Options Trading 101 - How Does Options Trading Work

Okay in this post options trading 101 we are going to assume you understand the basic premise of options trading and have read our options trading glossary.

How Does Options Trading Work

The best way is to explain by example.

OK…..Lets say we see the price of ABC Holding is $67 on May 1st and the premium (cost) is $3.15 for a July 70 call.

What this means is that the expiration date is the third Friday of July and the strike price is $70. This means the total price of the contract is $3.15 x $100 = $315. In the real world you would also have to pay commission but in this example we will ignore that.

Now if you remember a stock option contract is the option to buy 100 shares. That is why we have multiplied the contract by 100 to get the price. The strike price of $70 means that the stock price must rise above $70 before the call option is worth anything. Also as the contact is for $3.15 per share it thus makes our break-even price $73.15.

So when the stock price is $67, it’s less than the $70 strike price making the option worthless. However you have to remember that you have paid $315 for the option so you are currently down by that amount.

What Happens When The Price Shoots Up?

Now let us say that in four weeks the stock price has risen to $78. The options contract has increased along with the stock price so now is worth $8.25 x 100 = $825. Then when you subtract what you paid for the contract your total profit is ($8.25 - $3.15) x 100 = $510. Just like that you have almost doubled your money in just four weeks.

At this point you have the choice to sell the option which is called “closing your position” and take the profit there and then. The other alternative is to hold on to see if the price rises further. To explain options trading further in this example we are going to keep hold of our contract.

What Could Happen IF You Keep Hold Of A Contact

In our example we made the wrong decision we held on to our contract and the by the expiration date the stock was at a low of $62. This is bad because it is less than our strike price and there is no time left. We are now down the original price of the option which was $315.

To make it easier for both of us to understand I have put the calculations into a table:

Date	May 1	May 28	Expiry Date
Stock Price	$67	$78	$62
Option Price	$3.15	$8.25	Worthless
Contract Value	$315	$825	$0
Paper gain/Loss	$0	$510	-$315

What Does This All Mean?

The price swing for the length of this contract from high to low was a staggering $825 in just a few weeks. There was a point where the investment could have been an almost two-fold increase. This is leverage in action peeps.

Now let’s delve deeper into how options trading works in the real world. Yes we have talked about options as the right to buy or sell…..but in actuality the majority of options are not exercised. Let’s dig deeper shall we?

Exercising Versus Trading Out

When we look at our example we could have made money by exercising at $70 and then selling back at $78 for a net profit of $8 a share. We could also keep the stock in the knowledge that we are able to buy it a discount rate at the present value.

What happens in the real world is most holders choose to take their profit by trading out (closing out) their positions. The holder would sell his position on the option market with the writers buying back their position back to close it. Best estimates suggest that only about 12% of options are ever exercised, 58% traded out and the other 30% allowed to expire.

Let’s finish up this post and section by explaining pricing options in this example.

Intrinsic Value and Time Value

In our example the premium (price) of the option went from $3.15 to $8.25. This change can be explained by intrinsic value and time value.

What we mean is an options premium price is its intrinsic value plus time value. Note the intrinsic value is the amount “in-the-money” an option is which for a call option means the price of the stock is equal to the strike price. The time value represents the possibility of the option increasing in value. In our example what this means is:

Premium =     Intrinsic Value            +          Time Value

$8.25       =          $8                      +                  $0.25

In the financial world options pretty much always trade above their intrinsic value. In our example we just had to explain all possibilities that may happen when either buying or selling an option.

To learn more get our guide Options Trading For Dummies.

Your Basic Options Trading Glossary – Understanding Options Trading Terminology

Look, options trading is quite a complicated area of the financial market. Here is our basic options trading glossary so you have a foundation to increase your knowledge further.

Strike Price – This is the underlying price that the stock can be purchased or sold at.

Exercised – Before a position can be exercised the price must go above (for calls) or below (for puts) the strike price before the position can be exercised.

