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The Best Way To Learn Options Trading

epsiladmin · May 23, 2022 ·

The best way to learn options trading is by combining learning and doing. Learn the principles and theory, and then practice as much as possible.

Here’s the process in more detail:

1. Learn Options Principles & Theory

Options trading is a complicated beast, and it pays to know as much as possible about the basics before trading for yourself.

That may seem a little daunting, but there is some work to be done before you can confidently, and competently, trade options for real.

options gamma math — Learning Options can be complex….

Thankfully we can help on this.

We’ve created all the info you need to trade option and suggest you go through the following post to get yourself up to speed on the basics:

Start with our post on How Options Work: Trading Put & Call Options which will give you the basics on the two option building blocks: puts and calls.

Then we suggest you learn how you might combine trades in two or more options to create an options spread: Options Spreads: Put & Call Combination Strategies.

And then perhaps become familiar with some of the more basic options spreads such as a Covered Call, Calendar Spread or Iron Condor.

Finally you might familiarise yourself with some of the key options terms such as Implied Volatility and the Greeks.

There are also some excellent videos on youtube to watch. here are some we recommend:

The Best Ways To Learn Options Trading Videos:

2. Options Paper Trading

The next step is to do some options trading yourself, but without risking any cash.

You can do this this ‘paper trading’ as its called on several of the popular options brokers’ sites.

These brokers allow you to load up a dummy account with fake ‘money’ and trade the market – all at no risk. You’ll get all the functionality of their platform, without risking any hard cash.

This is a great way to practice trades and finesse your strategies before risking any capital.

It’s also a good way to try out the various brokers to see which you prefer.

Here are our choices:

Interactive Brokers:

Interactive Brokers offers a full paper trading service for new customers. You’ll have to sign up for an account first (at no cost) and then go to Manage Account >Settings >Paper Trading .

(See here for more info.)

The best thing is you’ll get full access to IB’s great tools:

Best Way To Learn Options Trading - PaperTrader — IB’s Tools

TD Ameritrade

TD Ameritrade has a great trading simulation environment called paperMoney.

See here for more info.

3. Trade (Slowly) For Real

Once you’ve found a style which, on paper, works and a platform you prefer it’s time to trade using real money.

Start slowly with money you can afford to lose. Indeed once you’ve loaded it into the platform treat it as gone to remove as much emotion from your trading as possible.

You’ll find that even with the above measures, trading with real money is very different to using paper money to practice.

In particular you’ll learn how to enter a trade properly – ie how to price a trade using the buy sell options prices – which is difficult to simulate with paper money.

Once you’ve been through these learning stages you can gradually increase the amount of dollars you have at risk.

The Sell Put And Buy Call Strategy | A Synthetic Long Stock

epsiladmin · Jun 5, 2021 ·

The Sell Put And Buy Call Strategy is an example of a synthetic stock options strategy: using call and puts options to mimic the performance of a position, usually involving the purchase of a stock.

We saw this when looking at the synthetic covered call strategy elsewhere.

In this case, what is being mimicked is a long position on a stock by selling a put and buying a call at the same strike price and expiry (usually at the money). Here’s how it works in more detail:

Long Stock

A Long Stock, purchased at $50 has the following payoff diagram:

As you would expect if the stock rises above $50 the ‘position’ is profitable and gets more profitable as the stock rises further. And the converse is true too: below $50 the stock is unprofitable and gets worse as the stock price falls.

How To Place A Synthetic Long Call

In order to place a synthetic call, it’s important to remember one of the key principles of options trading: if the pay-off diagrams of two positions are the same then they are, in effect, the same trade.

Therefore all we need to do is construct an options spread that has the same pay-off (or ‘P&L’) diagram as the above and we have ‘synthetically’ created a long call.

And the spread that does the job is to buy an at the money call and sell an at the money put. Both should have the same expiry date.

