Today I am going to write a bit about Option Basics and then outline one of the trades I put on today.
What are options?
Pretty simple question, totally understandable.
Options are contracts, agreements between parties.
There are two basic options:
- Calls – a purchaser of a call option is buying the right to buy 100 shares of stock or ETF at a certain price (the strike price) at any time before a certain date (the expiration date)
- Puts – a purchaser of a put option is buying right to force the seller of the put to buy from the buyer 100 shares of a stock or ETF at a certain price (strike price) any time before a certain date (expiration date)
Lets look at a real example, today is 2/13/2018 and lets look at a couple of Apple options, AAPL closed today at 164.34:
- AAPL Call – Let’s look at the March 16th Expiration call with a strike price of 165. Today this was selling around $445
- AAPL Put – Let’s again look at the March 16th Expiration, but this time the put. Unsurprisingly it’s a similar price, $475. Just a bit higher than the call but remember AAPL is 66 cents below 175
If one bought a 100 shares of AAPL instead of the call, you would have to pay $16,434. If you did not sell any other calls to help offset the sales price of $445 AAPL would need to rise to 169.45 before March 16th.
The advantage to the call is paying just a fraction of the cost of the stock to control 100 shares. If AAPL trades up to 200 by March you can make up to $3000 on each call.
The other advantage is you only risk $445. If AAPL takes a big hit, down to 150 or so like it did last week you don’t lose $1,500.
The disadvantage to the call is that owning the stock has no time limit. AAPL could trade right at $165 up until March 16th and then make a run to $200 in April. Unless you rolled the call up and out, you lose.
Puts work the same way, but in reverse. Basically, you would buy them if you thought AAPL was going lower.
In order for the put to pay off, AAPL would have to close at 160.25 or lower, on March 16th.
Of course, these are not the only options that exist, even in AAPL. There are monthly expirations and many stocks and ETFs have weekly expirations. There are strike prices very far away from where the stock or ETF is currently trading. The two options I mentioned above are basically ‘at the money’. There are strike prices that are ‘in the money’ (lower strikes in calls and higher strikes in puts) and ‘out of the money’ (higher call strikes and lower put strikes).
You can find these options on your broker’s site and are called an Option Chain.
Tomorrow I’ll go a little further into this, why people might use calls or puts before we move on to spreads.
Yesterday I wrote about a trade I put on in XOM. I opened a combination call spread pairing a calendar spread (one April 80 call paired with a March 80 call) and a credit spread (selling the same March 80 in the other spread and buying a March 82.5)
If XOM stays at or below 80 on March expiration I will end up with an April 80 call for $24.
Today for a while XOM opened just under 76 and made it to 76.7 before pulling back and closing at 76.3.
So I decided to add another calendar spread to this trade buying one March 75 call for $302 and selling a weekly 75 expiring a week from this Friday (2/23) for $221. The net debit is $81, adding the $24 from yesterdays trade has me in this multi leg, multi date spread for $105.