading the market.
How Is Options Trading Different?
So, what is option trading and how is option trading different?
To begin with, I’m gonna start with the latter, how option trading is different, so you can see why you’ll want to learn option trading.
So, when you trade stocks, or crypto, or forex, it’s pretty straightforward. If you buy, you want your instrument to go up. If you sell, you want it to go down. If you buy and it goes up, you make money. If it goes down, you lose money, very straightforward.
But what if you could buy a stock and still make some money if it goes down, that’s pretty interesting. What if you buy a stock and it goes nowhere? You can’t make any money on that trade. However, with options, you can.
Simply put, buying and selling stocks, forex, or crypto is really two-dimensional trading, meaning you need it to go up or down and you either make money if it moves in your direction, or you lose money if it goes against you.
But with options, you can make money if the stock goes up, down or sideways.
Have you ever traded something that, you know, you thought it was going to go up and it just went nowhere?
What if you could make money on that stock going nowhere?
That is the power of options. And as you build your option trading skillset, you can make money, not just from the market going up, down or sideways, but you can make money simply by time and volatility.
Oh, and I almost forgot, you can get paid just to enter a trade. Yes, that’s right. With options, you can get paid just to enter a trade.
If you buy or sell a stock, you don’t get paid for getting into that trade, but with options you can, this is one of the many ways option trading is unique.
What Is Options Trading?
Now that we’ve covered those unique points about option trading, let’s get into exactly what is option trading.
So, when you buy or sell a stock, you’re trading what is called the underlying. It’s the underlying asset that you’re trading directly. If you buy a stock you actually own those shares, and thus a piece of the company.
With options, you don’t actually buy the shares directly, but what you do is when you buy or sell an option, you’re trading a contract or derivative on that underlying asset.
The closest thing in the market today to options would be CFD’s, which is something that’s very popular in the UK, in Europe, and outside the U.S. CFD stands for Contract For Difference, and it’s simply a contract between a buyer and a seller – options are very much the same.
The difference in buying selling options is if I’m a buyer, I am buying that option contract. And if I’m a seller, I’m selling that option contract, that may sound straightforward, but there’s actually some nuance to that.
So, this buying and selling an option contract is very much like buying or selling insurance. For simplicity, let’s talk about car insurance.
Now, in the U.S. if you own a car legally, you have to have car insurance. If you want that insurance, you have to buy it from an insurance company. If you buy car insurance, you are paying what is called a premium, which is the value of the car insurance contract, and you can pay that monthly or quarterly or yearly.
On the other side of that transaction is the insurance company. If you’re the insurance company, you are selling that car insurance in exchange for that premium.
This is very much how options trading works.
If you want to, you can be a buyer of that insurance or an option straight, and you can be a buyer of that option. And if you sell the option, you get paid to sell that contract. This is why options trading is unique because you can be on either side of the contract. You can get paid to sell the option contract, where you can pay to get that option contract.
Now, taking this comparison further, if I’m the insurance salesman, I get to keep all the car insurance payments, or what is called the premium that I collect, if you the option buyer don’t get into a car accident.
So, if you sell an option contract, and it expires without ever hitting the option buyer’s price and target by expiration, you get to keep the full credit, just like the insurance company gets to keep the money.
If you don’t get in a car accident, you get to keep the full credit. That opportunity to sell options and get paid for it is unique to trading. You can’t sell a stock directly to someone else and get paid for it. The same for crypto or a forex pair, but you can with options.
On the other side of the contract, if I’m the option buyer, I will pay you if you’re the option seller. I’m gonna pay you a premium to get that option contract. And if it doesn’t hit my price before the option contract expires, you get to keep the full credit, I paid you for that option contract.
On the other hand, if my option contract that I buy from you hits my price target by the expiration, I can do what is called exercise in the contract, and you, the option seller, have to pay me the value of that option contract at that time. This is how options trading is unique. You can play either side of the trade, and you can as the option seller get paid, entering a trade.
Now, if that sounds fascinating to you as it did for me, keep on watching as you’ll want to learn how you can generate income every month selling options.
So, to sum up this first part, what is option trading, and how is it different?
When you’re trading options, you aren’t trading the underlying. You are trading a contract between two parties, which is a derivative of the underlying.
Just like car insurance, you can either be a buyer of insurance, or you can be a seller of that car insurance. And same with options trading, you can be a buyer of the option contract, or you can be a seller of that option contract. Hence you can be on either side of the transaction.
Now, one last part I’d like to mention about options trading is the main players in how the options market works. So, I’m gonna go to the game of football, or what Americans call soccer.
When you play soccer or football, you have the players on both teams. You have a field which is called a pitch, and you have a referee. In options, trading the players on both teams, the buyer and the seller options contract, those are the players on both teams.
So, the option buyer and the option shell, or those are the two teams involved. The referee and options trading is what we call the OCC or options clearing corporation. They clear all option contracts and they make sure all contracts are fulfilled. The playing field is the broker who brings the option buyer and the sellers together.
So, these three components, the referee, the option buyer, and seller, and the playing field, which is the broker, comprise the three main parties and trading any options.
Okay, so now that we’ve covered how option trading is different and giving you this overview on how to understand options, let’s talk about the advantages and disadvantages, and then we’ll get into the basics building blocks of options trading.
Advantages of Options Trading
So, here are just a few advantages of why you should be trading options.
