Do you ever wonder how people end up with all of those crazy P&L charts and turn $20 into a lambo, or get to post about a thousand bagger gains on an .SPX 0DTE, and you think 'wtf is all this nonsense?' - well this guide is for you! Let me introduce you to…
* Options Contracts
Ah Options Contracts - if stocks are like a fine whiskey that gets better over time, then options are the absinthe you got at your older brother's party that had you throwing up all over the lawn and passed out in less than an hour.
Less metaphorically, options are contracts between a buyer and a seller to either buy or sell shares at a certain price - if they're in the money.
The contracts hold the right to buy or sell these shares in lots of 100, and their value can change rapidly based on a number of factors such as the underlying strike price, implied volatility, time and general market sentiments and expectations. Not to mention the Greeks.
(Funnily enough IV isn't one of the Greeks, that's my bad)
With all of that in mind, you can spend hundreds, or thousands of dollars on Options Contracts only to have them expire out of the money and worthless - doesn't that sound exciting?
- So it's just fancy gambling?
In a lot of ways, yes and no. Options Contracts have some legitimate uses, some people use them for hedging and insuring positions against upside and downside moves of their stock holdings.
But yeah, we can use them for degenerate gambling, betting on stock price movements with leverage to make or lose huge amounts of money in a small time, as each contract effectively controls the right to 100 shares of the underlying stock.
Some General terms
* Short & long
Going long on a stock is a position you take where the value appreciates by the stock price going up. Holding stocks or buying Call contracts are long positions. Conversely, going short on a stock is taking a position that will appreciate as the stock price goes down, such as buying a put or short-selling the stock.
* Bullish & Bearish
These are just fancy trader terms for whether you think the stock will go up, or down. Bullish means you think it'll go up, bearish means you think it'll go down, that's basically it. Apparently it relates to how those animals attack, however...
* Calls / Puts / Rights / Obligations
Options Contracts come in Call and Put flavours, and these have different Rights and Obligations associated to selling and buying them:
Call - the buyer of a call option has the Right to purchase 100 shares at the strike price. The seller has the Obligation to sell 100 shares at the strike price.
Put - the buyer of a put contract has the Right to sell 100 shares at the strike price. The seller has the Obligation to buy 100 shares at the strike price.
- If selling comes with all of these 'Obligations', why would anyone choose to do it?
When you sell an Option Contract you receive a credit, or premium, for taking on the obligation to fulfil the contract. Think of it like selling insurance.
If the contract expires worthless, then you get to keep all of the premium received as profit. Sometimes traders who sell options will 'buy-to-close' their positions once the price has dropped and reached a certain percentage below their max profit, therefore locking in that profit and freeing up their capital to allocate elsewhere. (This is explored quite heavily by Tastytrades and their methodology). They might wait for Implied Volatility to come down, or for theta to decay the price down to their take profit level.
* ITM, ATM, OTM
In-the-money, at-the-money, out-of-the-money Oh my!
Often referred to as "moneyness", this describes the relationship between the underlying stock price and the strike price of the option contract. For a Call, if the stock price is *above* the strike price, it's in the money. For a Put, the stock price needs to be *below* the strike price to be in the money.
* Strike & expiry
Options Contracts have a Strike Price and an Expiry date. If the underlying stock price is not in the money by the expiry, the contract expires worthless.
This is another way that options trading is like gambling - you're essentially making a bet that the stock price will move by a certain amount (above or below the strike), by a certain time (the expiry) in order to make a profit. Some strategies, like Iron Condors, profit if the stock price stays within a set of strike prices up to a certain time.
The Expiry is often referred to by the "days to expiry" or DTE, for example, the preferred gambling medium of your average wallstreet bets regard, the brutal and beloved 0DTE (a contract that expires on the same day). Deep in the money options with long DTE, such as over 150-200 days, are often referred to as LEAPS.
* Assignment & exercise
Options that are 'in the money' can be assigned and exercised - where the buyer exercises their Right to either buy or sell the underlying stock in a lot of 100 shares. Most brokers will automatically exercise option contracts that are in the money at their expiration, so keep this in mind if you’re holding ITM contracts.
When this happens, a seller's contract is Assigned (a process handled by the OCC - Options Clearing Corporation), and the contract is Exercised - the brokers will complete the trade of underlying stocks for both parties (the buying and selling of the 100 stocks part of it all).
Happy trading! If you want to see more of my guides and memes, you can check me out on reddit here: https://www.reddit.com/user/GreenBean042/
And remember: this is not financial advice, don't invest any money you're not willing to lose, options contracts are complex financial derivatives, do not enter into a trade without fully understanding the rights, obligations and risks involved with doing so.
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