What is an option?
An option is a financial contract between a buyer and a seller. It is an agreement to buy or sell the underlying equity (stock or index) at a set price by a pre-determined date. Instead of buying the stock a trader could buy an option for a fraction of the price of the stock.
Options have the following characteristics:
- Traded as contracts and each contract represents 100 shares of the underlying stock or index.
- Pre-set expiration dates. Standard monthly options expire the third Friday of each month. Some index options like TVC:RUT , TVC:SPX , and TVC:NDX cease trading on Thursday before the third Friday. Weekly options expire each Friday.
- Price points, referred to as the strike price, are the prices at which buyers and sellers trade option contracts. Options are, usually, available to trade in standard price increments of $5 and $10.
- Quotes to buy or sell an option are presented as the bid and ask. When selling an option, the bid price is used. When buying an option, the ask price is used. Sell the bid / Buy the ask.
- Delta is the change in the value of an option relative to each $1.00 change in the value of the underlying stock. If an option has a Delta value of .45, it will change in value by 45 cents for each $1.00 change in the value of the stock.
- NASDAQ:GOOG is trading at 1445.
-The 1445 call strike has a Delta of .50
-GOOG goes down $10
-The 1445 call will decline in value by $5.00 = ( $10 * .50)
The Options Chain:
All option information for any stock or index is listed on an options chain. The options chain can be found on the website of the broker you use to trade. The chain will list all available strikes and expirations, the Delta, and the bid and ask prices. It will also display both Call and Put options.
Ways to trade Options:
There are four actions that could possibly be taken when trading options:
1. Buy To Open (BTO) - buying an option as part of opening a new position.
2. Sell To Open (STO) - selling an option as part of opening a new position.
3. Buy To Close ( BTC ) - buying back an option that was originally sold to open
4. Sell To Close ( ) - selling an option that was originally bought to open
When a position is Bought-To-Open, it is referred to as a long position.
When a position is Sold-To-Open, it is referred to as a short position.
When a position is Bought-To-Open, it is done for a debit.
When a position is Sold-To-Open, it is done for a credit.
Are you new to options trading? Stay tuned for Part 2 of Trader's Guide to Options which will include teaching about call and put options.