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
Last modified 2yr ago