Expiration Date – This is the time limit set by both the buyer and seller in which action must be taken dependent on the strike price being reached so the option can be exercised.

Options Exchanges – There are national options exchanges where trade can be done. When a deal is made through this avenue it is known as a listed exchange. One such exchange is the Chicago Board Options Exchange (CBOE).

Contract – When a deal is done on an options exchange there are fixed strike prices and expiration dates. Each listed options represent 100 shares of a stock otherwise known as a contract.

In-The-Money – You are considered “in-the-money” with a call option when the price goes above the strike price. Likewise with a put option if the price goes below the strike price you are “in-the-money” too.

Intrinsic Value - The amount of money you make on the option is called its intrinsic value.

Premium – This is the total cost (the price) of an option.

Time Value – This is the time remaining on the option before the expiration date.

Volatility – This is a term that states how high risk a certain option is.

Options Trading

This is a complicated subject but please bookmark this post Basic Options Trading Glossary so that you can come back to it a later date if at any point you get confused by the lingo. I know I did for the first few months when I was researching this part of the financial markets.

To learn more about this complex subject read our guide to the different Types Of Options.

Call And Puts Explained – The Basic Terminology Needed To Understand Options Trading

In this post we are going to explain calls and puts. They are the basic terms you have to understand if you are ever going to comprehend the complex form of investing that is options trading.

Options trading is the buying of the right to purchase a underlying asset in a predetermined time but without the obligation to go ahead with the sale. If you do not go through with the purchase all that happens is option will expire and you lose the original investment.

So let us look into call and puts so you can understand the basics of options trading in greater detail.

Call And Puts

When it come to trading options there are two types call and puts:

Call – This gives the holder (buyer) the right to buy an asset at a predetermined price within a specified time period. People buy a call when they believe the price of the asset will rise.

Put - This is similar to a call as it gives the right of the holder to buy an asset within a predetermined time frame. The difference is that the holder hopes by the time the option expires the price of the asset has fallen.

So what that means in there are four positions that one can take in the options market.

The Four Positions In The Options Market

1 – Buyer of a call

2 – Seller of a call

3- Buyer of a put

4 – Seller of a put

So let us try and clarify things further when someone buys an option they are called a holder. When someone is selling an option they are called a writer. When it comes to the financial markets the holder is said to have the “long position” and the writer the “short position”.

The Important Point To Remember When It Comes To Holders And Sellers

Call and put buyers (holders) do not have to buy or sell. All they have purchased is the right to buy if they choose to do so.

Call and put sellers (writers) do have the obligation to buy or sell. This means even if the writer stands to lose a lot of money they still have to go through with the transaction.

Options trading is a complex subject that many people find hard to get to grips with. This is understandable and many people truly never get a handle on this form of trading. All I say is never get into this form of investment if you do not comprehend it fully as it is a very quick way to lose a whole lot of money.

If you want more information on this complex subject then visit the site and get your Options Trading Glossary.

How To Get Started In Options Trading – Your Basic Trading Options Guide

Options trading isn’t the easiest subject to understand if you are a complete beginner. The world of finance is complex and options trading is I am afraid to say at the sharp end of investing.

If you do not know what you are doing then you can quickly lose your shirt with this form of investment. The reason people like this way of trading though is that if you do know what you are doing then you can make huge profits very quickly. People can double (or more) their money in a matter of week.

I have put together this article so that hopefully you get the basics of this way of trading. To start off let us look an accurate description of options trading as it actually is

A Description Of Options Trading

Description: An option is the right, yet not the obligation to sell or buy an asset (be it futures, commodities or perhaps currency) at a fixed price before a predestined date. This is a binding contract whose terms and properties have been strictly defined.

Look that may of not cleared things up entirely right? Well then let us look at things by way of an example to hopefully make things that much clearer.

