Options trading can seem extremely complex when compared to the traditional share trading method. Let’s clear up some of this complexity so that you can reap the benefits of trading options.
An option is a contract that is linked to an underlying asset, like a stock or ETF. Unlike shares, options have a set end date. The end date is more commonly referred to as the option’s expiration date. Once the contract expires, the contract can no longer be traded.
Owning an options contract gives you the right to trade 100 shares of the underlying asset at a predetermined price. This predetermined price is known as the option contract’s strike price.
A call option gives you the right to purchase 100 shares of the underlying asset at the strike price. Let’s say you own a call option contract on NVDA with a $200 strike price. You have the right to buy 100 shares of NVDA at $200 per share by the date of expiration.
A put option gives you the right to sell 100 shares of the underlying asset at the set strike price. Let’s say you own a put option contract on NVDA with a $200 strike price. You have the right to sell 100 shares of NVDA at $200 per share by the date of expiration.
Unlike the underlying share, options have several factors that go into determining their value. These factors include options greeks, implied volatility, intrinsic value, and extrinsic value.
While some traders get into options to exercise the contract and build an equity position, the vast majority of traders get into options trading as a cost effective alternative to trading shares. Because an option is a contract of 100 shares, each share gains a certain amount of value as it gains intrinsic value, leading to much larger % returns than traditional shares would, especially during times of volatility.
The AAPL $170 strike calls expiring on May 6th (8 days until expiration) cost $175 (1.75 x 100 shares within the contract). All of the value from this contract is extrinsic value because the contract is not in the money, meaning the strike price is of lesser value than the current price of AAPL, which sits at $159.
The delta of this contract is .26, allowing us to estimate that if $AAPL can go up $1 from $159 to $160 we would stand to make roughly $26 dollars (.26 x 100 shares) in profit on the $170 call option.
To summarize, the AAPL 5/6 $170 call option costs $176 and stands to gain roughly $26 in profit on a $1 move for 15% profit. To gain 15% profit on an AAPL share, we would need the stock to move nearly $24. For this reason, trading options contracts is viewed by many as a potentially lucrative alternative to trading shares if you don’t have $100’s of thousands in trading capital.
Sadly, options trading isn’t all positive. There is a lot of risk to trading options if you aren’t careful. For starters, the delta of .26 on our AAPL $170 call option goes both ways. A $1 decrease in AAPL’s share price would cause the AAPL call option to lose roughly $26 in value.
Remember that unlike shares, option contracts have a predetermined expiration date. As an option contract moves closer to expiration, it loses extrinsic value.
Let’s say you own a call option that has a theta of .80 and a delta of .40. You would need the underlying asset to increase $2 over the course of the trading day just to offset the theta. If you’re trading short term option contracts, be sure to check the theta and have an exit plan in place.
As an options trader, it is important to have a set of tools that allow you to make calculated decisions with confidence. One of the best tools you can arm yourself with is Options Flow & Darkpool Data. These resources arm everyday traders with insight into what massive institutions are trading with confidence.
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