- Leverage and margin. When you trade stocks, you can get anywhere from 2 to 4 times leverage. That means if you want to buy 1,000 shares of a stock that is $50, you have to put down either $25,000 for two times leverage, or $12,500 if you have four times leverage. That’s a decent chunk of change to control 1,000 shares of that stock. Now with options, you can get much greater leverage, and thus use less margin or your capital to trade the same 1,000 shares. For example, in options when you’re trading every single option contract represents 100 shares of that stock. To control 1,000 shares, you’d need to trade 10 option contracts. And so, the math is 10 contracts x 100 shares, it’s 1,000 shares. Now, let’s say you buy XYZ stock, which is currently priced at $50 a share. In the option contract, which in this case is called a call, is an option contract that gains value if the stock goes up. Now, let’s say this option contract or this call is priced at $4.50. Since each option contract equals 100 shares, one option contract on the stock is going to cost you $450. The math is very straight forward – $4.50 for the option contract x 100 shares = $450, but you want to do a thousand shares. So, we have to do $4.50 x 100 x 10 contracts = $4,500, that’s $4,500 in margin. That $4,500 in margin is almost 3x less than if you wanted to buy the stock directly. If you want to buy the stock directly on 2x margin, you’d have to put down $25,000, and 4x margin you have to put down $12,500. But with options, because you have greater leverage, you only have to put down $4,500 to trade 1,000 shares. So, options have this advantage of giving you greater leverage than just trading stocks or forex or whatever it is for trading.
- Market-neutral strategies. So, the second advantage of trading options has to do with making money when the market goes nowhere. As we mentioned before, if you buy stock and it goes nowhere, you don’t make any money. But with options, you can trade what are called market neutral strategies, which actually make money if that stock or instrument goes nowhere. Think the markets are heading into a range, sell market-neutral strategies. Think we’re going into a period of low volatility, perhaps this summer, sell market neutral strategies. The opportunity to make money when the markets are going nowhere, it gives you a powerful tool to earn income during non-training environments, which is a fair amount of time of the year. This is a very powerful component of options trading that you can make money if it goes absolutely nowhere.
- Collecting premium or income. As we mentioned before, when you sell options, you collect the premium on that contract. So, when you’re the option seller you can get a guaranteed income on those contracts that you sell. Now, if they go against you, you’ll have to pay out from the credit you receive, but the value of the contract that you have to pay out may be less than what you collected. So, you still get to keep the remaining amount and that’s a major advantage. Sometimes you have to pay out more. Sometimes you sell a contract and that contract actually gains in value as it progresses, that can happen, but either way you get to keep the premium and the credit. Thus, you can collect an income just for getting into a trade, which is pretty cool.
- Unlimited upside. Another range of trading options, and this is available to some degree in stocks and forex and crypto, is that there are certain contracts which have no limit to how much money you can make. A stock could go to the moon and you can profit from them moving, as long as the option has an expiry. That’s a really nice feature to know that there are some trades where there’s no limit to how much you can make.
- Fixed risk and profit. So, when you buy a stock, say XYZ stock at $50 a share, technically that stock can go to zero. It can sell off past your stop loss and you can take on a greater risk than you had anticipated. However, with options, there are option trades, which will have a fixed or defined risk, meaning you can’t lose any more than a fixed amount. Regardless if the stock goes to zero or to the moon, this offers you a level of protection that owning certain stocks doesn’t.
- The put-call ratio. So, we’ll get into this shortly, but a call option is a bullish contract on a stock. Basically, if you buy a call on a stock and that goes up in value, that call contract is worth more, that option is worth more. So, call is a contract that gains value if the stock goes up in price, I’ll put option is just the opposite. It’s a bearish play in the stock, a put option gains in value if the stock goes down in price. When you trade options, though, this is kind of a unique thing, you can see the put-call ratio, meaning the actual number of puts and calls in the markets up to the current time and date. This gives you information about the actual buying and selling orders in the market. This information is not available in forex, but it is in options. So, this put-call ratio will simply tell you whether the market is more bullish or bearish. And by how much, depending upon the ratio between those calls and puts. A great way to think of this is as a way to see the order flows in the market and the sentiment of the option players in the market.
- Making money even when price doesn’t hit your target. So, one of the unique advantages of trading options is that you can actually make money if the stock doesn’t hit your price. If I buy stock at $50 and I have a target of $60, if the market never hits that $60 target, or for that matter it doesn’t go anywhere, I make no money. But options have ways that you can make money, even if the stock never hits your price target, how is this possible? This has to do with option pricing, and for this, let’s go back to our insurance analogy. So let’s say you live in California, where fires are a risk to your home every single summer. If you were to buy fire insurance and there hasn’t been a fire in your area or region for years, it’s likely that fire insurance will be cheap. However, if you decide not to buy fire insurance and then a fire happens in your area, that same fire insurance, that same level of protection and coverage is gonna be way more expensive, because it’s been repriced due to an increased risk that there’s a fire in your area or fire may destroy your home. So, that insurance, the same coverage, same level of deductible on everything like that all becomes more expensive, just because the risks and the variables in the market have changed. The same goes for options, you can buy certain options that may be cheap one day, but then because of risk events in the markets or an increase or decrease in volatility, the prices of those options that you own can be repriced due to these changes in the markets, due to the changes in volatility. Thus, the stock can go nowhere or not hit your target, but because of the options repricing, you can make money on your option trade without ever hitting your target. That is a unique advantage to trading options that is not available in trading stocks, crypto, or forex.
Disadvantages of Options Trading
It’s important that you understand both sides of the coin. Anything you trade there are advantages and disadvantages. Options are no different.
So, we’ve covered some of the major advantages to trading options. Now, let’s go over some of these disadvantages.
- Don’t actually own the shares. When you buy a stock, you actually own the shares of the company. However, when you trade options, you don’t actually own the underlying shares. Your option trades can be converted into actual shares if you exercise the option. So, if you’re an option buyer, then your option trade can be converted into the number of shares. If you have one contract, that’d be 100 shares of that stock. You have 10 contracts, that will be 1,000. But while you’re trading the option itself, before you exercise it, you don’t actually get to own the underlying shares. So, you don’t get to participate in the dividends. There are ways to kind of get dividends built into your options, but that’s another subject. So, you don’t get the same advantages.