An Example Of Options Trading

Right say you have seen a yacht (it is nice to dream) for sale for $300,000. The problem is it will be three months before you have the money in place. At this point you can speak to the owner and work out a deal to pay $4000 now with option to buy the yacht in three months time for $300,000.

What Happens Next?

In this example two circumstances could come about…..

Circumstance 1 – The value of the yacht could rise to a cool $2m because you find out that the boat was previously owned by a famous celebrity. This is fantastic for you because the owner of the yacht has to still sell you the yacht for $300,000. This means a profit of $1,696,000   ($2 million - $300,000 - $4,000) just like that.

However what is more likely to happen is…….

Circumstance 2 – The value of the yacht could be worthless. You have the yacht checked out and she proves unseaworthy with many leaks and serious flaws in the hull. As you have only bought the option to buy it you are under no obligation to physically purchase it. In this scenario you only lose the initial $4,000 the price of the option.

So How Does This All Come Together?

Well it all comes to two factors you have to consider:

Factor One – Just because you buy an option there is no obligation to go ahead a purchase; it just gives you the right. If you decide against a purchase the option will expire and at that point it becomes worthless. All you lose is the original investment.

Factor Two – An option is simply a contract that deals with an underlying asset. That is why in the world of finance we call an option a derivative; what this means is an option derives its value from something else. In the example we have used the yacht as the underlying asset but in finance in can be stock, commodities or currency.

Conclusion – Options Trading

The example we used here was to give you a tangible grasp of options trading using a real world scenario. Options trading is a very complex form of trading but can be done by an individual and many people make a living online option trading from home.

To learn more about visit the site Options Trading 101.

Article One – Options Trading 101 – Your Simple Guide To Trading Options

This article is to help people looking to get into options trading. The is an extremely complex part of the market; so as much as possible I have tried to simplify the concept to make it easier to digest and understand.

If you don’t understand the basics of options trading (most people) then it can be a very quick way to lose lots of money. Bearing in mind this is a very risky form of investment I wanted to explain what exactly options trading involves in a way everyone can understand.

I hope you use this article to understand the concept in much greater depth and make money from options trading.

A Definition of Options Trading

Definition: An option is the right, however not an obligation to buy or sell an asset (be it stock, currency or commodity) at a fixed price before a predetermined date. It is a binding contract with strictly defined terms and properties.

Still confused? Fine lets use an example to make the whole process a lot easier to figure out.

Options Trading Explained By Example

OK you see a house for sale for $250,000 BUT don’t have the money just yet but will have the funds in four months time. You can speak to the owner explain the situation and work out a deal to pay them $3000 now with the option to buy the house in four months time for $250,000.

Now In That Time 2 Things Could Happen

Scenario 1 – The value of the house could rise to $1.5 million because they find out that Frank Sinatra was born there. Now the owner still has to sell you the house for $250,000 as he sold you the option. This means you could then make an instant profit of $1,247,000 ($1.25 million - $250,000 - $3,000).

But hold your horses……..

Scenario 2 – You have a survey done and the house is structurally unsound and is full of dry rot and termites. The house is worthless in all but name. Now as you have bought an option you are not under any obligation to actually purchase the house. Instead you just lose the $3,000 the price of the option.

What Does This All Mean?

Well there are two points to think about:

Point 1 – When you buy an option you have the right but not the obligation to buy something. You may just let the option expire and which point the option becomes worthless. At this point all you lose is the original investment.

Point 2 – An option is just a contract which deals with an underlying asset. This is why an option is called a derivative meaning an option derives its value from something else. In our example the house was the underlying asset but in finance it is usually a stock.

Conclusion – Options Trading 101

This explanation is just so that you understand the basic premise of online option trading. There is a lot more to learn but too much information quickly leaves us all confused especially when it comes to financial matters and markets. Consider this article Options Trading 101 a foundation to learn more.

There are websites set up to help you increase your knowledge. It just takes a quick search in the major search engines such as Google to find such relevant sites.

Or just visit tone site where all the information is there for you it is called Options Trading 101.