The long call has the following P&L diagram:

long call part of the Sell Put And Buy Call Strategy

And here’s the short put’s pay-off:

sell put part of the Sell Put And Buy Call Strategy

And when put together they produce:

The Sell Put And Buy Call Strategy produces the Synthetic Long Stock

Which is, of course, the same pay-off diagram as the Long Stock above, and therefore the same trade.

Advantages Of The ‘Sell Put And Buy Call’ Strategy

Why would you go to the bother of putting on the synthetic version of a bought stock when you could quite easily just buy the stock? Here are a couple of reasons:

Lower Capital Outlay

To own stock you require the capital to purchase the shares. Even if you’re buying stock on margin you still need to deposit 50% of the purchase price with your broker.

The margin requirements for the ‘sell put and buy call’ strategy is much smaller and therefore less cash is required.

Flexibility

Because options are involved a sophisticated trader has more, well, options to manage the trade.

For example if the stock price drops, therefore increasing the price of the short put, it could be rolled down (ie sold at a lower price point) or out (buying back the put and selling a put of a later expiry date).

Downsides To The ‘Sell Put And Buy Call’ Strategy

With all options trades there is a downside to consider to placing the synthetic version of the long call. Here are a few:

Dynamic Margin

The required margin is lower than a purchased stock as we’ve seen. However, because the trade includes an uncovered sold put, your broker will recalculate your margin requirements daily. If the stock has moved down significantly you’ll be asked to post more margin immediately.

Increased Leverage

For a smaller amount of capital you’re being exposed to the full risk profile of the stock. Therefore, when compared to the capital outlay you have more risk.

This is the flip side of being able to put the trade on for less capital: you’ve effectively leveraged yourself to the stock price. You could get more return (on your capital requirement) but for a greater risk.

Conclusion

The ‘Sell Put And Buy Call’ strategy, the sell of an ATM put coupled with the purchase on an ATM call, is a way of creating a synthetic long stock position. It requires a lower capital outlay than simply purchasing the stock, but also exposes you to the same risk.

Can You Sell A Call Option Before It Hits The Strike Price?

epsiladmin · Dec 18, 2020 ·

We’re starting a series of posts on common questions options traders, particularly beginners, have. So here’s the first one:

Question To Be Answered: Can You Sell A Call Option Before It Hits The Strike Price?

The short answer is, yes, you can. Options are tradeable and you can sell them anytime. Even if you don’t own them in the first place (see below).

The longer answer depends on whether you do own the option. And whether the call option is in the money (ITM) or out of the money (OTM) at present (ie in which direction is it likely to ‘hit’?).

It also would be more useful to answer the related question on desirability: is it a good idea?

Scenario 1: You Own An OTM Option

Let’s say you own a call option with a strike price of 120 and the stock price is $100. In other words, it is $20 out of the money. And there are 20 days before expiry (say).

An OTM option before expiry will have intrinsic value. It will still have a value which can be sold in the market.

This is better than the alternative of exercising the option: you’d receive stock for which you’d pay $120/share, not recommended when stock is available at $100 on the open market.

The key decision on whether to sell or hold depends on whether you believe the stock is going to move up sufficiently within the next 20 days to counter the effect of time decay.

Long options positions naturally reduce in value, all other things being equal, as they are theta positive.

Scenario 2: You Own An ITM Option

Let’s say you own a call option with a strike price of 80 and the stock price is $100. In other words, it is $20 in the money. And there are 20 days before expiry (say).

In this case the option will have both extrinsic value of $20 (the difference between the strike and stock prices) plus intrinsic value due to there still being 20 days remaining on the options contract.

As above this intrinsic value will fall over time, all things being equal, and so again you should only sell if you believe the stock will not rise to counteract this eventual loss in intrinsic value due to time decay.

Scenario 3: You Don’t Own The Call Option

Options traders can actually sell options that they don’t own – called writing an option.

This can be lucrative: both ITM and OTM options have intrinsic value which falls over time. Hence if the option expires OTM it will be worth it, and the premium ‘sold’ is kept as profit.

It is also risky: should a call option expire ITM it will be exercised and the option holder is entitled to purchase stock from you at the lower strike price (compared to the current stock price).