- Can have unlimited risk. There are some option trades which technically have unlimited risk. It’s important you understand that. At the same time, this is not something to be afraid of because you can easily neutralize this unlimited downside pretty easily. But some options individually by themselves can technically have unlimited risk.
- Lesser liquidity. Generally speaking, trading options has less liquidity than if you’re trading the stock, or the FX pair or the crypto itself. In some cases, it can be hard to get in and out of certain options. So, it’s important you understand these risks. Now, this is something that can be avoided, but it’s important to know that this is a possibility. Also lesser liquidity as a whole means spreads on options could be a bit wider than the actual stock. Again, this can be mitigated, but it’s important to know that this lesser liquidity can affect certain trades and the spreads.
- Time decay. So, there are certain option contracts that you can buy, where time will actually work against you. Meaning the longer you hold the contract for each passing day, that option contract you own will lose money. This is called time decay or what we call theta decay, which we’ll get into in a later video, but it’s important to understand how time can work for or against you in trading options.
- Complexity. As you might have already guessed, trading options is simply more complex than just buying and selling stocks. Buying and selling stocks is like playing checkers. Trading options is like playing chess. And as you dive deeper into options, it can start to become almost like three-dimensional chess. This makes options harder to learn since it has a steeper learning curve, but as a complement to the complexity, you have more opportunities or more ways you can make money trading options, than you can if you just buy or sell the stock.
So, these are some of the main disadvantages of trading options.
Okay, now that we’ve gone over the advantages, disadvantages of trading options, let’s get into the basic types of options.
Basic Types of Options
It is key that you learn the basic types of options because they form the building blocks for all types of options trades and strategies you will learn going forward.
In this section of the free options trading course, we’re going to cover what are called calls and puts. We talk about the difference between buying and selling calls, or puts. What is the option premium, the option strike price, option expiration.
We’re also gonna go with what “At The Money”, “In The Money”, and “Out Of The Money” mean. These are terms you often hear about options trading.
Lastly, we’re gonna go over a standard option P&L chart. So, you can analyze the profit potential of a loss of every option trade you take.
Call Options Explained
So, this section is all about calls and puts calls. Calls and puts are the most basic types of options you can trade.
A call option is an option contract that gives the buyer, not the seller, the right, but not the obligation, to buy a stock.
Essentially, calls represent a bullish view of a stock if you are a buyer of calls, and it’s pretty straightforward. When you buy a call on a stock, you profit if the underlying asset or stock goes up in price.
On the other hand, if you’re the option seller of that call, then you are bearish on that stock. Or at least at a minimum, not wanting the stock to go up in price at all. It can go nowhere or it can go down and you will keep your premium.
So, going back to our analogy of the car insurance, a buyer of this call is like the car driver needing insurance on his car.
So, he will buy that option and he will pay a premium. If you want to be the option seller, you would be like the car insurance company who sells that option and collects the premium.
If calls are options that gain in value as the price rises on that stock or underlying instrument, a buyer of calls wants stock price to increase – very straightforward.
Whereas the option seller wants that stock price to decrease or stay the same. This is how calls work. We’re gonna show you some graphs and diagrams on this, that it will make it a little bit more relatable for those you’re much more visual learners, but we’re just gonna go over this basic thing first and then we’ll get into the diagrams.
So, those are calls.
Put Options Explained
Puts are the opposite of calls, they are also the most basic type of option that you can trade. Puts are simply bearish trades on the market.
If you buy a put, you want the market to go down in price. If you sell a put, you want the stock price to go up or stay the same.
So, buyer puts on XYZ stock will profit if the stock price goes down, but they will have to pay a premium because again, if you’re an option buyer, you have to pay a premium to get into that trade, to get that option contract.
Meanwhile, the seller puts they’re gonna collect a premium. So, if you sold that put, you’re gonna collect that premium that the option buyer’s gonna pay you. And you will profit if the stock goes nowhere in price or it increases in price.
So, puts are option contracts that gain in value if the stock price goes down, but calls are option contracts that gain in value if the stock price goes up. Those are the basics behind calls and puts.
Again, we’ll show you some profit and loss or diagrams for calls and puts, but this should give you the basics for now.
What is the Options Premium?
So, what is the option premium? We’ve talked about this premium before, and we’ve talked about how insurance companies charge insurance premiums for car insurance or fire insurance or whatever it is.
In options trading, the premium is the price of each option contract. These prices are given by your broker. All option contracts have a premium.
Now, if you’re a buyer of that option contract, you are gonna pay that premium. If you’re an option seller you are going to collect that premium. For option buyers that premium is paid upfront. Hence, if you wanna buy a call on XYZ stock, let’s say a bullish trade here, or a put on XYZ stock, which would be a bearish trade, you’ll pay the premium upfront to get that option contract.
For option sellers, the premium the auction buyer pays it goes as a credit to your account. Hence, if you sell a call, you will collect that premium. If you sell a put same thing, you will collect that premium upfront.
All premiums are calculated based on several variables, such as the stock price now, the strike price, which is the price target for an option contract, the time to expiration.
So, how many days or weeks from now until that option contract expires, just like your car insurance will expire after a month or a quarter or a year, the same goes with option contracts. They have an expiration date.
And another thing that actually affects the variables and option pricing is volatility. How much, or how little does that stock move? There are other more technical variables, which we’ll cover regarding option pricing at a later date, but for now you don’t have to calculate it or you don’t have to understand it. It’s all done for the broker for you.
