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Options Trading 101 - Must Read!




To anyone new to trading options. You need to understand, this is a craft. A skill. You must learn and respect it, or it is going to disrespect you. Very violently in some cases. You HAVE to know what you're doing, not just THINK you know what you're doing.

You must understand the Greeks. This is essentially what your option is. If you don't know what they are exactly and how they can effect your option, you are straight gambling.

I don't know if new people are not reading the helpful information posted in this blog before jumping into options (Especially the people selling spreads that are asking what it means when they get assigned, etc. You're screwing yourself by not understanding these very basic but essential options trading concepts.

I took this from the tutorial section of the Discord I run to try to make it as simple as possible.

OPTION BASICS

ATM= At the money (Stock is 55 and you pick a 55-56 strike call)

ITM= In the money (Stock is 55 and you pick a 55 strike and lower call)

OTM= Out of the money (Stock is at 55 and you pick a 100 strike call)

Understanding Greeks

Greeks encompass many variables. These include delta, theta, gamma, vega, and rho, among others. Each one of these variables/Greeks has a number associated with it, and that number tells traders something about how the option moves or the risk associated with that option. The primary Greeks (Delta, Vega, Theta, Gamma, and Rho) are calculated each as a first partial derivative of the options pricing model (for instance, the Black-Scholes model).

The number or value associated with a Greek changes over time. Therefore, sophisticated options traders may calculate these values daily to assess any changes that may affect their positions or outlook, or simply to check if their portfolio needs to be rebalanced. Below are several of the main Greeks traders look at.

Delta

Delta (Δ) represents the rate of change between the option's price and a $1 change in the underlying asset's price. In other words, the price sensitivity of the option is relative to the underlying asset. Delta of a call option has a range between zero and one, while the delta of a put option has a range between zero and -1. For example, assume an investor is long a call option with a delta of 0.50. Therefore, if the underlying stock increases by $1, the option's price would theoretically increase by 50 cents.

For options traders, delta also represents the hedge ratio for creating a delta-neutral position. For example, if you purchase a standard American call option with a 0.40 delta, you will need to sell 40 shares of stock to be fully hedged. Net delta for a portfolio of options can also be used to obtain the portfolio's hedge ratio.

A less common usage of an option's delta is the current probability that the option will expire in-the-money. For instance, a 0.40 delta call option today has an implied 40% probability of finishing in-the-money.

Theta

Theta (Θ) represents the rate of change between the option price and time, or time sensitivity - sometimes known as an option's time decay. Theta indicates the amount an option's price would decrease as the time to expiration decreases, all else equal. For example, assume an investor is long an option with a theta of -0.50. The option's price would decrease by 50 cents every day that passes, all else being equal.

Theta increases when options are at-the-money, and decreases when options are in- and out-of-the money. Options closer to expiration also have accelerating time decay. Long calls and long puts will usually have negative Theta; short calls and short puts will have positive Theta. By comparison, an instrument whose value is not eroded by time, such as a stock, would have zero Theta.

Gamma

Gamma (Γ) represents the rate of change between an option's delta and the underlying asset's price. This is called second-order (second-derivative) price sensitivity. Gamma indicates the amount the delta would change given a $1 move in the underlying security. For example, assume an investor is long on a call option on hypothetical stock XYZ. The call option has a delta of 0.50 and a gamma of 0.10. Therefore, if stock XYZ increases or decreases by $1, the call option's delta would increase or decrease by 0.10.

Options traders may opt to not only hedge delta but also gamma in order to be delta-gamma neutral, meaning that as the underlying price moves, the delta will remain close to zero.

Gamma is used to determine how stable an option's delta is: higher gamma values indicate that delta could change dramatically in response to even small movements in the underlying's price. Gamma is higher for options that are at-the-money and lower for options that are in- and out-of-the-money and accelerates in magnitude as expiration approaches. Gamma values are generally smaller the further away from the date of expiration; options with longer expirations are less sensitive to delta changes. As expiration approaches, gamma values are typically larger, as price changes have more impact on gamma.

