Selling options for profits

Definitions An option gives you (the buyer) the option but not the obligation to buy/sell a specific “underlying” at a specific price (strike price) on or before a specific time (expiration date)

Expiration Date Occurs the Saturday after the third Friday of every month

Underlying Underlying can refer to a Stock or an Index

Strike Price Strike price internals are standardized Strike priced between 0-25; 2 ½ strike intervals Strike priced between 25-200; 5 strike intervals Strike priced above 200; 10 strike intervals

Front Month The month to expire next for a specific stock. Most stocks with options will have front month, the month after front month and 3 month separated expirations afterwards

Contracts Prices for options are quoted on a per contract basis, each contract is equivalent to 100 shares so you have to multiply by 100 to know the cost of that option

Open Interest The amount of outstanding contracts out in the market for a specific stock option

Selling Short Borrowing shares from your broker expecting them to go lower so that you can “buy to cover” them at a lower price and make a profit

Buy to Open/Sell to Close The conventional way to think about the stock market, you buy to open x# of shares and sell the shares to close the transaction

Sell to Open/Buy to Close You can also Sell to Open in the case of stock by doing a short selling and buy to close, buy to cover, later on. When dealing with Options you can also sell to open and buy to close

Calls give you the right to sell at a specific price

Puts give you the right to buy a specific price

Symbol nomenclature 5 IBM Apr 100 Calls or 5 IBM1016D100 (10 = year, 19 = day, D designates Call and april, 100 = strike)

If you buy the above you have the option to buy at any time before the third Friday in Apr 500 Shares of IBM at $100

In the money, at the money and out of the money In the previous IBM example the option was In the money since it had intrinsic value, i.e. your strike price was less than the current stock price on a call option and vice versa for a put option

When an option is out of the money it has only Extrinsic Value

Since very rarely a stock is exactly at a strike price the term quasi-at the money is used, and is defined as the strike price closest to the current stock price

The Greeks explain the behavior of the stock option when compared to the underlying stock

Delta can be seen as

• The amount the option premium will fluctuate for $1 change in the stock or

• The probability that the stock will end up at that strike price

• Delta will be negative on Puts because a decrease in the underlying stock price will increase the value of the put

Theta

• The change of an option’s price with the passing of one day (all else being equal)

Vega

• The change of an option’s price with the change of the underlying’s volatility (all else being equal)

Examples

Order types

By duration (equities)

• Day: Good only for the Day you place the order

• Day+: Good for regular trading hours (9:30 AM to 4 PM EST) plus after hours that day

• After hours trading comprises of

• 8 AM – 9:30 AM EST

• 4 PM – 8 PM EST

• GTC: Good till cancel, most platforms will keep these orders 3 months active

• GTC+: Good till cancel for regular and after hours

Stock Options trade during regular trading hours only

By Execution

• Market Used to enter an order that will get executed almost immediately since it will be placed at current market price

• Stop Loss A market order triggered by a predetermined stop price

• Limit When selling it will sell at or above a predetermined limit price, and when buying it will buy at or below a predetermined limit price

• Stop Limit A combination of a stop order and a limit order, it will get triggered when the stop price is reached and execute at limit price or better

• OCO (Order Cancels Order) When any of the orders gets filled it will cancel the rest

Tip: Use limit orders when applicable and as much as possible to control your entries and exits