All option premiums are based in dollars and cents. So, if a call on XYZ stock costs $2.75, that means it’s $2.75 x 100 shares, because every single option contract represents a hundred shares. So, $2.75 x 100 is $275. So, if you want to buy that call, you’re gonna have to pay $275.
If you want to sell that call, you’re gonna collect $275. If a put cost $3.50 cents to buy that put, and you want to buy it, you have to pay $3.50 cents times a hundred shares will be $350. And if you want to sell that put you’re gonna collect $350.
So, this is what the option premium is and how that pricing works.
What is the Option Strike Price?
So, what is the option strike price? All option contracts have a strike price. The strike price is simply the price the option contract can be bought or sold when exercised. Only option buyers can exercise an option, very much like if you buy car insurance. You can exercise this car insurance if you get into an accident and need the coverage. If the option buyer exercises the option contract, it then becomes what is called assigned.
Who is the option contract assigned to? The option seller. So, if you buy an option contract and you exercise that and I sold it to you, that contract will be assigned to me and I have to pay out the value of the option contract at that time.
Now, in using our basic call and put options, the strike price is the price the stock or the underlying security can be bought at by the option buyer.
Whereas for put options, the strike price is the price whereby the security or stock can be sold by the put buyer. So, for example, if a stock XYZ is currently trading at $40, and you want to buy a $45 call option on XYZ stock, you need that stock to rise above your strike price $45 by expiration to profit.
The strike price is what you can buy the stock at, and even if it rises above $45. So, let’s say you buy the $45 call option on XYZ stock and it closes at $50 by the time that contract expires, technically what that means is you can buy that stock at $45 cause that was your strike price, and you get to profit the difference between your $45 call strike price, and the current price of the stock $50 to come profit $5 for sharing – that’s the option strike price.
So, all option contracts have expiration dates. This is a major difference from trading stocks by themselves or spot forex. When you buy a forex pair or stock, there’s no date that you have to exit the trade. As long as it doesn’t hit your stop loss or take profit, you can remain in the trade indefinitely.
With options, option contracts have an expiry date. So, you have to learn to time your trades and where you think they will be or can be by the expiration date. Traditional option contracts are what we call monthly options, meaning they expire on a fixed date for the month, which is the third Friday of each month.
For example, I’m recording this video at the end of April 2021. The next monthly expiration is May 21st, which is the third Friday in May.
Now, there are also weekly contracts, which expire each Friday. Some instruments have midweek expires like VIX, or S&P or QS, they can have expiration dates on Wednesdays or other days of the week.
If you bought a $50 call and XYZ stock to expire May 21st, and on May 21st at the market close, the price is $49.99, your call will expire worthless since it didn’t achieve your target by the expiration date.
Hence, think of the expiration date as the final date your option contract is valid for and can profit from.
If you have an option in profit before the expiration date, and you were the option buyer, you can exercise the option for profit before the expiration date. You don’t have to wait out the whole time period. If it gets there in one day, you can close it out in one day. If it gets there and we can close on week, as long as it gets to your target before the expiration, you can close that out at any time.
ATM, ITM & OTM Explained
Okay, so what does ATM, ITM and OTM mean? Well, these definitions you’re gonna hear these a lot.
So, we covered expiration date and now it’s time to cover these definitions, ATM ITM, OTM.
ATM is very straightforward – it stands for “At The Money“. And it essentially means that the current price of the stock is at the money of your strike price.
So, if your strike price is $45 and the stock is closing at $45, then that would be an “At The Money” strike.
“In The Money” – this means the current price of stock is in the money of your strike price. So, if you have a strike price of $45 and the current stock is at $50, your call would be in the money.
OTM stands for “Out of The Money“, which means the current stock is out of the money of your strike price.
So, if you have a call with a strike price of $50 and the current price is $45 your strike price, your option is out of the money.
It’s not “In The Money“. It’s not “At The Money“, it’s “Out of The Money“. So, those are the definitions for ATM, ITM in OTM
Option Profit & Loss Diagrams
Now, option profit and loss charts and diagrams.
This is the last key component for understanding options – is the option P&L chart. It’s, you know, unique to options. You don’t really see this when you’re trading stocks by themselves or currency pairs, this is a unique diagram and it’s a really nice feature for options because it shows you all the different scenarios on how your option can make or lose money, and how much profit that will be at the time of expiration.
It’s a very important diagram because it helps you evaluate your option contract, and at what prices you’re gonna be in profit and by how much (or not), it’s a simple tool to help you analyze your option trades.
So, let’s look at the following P&L diagram below, and we’re gonna analyze it in detail.
Okay, we promised we would do an option call diagram, and we will do a put one as well.
So, this is a P&L chart for a call on a particular stock. So, you’re gonna see two axes here on this axis here. These are the strike prices and it starts from low and it goes to high. So, $30 strike, $40 strike, $50 strike, and so on, and so on.
The left side or the y-axis is your profit and loss. So, this horizontal line here always represents the zero line, meaning that above this, your option makes money and below this, your option loses money.
So, let’s say you buy a $40 call and it’s $2 for that call. So, as we know, each option contract is for 100 shares. If this call is $40 and cost $2, well, $2 times 100 for 100 shares for each option contract equals $200. So, you’re gonna pay $200 to get into this.
And the way this works out is that if the stock closes below your strike price, then you don’t lose any more money, you just have your $200 loss that you paid up front and that’s it.
Now, since you paid $2 for this option contract, or $200 out of your pocket, well then technically for 100 shares, you need the stock to go up $2 in price just to break even to make up that money that you paid for it.
So, at $42, you are at what we call breakeven. If the stock goes to $45, $50, $55 or $60, you continue to make more and more profit as the stock goes up. This is one of those unlimited profit potentials because the stock could technically go to the moon and you’ll just keep making more and more money.