However many stock holders do sell call options against their portfolios, receiving additional income from the sold option premiums, at the risk of having their stock ‘called away’ (in other being forced to sell to the call option holder if it expires ITM). This is the covered call option strategy.

In summary then it is almost always possible to sell a call option before it hits the strike price. The more pertinent question is whether it is desirable to do so.

Protective Put: This Defensive Put Option Strategy Explained

How Can The Protective Put Strategy Help A Trader?

Introduction To Protective Puts

The protective put (sometimes called a married put) strategy is one of the simplest, but most, popular, ways options are used in the market. Here we look at this defensive strategy and when and how to put it in place.

Options provide investors and traders with an extremely versatile tool that can be used under many different scenarios.

Options can be used to make directional bets on a market, to hedge a long or short position in the underlying asset and to make bets on changes in implied volatility. Options can also be used to generate income.

One of the biggest uses of options is to mitigate risk on a long position in a stock or other asset.

Description of the Protective Put Strategy

The protective put is a relatively simple trading or investing strategy designed to try to hedge the risk associated with a long position.

For example, if a trader or investor is long 100 shares of stock ABC, then he or she may look for ways to protect against a decline in the stock price.

The protective put strategy simply involves the purchase of a long put option that may potentially gain in value if the stock price declines. Here is a simple example:

Protective Put Example

Trader Joe is bullish on stock ABC and owns 100 shares at an average purchase price of $40 per share.

The company has a major earnings announcement coming up in a few weeks, and Joe wants to hedge his downside risk in the stock using protective puts.

With the stock currently trading at $45 per share, Joe decides to purchase the two month $40 put option (ie the strike price is $42) for a premium of $4.

Protective Put options strategy — Protective Put Example

If the earnings announcement is considered bullish and the stock price rises, the put option can either be sold back to the market at a loss or can be held until expiration.

If the stock price is above the option strike price of $40 at expiration, then the option simply expires worthless and Joe is out the $4 premium paid for the put.

If the stock price were to plummet, however, Joe’s put could potentially gain in value and possibly offset some or even all of the losses on the stock.

If the stock price is below the option strike price of $40 at expiration, then Joe has the right to sell his shares at $40 regardless of how low the stock price goes.

For example, if the stock price declined all the way to $35 per share, Joe’s losses would be limited to the $4 option premium paid per share.

When To Put It On

The protective put is used to try to mitigate downside risk on a long position, and can be used under a variety of circumstances. In the example used above, the trader wanted to try to hedge the downside risk that could come from a major earnings announcement.

In another scenario, a long-term investor might continually purchase long puts on a stock position that he believes could see a sharp rise in volatility. Long puts are also long vega.

In yet another case, a trader or investor could purchase a put if implied volatility levels are very low, thus making the options relatively less expensive.

Pros of Strategy

The protective put’s primary purpose is to hedge downside risk of a long position in the underlying asset.

Options can provide a degree of protection for a long position as may also potentially produce a profit if the shares drop or if there is a significant increase in implied volatility levels.

Because the put option is purchased, the risk on the put position is limited to the premium paid for the option.

Cons of Strategy

The strategy does come with some cons as well. Because options have an expiration date, the option will lose value as time passes with all other inputs remaining constant.

Options that are close to the current share price may also be prohibitively expensive, forcing the trader or investor to purchase puts that are further away from the money.

Although puts that are further away from the money may provide a hedge against a major sell-off, the trader or investor is still exposed to a degree on the stock.

A put that is a few dollars out of the money may not gain enough value to provide a hedge against a minor to moderate decline in the stock.

Risk Management

Risk management for a protective put can be accomplished in various ways.

If one is hedging a long position, he or she may be willing to simply hold the option until it expires knowing that they will lose the entire premium paid.

Another way to manage risk may be to sell the put back to the market if it loses a certain amount of value. Some traders may decide, for example, to sell a put back to the market if it loses half of its value.

Another method of risk management could include rolling the put out to a later expiration date.