Vega

Vega (v) represents the rate of change between an option's value and the underlying asset's implied volatility. This is the option's sensitivity to volatility. Vega indicates the amount an option's price changes given a 1% change in implied volatility. For example, an option with a Vega of 0.10 indicates the option's value is expected to change by 10 cents if the implied volatility changes by 1%.

Because increased volatility implies that the underlying instrument is more likely to experience extreme values, a rise in volatility will correspondingly increase the value of an option. Conversely, a decrease in volatility will negatively affect the value of the option. Vega is at its maximum for at-the-money options that have longer times until expiration. (edited)

Rho

Rho (p) represents the rate of change between an option's value and a 1% change in the interest rate. This measures sensitivity to the interest rate. For example, assume a call option has a rho of 0.05 and a price of $1.25. If interest rates rise by 1%, the value of the call option would increase to $1.30, all else being equal. The opposite is true for put options. Rho is greatest for at-the-money options with long times until expiration

When looking at options for day trading, I tend to only look at Delta, Gamma, and Theta, but the others are important aswell, such as a LEAP with a high Vega.

What Are Long-Term Equity Anticipation Securities (LEAPS)

The term long-term equity anticipation securities (LEAPS) refers to publicly traded options contracts with expiration dates that are longer than one year, and typically up to three years from issue. They are functionally identical to most other listed options, except with longer times until expiration. A LEAPS contract grants a buyer the right, but not the obligation, to purchase or sell (depending on if the option is a call or a put, respectively) the underlying asset at the predetermined price on or before its expiration date.

IE: LEAPS are LONG term calls. At least 3 months out. Personally I like ATM year leaps. They might cost more, but they will print harder. You're buying theta here.

EXAMPLE 1:

You can buy a 365 DTE 10.00 Call strike and because you are basically taking NO risk in this case...you will be getting no extrinsic value on that call. There is about a 100% chance that it will be exercised. So that call right now will be worth $90. It's all intrinsic value. Similarly...as the stock price goes up and down the value of this option will track that almost 1:1. If the stock goes up 20, the call will go up about 20. If the stock goes down 15, the call will go down 15.

You can also buy a 365 DTE 200.00 Call strike and because the chance of this stock increasing 100% in 1 year is extremely low, this call will have about zero intrinsic value and all extrinsic value and will be very cheap. Maybe a $1-$2 at best. Moreover...as the stock price moves up and down the value of this option barely budges, especially in the lower ranges.

Now compare to a 365 DTE 100.00 Call strike. There is a lot of risk here. Currently there would be no intrinsic value to this option as 100 - 100 is zero, but there is a substantial amount of extrinsic value. Might be worth $15. The value of this option also changes significantly even with minor 5% changes in stock price.

So basically no risk buying very deep ITM and deep OTM calls. The most substantial risk takes place ATM.

So I look at deep ITM LEAP calls as a stock replacement strategy, and OTM calls as a speculative strategy. One could also look at deep OTM calls as a very bullish strategy that comes with near 100% of losing your debit, because if that stock price never appreciates as much as you think it will not substantially change in value.

Case in point...as a mental exercise. A stable company has a stock price of 100. It's beta is 1.3 (low volatility). You buy a 365 DTE 200.00 call and spend $0.50. How much would the stock price have to go up, and by when, for you to call option to double in value? Remember even at expiration if the stock price is $199, that call is worthless.

I think also you should note that deep OTM LEAPs have very high vega and if you buy a LEAP on a particular ticker during very low volatility, the stock doesn't really have to go up all that much for you to turn up a large profit. As long as there is a spike in volatility, you will make gains due to LEAPs having very high vega.

If you cannot watch the stock everyday I encourage you to do LEAPS.

Also, please feel free to ASK PEOPLE before you jump into something you're unsure of and will end up with a losing position and a loss.

I hope this help new people, sorry if any of this information was previously posted.

Good Luck!


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