So, if you get a really nice bullish move in the stock and it increases to like say $50 or $55, you could make 5x your risk on this one here, you pay $200 to get into it. You can walk away with a $1,000 profit on this one trade – that’s the power of calls.
And to show you a chart to kind of exemplify this here.
So, looking at the Bank of America Corporation, but say you bought the $40 strike, and it costs you $200. Well, once you get to $42, that’s when this thing starts to go break even and starts making money. So as the price goes up, your call also makes money.
Again, it’s not the most precise thing, but it really visually kind of demonstrates how this works out.
Now, this is a put P&L diagram or put P&L chart. And if you notice it’s like a horizontal mirror image of a call, that’s because puts gain in value as the stock goes down in price.
So, let’s say you bought a $40 put and it costs you $2 to get in, so $200. Well, if the stock goes up in price, you don’t lose any more money, whatever you paid, that’s it, that’s your max loss right off the bat.
Since you paid $200, you needed it to go to $38. If it goes from $40 to $38, that’s a $2 profit per share x 100 shares, that’s $200. So, $38 would be your breakeven and as the stock price continues to decline, this call option will gain more and more value as it declines further and further.
So, looking at the chart, it’s just a mirror image in the sense here. You pay $200 to get into this trade and if it starts to get below $38, $37, $36, $30, all the way down, you can make more and more money. So, this is a typical option P&L chart.
They can get more complex as you start to add multiple legs to your chart, your calls and puts as you make combinations of calls and puts, they get more complex, but this is the basic P&L chart that you see right here.
This is the basic profit and loss diagram. X-Y axis will always be the same. The x-axis will represent the price and the y-axis will represent your profit and loss. It’s a very nice and simple way to understand how your options trade are gonna play out over time.
Reading the Option Chain
Okay, so we’re gonna introduce the option chain near to you. And this is again, a super important tool when you’re trading options.
The option chain or sometimes referred to as the option matrix is a primary tool for seeing all the available option contracts. All the option contracts, the prices, the date for all the contracts that cause it puts on any given stock, ETF, security doesn’t matter.
So, they are an incredibly informative way of presenting the option contracts such as premium strike price, expiration dates. All the various probability that the option is gonna land in the money or out of the money.
You can find an option chain for any broker that offers option trading on their platform. For this lesson, we’re gonna be using The Thinkorswim Option Chain on the desktop version of their platform. This is my preferred option trading platform, and it’s where I place all my option trades.
Now, what you see here is the exact option chain I use on my Thinkorswim platform. And it’s configured exactly how I use it on a daily basis. I’ve chosen this configuration because it allows me to peruse and scan the most important piece of information regarding the option chain for all the stocks and securities that I trade.
So, it’s super simple. It’s super straightforward. It may look complex right now, but I’m gonna break it down for you piece by piece.
So, for our purposes, we’re gonna start with Tesla stock and we’re looking at the May 21st expiration. You can see May 21 expiration by looking at the data in the top left where it says 21 May 21. What that means is the 21st of May, 2021.
Now, let’s start with the vertical columns from the top left over to the top right. And after this, we’ll work our way through the numbers and what it all means. I know it may seem confusing right now, but this will become very understandable and straightforward once we’re done with it.
So, you should see an image below the two red boxes highlighting the columns on the left and the right side. If we start on the left, you’ll see the following. You’re gonna see Delta, which is one of the Greeks, which we’ll explore in Part 2 of our Intro to Options Trading series.
For now, you don’t need to know about these Greeks, that’s something you can learn later on you do not need to know these right now. Gamma, it’s another one of the option Greeks, we’ll cover this in Part 2 and same thing with Theta, another option Greek, which we’ll cover in Part 2. For now you don’t need to worry about these at all.
Now, the thing that says “Imp Vol” – that stands for “Implied Volatility”, and this is an important percent or number for you to know as it represents the market’s implied volatility for that contract. The expected volatility of that particular stock.
So, implied volatility affects the pricing or premium of the option contract. Higher implied volatility makes the option contracts more expensive because there’s a greater risk of the price moving more up or down.
Think of this like the fire insurance. If you live on an Island with no trees, your risk of fire is very low, but if you live in a forest with dry trees and hot weather, your risk of fire is higher, thus, a higher premium. This is what implied volatility represents.
My general parameters is that any level of implied volatility above 50%, 60% is generally considered medium to high implied volatility. Below that as generally low volatility. We’ll get into this more in Part 2, but just to understand the basics of how this works.
Now, the next one you see is “Prob.ITM” – that stands for “Probability In The Money“. This represents the probability that this particular strike price will end up in the money or in profit by the expiration date.
That’s a very powerful tool if you think about it. If you know that something is a 45 or 50% chance of being in the money, that makes it much easier for you calculate risk-reward capabilities, that’s not something you’re gonna have when you trade stocks or forex by itself.
The next one is pretty straightforward Volume. This is the number of option contracts being traded at that strike price. So, it helps you to see the liquidity of the option contracts at a particular price. Obviously, the higher the number the better.
Bid and Ask these are simply the bid and ask price for the option contracts. You’ll see that there are two sides to the options chain. So, there’s this left side, which we’ll highlight in gold here for you and then the right side.
So, the left side is for the calls and the right side is for the puts. Now, looking at the same image here, as you can see in the red box in the middle, which you’re highlighting for you here. You’ll see the date 21 May 21, which tells you the date and expire for all these option contracts you’re looking at the calls and left side and the puts on the right.
You can also see in the second column, the Strike, which we’re gonna highlight in gold here. This is the strike price for each option contract. So, each one of these horizontal rows and all of the data in it, you know, the Delta, the Gamma, Theta, implied volatility probability in the money, Volume, Bid and Ask that’s all the data for that particular strike price on the call and the put side.
