I think most College Investors are interested in options trading. As I have mentioned before, I believe the best platform to do this is Thinkorswim. If you want to understand more about Thinkorswim, check out my post on it here. Over the next few weeks, I really want to deep dive into how to trade options, and how to do it in Thinkorswim. But first off, lets start with the basics.
Trading Options Basics
The building blocks of all options trades:
Call – The option to buy a stock at a given price
Put – The option to sell a stock at a given price
Long Call – Strategy used if you think a stock's price will rise before the expiration of the option. Generally seen as less risky than buying the stock, but it is important to remember that options expire and stocks do not. You can sit on a stock forever waiting for a price increase.
Short Call – Strategy used if you think a stock's price will fall. However, a short call has limited profit potential in exchange for unlimited risk (if, for example, the underlying stock's price skyrockets)
Long Put – Strategy similar to selling short stock. However, the maximum loss is the price paid for the put, and the maximum potential profit is if the underlying stock goes to $0.
Short Put – Strategy that is the opposite of a long put. You assume very large risk (if the underlying stock goes to $0), for a limited profit, which would be the premium you received for the put.
Option Pricing Basics
Next, you have the ability to buy options that are either In-The-Money (ITM), At-The-Money (ATM), and Out-Of-The-Money (OTM).
ITM – In the money options are options whose underlying stock value exceeds the strike price of the option. These options act more like a stock, especially as they get deeper in the money.
ATM – An at the money option is the one with the greatest risk as it is at the strike price. It is very sensitive to changes in the stock price, volatility, and time to expiration.
OTM – An out of the money option is one whose underlying stock value is below the strike price. These options are usually the cheapest to purchase as the goal to make a profit is a large move in the underlying stock. However, these options can expire worthless if that move never occurs.
Option Trading Math
|Long 1 XYZ Sep 50 call @ $2.00|
|Total Cost||Option premium paid, $200|
|Maximum Loss||Option premium paid, $200|
|Short 1 XYZ Sep 50 call @ $2.00|
|Total Credit Received||Option premium received, $200|
|Maximum Profit||Option premium received, $200|
|Long 1 XYZ Sep 40 put @ $1.00|
|Total Cost||Option premium paid, $100|
|Maximum Loss||Option premium paid, $100|
|Short 1 XYZ Sep 40 put @ $1.00|
|Total Credit Received||Option premium received, $100|
|Maximum Profit||Option Premium Received, $100|