Possible Adjustments

There are several ways to adjust a long put position. The trader or investor could initially buy a put that is further from the money, and roll it closer to the stock price as expiration gets closer and the options become less expensive.

Another method could be to roll the long put out to a later expiration date using the same or even a different strike price. The trader or investor could even decide to spread the long option by selling an out-of-the-money put against it to lower the cost basis.

Using a put to protect a long position in the underlying is a relatively simple position, but it does come with its own set of risks.

Traders and investors must decide how much risk they are willing to assume on the stock price, and must also decide what they are willing to pay for the hedge.

Used under the right circumstances, the long put can provide a degree of protection for a long position, but that potential protection does come at a cost.

Bull Call Spread vs Bull Put Spread

epsiladmin · Jul 8, 2019 ·

We’ve looked at both these options spreads before – but which one is better? Here’s the bull call spread vs bull put spread head to head…

Both the bull call spread and bull put spread produce a limited profit with limited risk on a rise in the price of the underlying security. However the former is a debit spread which decreases value over time and on an decrease in implied volatility; the latter is a credit increases in value over time and on a decrease in volatility.

First let’s look at what each these vertical spread strategies entails:

Bull Call Spread

A bull call spread involves the purchase of a (usually out of the money) call option, partly financed by the sale of a call with a higher strike price but the same expiration date. It is a debit spread (it involves a cash outlay).

Here’s the P&L diagram:

bull call vertical spread — Bull Call Spread P&L

A trader would put this spread on if they believed that the stock would rise, but was unwilling to risk losing all their call premium investment should the trade go against them. Thus they are willing to give up some of the upside to protect the trade.

Another way of looking at this is with reference to the options greeks.

Delta

A call option is strongly delta positive (ie it is sensitive to stock price movements). The sale of the call option, making a bull call spread, reduces the delta of the trade, and hence minimises the loss should it go against the investor.

Vega

A more subtle risk is vega, the sensitivity to changes in volatility. A call option is vega positive; it rises in value with a rise in implied volatility (and vice versa).

Unfortunately volatility tends to fall as stock prices rise, reducing the gains to a long call should the stock rise. Again the sold option reduces the position’s vega, reducing this effect.

Theta

Again a long call has negative theta – it falls in value over time – but this is mitigated by the sale of the call to make a bull call spread.

Bull Put Spread

A bull put spread involves the sale of a (usually out of the money) put option combined with the purchase of a further out of the money put. It is a credit spread – a net premium is received.

Here’s the P&L Diagram:

As with the bull call spread the trader believes the stock will rise hence he/she will get to keep the premium earned.

Some of the greeks, however, are different:

Delta

This is the same as before: the spread is delta positive but less so than the outright purchase of the put.

Vega

The spread is now vega negative: as volatility rises the options’ values fall which, given the trader has sold them for a net credt, this is good news.

Therefore as the stock rises, and volatility falls, the spread falls in value (again, good news). This increases the spread’s profitability (but also the risk – if the stock were to fall, volatility would rise and the options rise in value).

Theta

Unlike before, theta works in the trader’s favor: the bull put spread is theta positive. As time passes the spread increases in profitability.

Bull Call Spread Vs Bull Put Spread

Here then are the similarities and differences of these two options strategies:

Similarities:

Both spreads have similar P&L Diagrams: they make a limited profit/loss if the stock price rises/falls.
Both are delta positive: they are put on should a trader expect a stock to rise.
Both a limited risk strategies: their downside is limited (at a cost of a limited upside)

Differences:

The bull call spread is a debit spread, whereas the bull put spread is put of for a net credit
The bull call is vega positive: it increases in value with increases in volatility. Whereas volatility increases reduces the value of a bull put spread.
The bull call theta negative: it loses value over time; the bull put spread increases in value over time.

So Which Is Better?

As with most options related question, the answer is ‘it depends’.

Some options traders are happier with the relatively easy to understand debit spread; others love to see the value of the their credit spreads increase over time.

Whichever one you chose, be careful to understand risks – especially the more subtle options greek risks – beforehand.