So, looking at this image here, you’re gonna see two red boxes. On the left side, you see this one section on the upper part that shade in this light purple a blue. And then you also see that same color shading on the put side on the right on the bottom.
Now, as we mentioned before, the left side of the option chain is the calls and the right side is the option puts. Those purple or blue boxes, whatever color you want to call it, that represents all the calls that are in the money.
Since the current price of Tesla is $730, you look at all the ones that are shaded blue, 700, the 705, the 710, 715, 727, 725, 730. Those are all the calls that are in the money right now.
On the put side, you can see everything from 735 down to 765, those are all the puts that are in the money. So, that’s what that shading means and is a nice way to help you see what is in the money and what is out of the money at the current price.
Now, looking at the same option chain image, we’re gonna look at these two whole boxes for the strike prices, 725 and 745.
Let’s start with the 725 strike price on the call side, which is again the left side of the chain, particularly looking at the implied volatility and the probability in the money columns.
So, you can see on the left side of the option chain, the 725 strike price has an implied volatility of 60.02% and a probability in the money of 48.34%. This means the May calls for the 725 strike is pricing a 48.34% chance, Tesla will be at or above this price by May 21st. That’s very useful information for us as traders to see how the option market is pricing in probabilities of this price being in the money.
Now, just think about how useful this could be when you are starting to evaluate your trades just to know the relative probability they will be in profit. This is very powerful information.
Now, moving on to the volume column. We can see 293 contracts have been traded at this price for this strike and expiration date, going to the bid and ask, we can see a 50.25 and an ask of 51.20.
This means if you want to sell the 725 call as an option seller, you’re gonna receive 50.25 credit. In other words, 50.25 times a 1000 shares that’s $5,025 in premium. If you want to buy the 725 call for the May 21st expire, you’d have to pay a premium of 51.20 or $5,120 per contract.
Now, if you’re thinking this is expensive for one call, it’s important to note that Tesla options tend to be very expensive as a whole. A lot of the calls and puts you’re gonna buy are gonna be in the single dollar or even cents range. So, don’t think of this as the norm.
Now, going to the other side of it just to show you how and get your practice on, reading the other side, let’s take a look at the 745 strike, and the 745 put price, which is again, on the right side of the option chain.
We can see the bid is 56.10, and the ask is 57. So, if we want to sell a put-on Tesla for the May expiring at the 745 strike price, you will get 56.10 in premium or $5,610. And if you want to buy a put or the 745 strike on the same May expiry, you will pay a premium of $57 or 5,700. You can see the volume on those 745 contracts is 69 and the probability of those expiring in the money is 58.14%.
Now, if you got all that down, congratulations, you’ve just successfully gone through your first option chain. If it seems overwhelming, confusing. Don’t worry after doing this a few times, you’ll have it down pat it will be automatic. It’ll be just very easy. The first time I read an option chain, I was confused. It took me several times just to kind of get it down.
By and large this is all you need to know about reading your option chain for now is it will tell you the pricing, which is the bid-ask, the volume and probability or strike where we’re expiring the money, the prices of each strike, so on and so forth.
So, congratulations you’ve just gone through your first option chain. Now the option chain is one of the most important and fundamental windows you will need to understand, to price your options, analyze the data, and see if it’s probably you’re gonna make money and how much and what’s available to trade.
So, really take some time reading over the option chain on your broker platform. You know, they get a demo account, get a broker platform with options, learn how they set up their option chain. And just learn to read it, so you get it over and over again. So, it just becomes second nature.
This is important because it’s gonna be a main tool used to buy and sell options. But again, pretty soon it will become second nature.
Okay, so what’s next, we’ve covered a lot of new terms in this free video, such as premium, calls and puts, in the money, strike price is a lot of material we cover. The goal of this free intro to options trading video is not to give you a full introduction to options trading.
It’s not to cover options strategies or how to trade options. This is meant to be a primer to give you a foundation, so that you can start your journey and take the next steps. Have the springboard to diving deeper into options.
We’ll be doing a part two to this free intro to options trading series soon, and we’ll go into some more nuance option terms and strategies. So, yes, I will not only teach you more terms, but I’ll actually teach you options strategies you can use to make money trading options.
After these two videos, you should have a solid primer to start options trading and take your first option traits.
If, however, you feel like, hey, I’m totally fascinated. I wanna learn more. I wanna dive into this. We have some training on this. We have an Options Bootcamp where I share eight options strategies to generate income.
I share how I use these strategies and something unique in the options world. I share with you the price section context and what the charts should look like when you trade these options. When you go to other options books, and other options videos, they’ll say, Oh, use this option if you’re mildly bullish, use it if you’re really bullish, but what does that look like on the charts?
This is what we do. We show you exactly what the chat should look like when you want to use these options strategy. So, if you’re interested, check it out on our website, go on The Options Bootcamp thing. I’ll leave a link below the description here and until you’re ready for that.
And if you’re not ready, no biggie, take your time in this there’s no rush at all, until you’re ready for Options Bootcamp the best thing you can do is get these basic terms and concepts down. So, you know them inside-out.
Now I mentioned there was gonna be some homework. My suggestion is to practice the following.
- Practice reading the option chain, which you mentioned before, go through a few option chains till you feel you have that down pat. Thinkorswim has a great option chain and it’s who I trade my options with.
- Spend time looking at various options and understanding the Option P&L diagram, look at calls and puts per various stocks. Get some time to kind of just look over that, so you understand how that analyze P&L tab looks, so you can see how options change over time, over price.
- Grab a demo account with a broker that offers these options. Practice trading a few calls and puts. With weekly or monthly expirees, ideally any expiration date that is less than 15 days. Start with buying calls and stocks that you are bullish on and buy puts on stocks that you are bearish on.
Get some reps with that. Get some reps from reading the chain. Get some reps on making the trades. Get some reps on the reading, the P&L diagrams. Just get some reps and you need time on the driving range.
Doing these option trades on a demo account we’ll give you that experience. And then again, the next thing you can do is watch this video again and again, to make sure you got the terminology and foundation down. It’s gonna take a few run-throughs before you start to have this down pat, before it’s solid base and you really understand it. What you learned here today is a critical foundation, you’ll need to dive deeper into options.
Now, as I mentioned in the beginning, normal stock trading is like checkers and option trading is like chess. It takes a bit more time to learn options, but once you do, you will realize there are way more, no pun intended, options to making money trading.
Until then I hope you enjoyed this primer into options trading. There’s certainly a lot more to learn and you won’t feel anywhere near complete – that’s not the goal of this free video. The goal is simply to give you this primer and spark a curiosity to learn more about options trading as it did for me.
Let us know what questions you have about the material covered in the video. I’m sure you’re gonna have questions. Ask them in there and we will answer them personally. Until then, good luck trading.
Part 2 Transcript:
Hey traders, welcome back to our Part 2 of this free Option Trading course for beginners.
In this video we’re going to dive into the basic building blocks of all options so it’s going to be all about calls and puts.
This is super important because if you get down these calls and puts, you have the foundation to explore all option strategies and setups going forward, whether they’re more complex or not.
All options are calls and puts, or variations and combinations of calls and puts, so your ability to get this down is super important and it will really allow you to start making your first option trades.
Now to recap in part one of our free option trading course for beginners, if you haven’t watched that click on the link above.
But to recap, we covered how options work, how you can make money trading options that you can’t in just trading stocks. We also covered the differences between buying and selling options, how to read the option chain and more.
Today we’re going to simplify calls and puts – show you how they work, how you can trade them and why you’d want to trade call and put options.
Option Calls & Puts
Okay, so starting off with calls.
A call option can be simply defined as an option that gives the option holder the right, but not the obligation, to buy shares of a stock at an agreed upon price on or before a specific date.
A put is simply the opposite of a call – it gives the option holder the right, but not the obligation, to sell shares of a stock at an agreed upon price on or before a specific date.
Now I’ve talked about on or before a specific date, and I’ve talked about an agreed upon price. What are those?
The strike price is the agreed upon price the stock can be bought or sold at. Also all option contracts have an expiration date, unlike buying stock.
In and of itself if you want to buy a hundred shares of Apple, there’s no expiration date on that. So as long as it doesn’t hit your stop-loss or take profit, you can hold that indefinitely – there’s no time that that trade will expire.
However, all options have an expiration date and that’s the specific date that that option contract expires.
So these four definitions for calls, puts, strike and expiration date – those are the bare bones that are in every single option contract.
Option Call & Put Examples
With that being said, let’s go through a very simple example of a call and a put.
So let’s say you are going to buy a call on a stock at $50, with what we call 30 DTE or 30 Days To Expiration. Owning this call option allows you to purchase a stock at $50 per share, which is the strike price, between today and the next 30 days, which is the expiration.
So if the stock goes from $50 to $75, your call option allows you to buy the stock at $50, regardless of the fact that it’s trading at $75 today.
That means you can exercise the call option on this stock, purchase the stock at $50 per share and thus profit $25 per share. And you can do this with a lot less margin than buying the stock outright.
I’ll explain that in terms of margin and leverage of an option shortly, but let’s go over a put option to kind of give you the same example.
So we’re going to buy a put option on the same stock at the same strike price of $50, with 30 DTE.
Owning this put option allows you to sell the stock at the stock price of $50 per share between the time you buy the option, and the expiration date of 30 days from now, regardless of where the stock is at.
So if the stock crashes from $50 to $25, then your put option allows you to sell the stock at $50 dollars per share, which is your strike price, even though the stock is at $25 right now. Which means you can profit $25 per share.
Now the question must be coming into your mind, why would you buy a call or a put option versus trading the stock directly?
This is a very good question – we did cover this in Part 1 of our intro to option trading course, but there are several reasons to buy calls and puts.
For example, if you buy a stock at $50 per share, and you buy 100 shares, you’re gonna have to put up $5,000 in margin if you have a cash account.
If you have a margin account, you have to put up $2,500. And if you have a day trading account, which is any account above $25,000, then you can put up $1,250 a margin.
Now owning this stock at $50 means the stock could technically go to zero, so technically you have a $5,000 risk if the stock goes to zero.
This is where a put option comes in.
Remember if you buy a put option on the same stock with a $50 strike price, if the stock price goes down, the put option gains in value while your stock trade loses value.
Think of it like buying insurance on your stock position. The put option will protect your stock trade even though your stock trade itself is losing value, your put option is gaining value. So it’s like getting insurance or hedging the risk on your long stock position.
Now what about a call option? Well you can just flip that scenario.
Let’s say you want to sell a stock that you think is going down in price, and it’s also currently priced at $50. If you sell 100 shares of that stock at $50, technically the stock can go to infinity so your risk is unlimited on this short stock trade. But if you buy a call option, you are hedging your short stock trade because your call option gains in value as the stock goes up.
So again you’re buying insurance on this short stock trade, hence one of the main reasons to buy and sell options is to protect/hedge or buy insurance on your long or short stock positions.
Another reason to buy calls and puts is leverage. Options have more leverage than buying and selling stocks outright.
For example, going back to our long stock trade at $50.
If you’re long stock at $50 for 100 shares, you have to put up $5,000 in the cash account, $2,500 if you have a margin account and $1,250 if you have a day trading account.
However, with options you can control 100 shares of the stock for much less.
So let’s say a call option on this same stock at $50 with 30 DTE cost $2.50. Now if you remember from Part 1 of our Intro to Options video, each option contract represents or controls 100 shares of that stock.
So if you buy one option contract for $2.50 x 100 shares = $250. So you can own a call option contract on the same stock for $250, vs having to put down $5,000 or $2,500 or $1,250 margin.
That means you get a lot more leverage trading options, and therefore you can use that capital to make other trades as well. So this is another advantage to buying calls and puts.
Now let’s walk you through a couple examples of call and put options and how that works.
So you own 100 shares of a stock at $50, and you have a downside risk on that stock if it falls. You decide to buy a put option on that stock for the same $50 strike price at $2.50 or $250 dollars a margin.
If the stock climbs from $50 to $60 dollars, you gain $10 per share on your long stock position. This gives you $1,000 profit, which is $10 per share x 100 shares = $1,000.
But you also bought insurance on this stock trade. You bought a put option which cost you $250, so your net profit is $750 to protect your long stock position.
This is one example of how you can use options to protect or hedge your stock trades.
But let’s look at that same example with your stock price falling.
So you bought 100 shares of XYZ stock at $50 and you also bought the 50 put option for 30 DTE at $2.50, which is $250 of your capital.
Let’s say the stock falls from $50 to $40 per share on your long stock trade. You’re losing $10 per share x 100 shares – that’s $1,000 loss.
However, you have a long put option that gains in value if the stock falls and that put option allows you to short the stock at $50, thus you can exercise that put or your put option insurance, and get $10 per share on that put option.
So you lose $1,000 on your short stock trade, but you gain $1,000 dollars on your long put option, which is a net zero loss. You did pay $250 dollars for this put option and insurance, so instead of losing $1,000 on this trade, you only lose $250, which is much better than taking the full $1, 000 loss.
For every single loss you had on all your trades this year, instead of losing the full amount, what if you took anywhere between 25% and 75% less than your full losing position.
How much would that help your account?
This is one of the benefits of trading options. It gives you a natural way to protect your trades by giving you that insurance.
Now what if you don’t want to buy insurance on your stock trades, or what if you want to trade the stock prices without actually owning stocks? That is the benefit of trading options.
So let’s say you don’t own any shares of a stock, but you want to own shares and profit from that stock’s price movement. You’re bullish on it, however the stock is too expensive, say at $300 per share.
Well this is where call options and then option leverage comes in. Call options as you recall gain in value if the stock goes up, and they give you better leverage than owning the stock outright.
So to buy 100 shares of a $300 stock requires $30,000 in margin if you have a cash account. If you have a margin account, you have to put in $15,000 in margin, and if you have a day trading account, you have to put $7,500 down in margin.
But let’s say you don’t have that $7,500 in margin to buy this stock, this is where option leverage comes in – this is where call options come in.
You can buy a call option at the $300 strike price with 30 DTE. That gives you the right, but not the obligation, to buy 100 shares of that stock at $300 per share anytime between now and the next 30 days.
Now let’s say this call option costs you $5. That means you have to pay $5 x 100 shares. That’s $500.
That’s much better than putting the $7,500 minimum, just to own 100 shares of that $300 stock.
Now let’s examine 2 scenarios using options. One where the price goes up, and another where the price goes down.
In the first example, the stock goes from $300 to $325.
You own a $300 call option for $500. The stock appreciated $25 at 100 shares per option contract. You can now exercise that call option, which means you can buy that stock at $300, even though it’s now at $325 a share. That’s a $2,500 profit. The math is $25 a share x 100 shares.
So profit of $2,500, however you did buy the call option for $500, so your net profit on this call option trade is $2,000.
If you have bought the stock outright, you would have a $2,500 profit, but you would also have to put up that $7,500 margin, and if you didn’t have it, you wouldn’t be able to profit from it.
That’s where options can allow you to profit from stocks while not having to put up as much margin. It’s pretty cool.
Now in the second scenario, you bought that same call option at the $300 strike price for $5 or $500 in margin.
Let’s say the stock price falls to $275.
Well that call option gives you the right, but not the obligation, to buy the stock. So you don’t have to exercise that option. There’s no point in exercising that option if the stock price falls, so if you were long 100 shares of that stock at $300, and it falls to $275, you lose $2,500.
However, by buying that call option for $500, you only lost that $500.
Hence options can allow you to buy stocks with greater leverage and also reduce your risk. This is the power of trading options. You can put out much less capital, have less risk, all for the exchange of a small premium. The same goes for put options.
So to recap.
Call options are options that allow you to buy a stock at a set price, which is called the strike price, within a specific time frame, which is the expiration date on or before that date.
Put options are the opposite. They allow you to sell a stock at a set price within a specific time frame the expiration date on or before that date to buy a call or put option you get greater leverage you have less risk but you do have to pay a premium as we also mentioned.
You can use those calls or puts to buy insurance on your long or short stock trades this gives you the option to hedge or reduce your risk on those same long and short stock trades.
Now it’s important to understand there are very specific times to buy calls and puts but there are also times which you should not buy those calls and puts even if you think the stock is going up or down. There are certain times where you should buy calls and puts and there’s certain times you should not buy those calls and puts.
If you want to learn when and how to do this, then check out our options boot camp where we teach you the how and when to buy calls and puts and when not to buy calls and puts.
We also teach you eight option strategies to generate income and on top of it we teach you the exact price section context in the charts what the chart should look like when you want to buy these calls and puts.
So I hope you enjoyed this Part 2 of our free option trading course, and I hope this really simplified it a little bit further for you on the natures of calls and puts calls and puts are the basic building blocks of all options
If you get this down, you understand options and how the basic building blocks of options work
With that being said, I hope you enjoyed this video. I look forward to your comments and feedback and I’ll see you in the next one.