Concept

Basics and Fundamentals

What Are Options?

-Gives an investor the right, but not the obligation, to buy or sell a stock at an agreed-upon price and date
Represents 100 shares of the underlying stock.
-Calls and Puts, where the option is a contract, an agreement between two parties to sell/buy the stock
-When a contract is written, it determines the price that the underlying stock must reach in order to be in the money, known as the strike price
An option's value is determined by the difference between the underlying stock price and the strike price
- Expiration Date: enable the trader to choose a specific date when they expect the stock to rise or fall
- Strike Price: determines whether an option should be exercised; trader expects the stock to be above or below by the expiration date
Contract Size: represent a specific number of underlying shares that a trader may be looking to buy
- Premium: price paid for an option that is determined by taking the price of the call and multiplying it by the number of contracts bought, then multiplying it by 100
Allow investors to speculate on the price of a stock, elevating their risk

What Are Futures?

-Derivative financial contracts that obligate the parties to transact an asset at a predetermined future date and price
- The buyer must purchase or the seller must sell the underlying asset at the set price, regardless of the current market price at the expiration date
- A futures contract allows an investor to speculate on the direction of a security, commodity, or financial instrument
- Futures are used to hedge the price movement of the underlying asset to help prevent losses from unfavorable price changes
- Expiration dates known up from; identified by the expiration month
- Obligated to take possession of the underlying commodity (or the cash equivalent) at the time of expiration and not any time before

Calls, Puts, Covered Calls, Cash Covered Puts

Intrinsic Value

-Refers to fundamental, objective value contained in an object, asset, or financial contract
-If the market price is below that value, it can indicate a buy for value investors
-When evaluating stocks, there are several methods for modeling, such as dividend streams, discounted cash flows, residual income, ratio analysis, and Duponts model
-Relies on logical, good assumptions, and margin of safety is useful to account, to reduce errors that can deviate from the true intrinsic value of the stock/company

Extrinsic Value

-The difference between the market price of an option, also known as its premium, and its intrinsic price, which is the difference between an option's strike price and the underlying asset's price
-Rises with increase in volatility in the market
-Known as "time value" because the time left until the option contract expires affects the option premium
-Contract loses value as it approaches its expiration date because there is less time for the underlying security to move favorably

Shorting Options

-Option writing/shorting is the act of selling either calls or puts first
-Hoping that the value goes to zero or buy it back at a lower price to earn a profit
-Signify that the options were sold first before being bought
-Selling options is used when exiting options that were already bought
-Borrowed shares believed to drop/rise depending on type of option

The Greeks

Delta

-Measures how much an option’s price can be expected to move for every $1 change in the price of the underlying security or index
-Helps you predict whether a given option will expire ITM
-Higher-Delta options are not always profitable, but if you paid a large premium for an option that expires ITM, you might not make any money
-Commonly used when determining the likelihood of an option being in-the-money at expiration
-Measure directional risk of a given option or options strategy
-Higher deltas may be suitable for higher-risk, higher-reward strategies that are more speculative, while lower deltas may be ideally suited for lower-risk strategies with high win rates
-Delta is also used when determining directional risk
-Positive deltas are long (buy) market assumptions, negative deltas are short (sell) market assumptions, and neutral deltas are neutral market assumptions
-When you buy a call option, you want a positive delta since the price will increase along with the underlying asset price, but when you buy a put option, you want a negative delta where the price will decrease if the underlying asset price increases
-Tends to increase closer to expiration for near or at-the-money options.
-Evaluated by gamma, which is a measure of delta's rate of change
-Can change in reaction to implied volatility changes

Theta

-Measures the rate of time decay in the value of an option or its premium
-Time decay represents the erosion of an option's value or price due to the passage of time and as time passes, the chance of an option being profitable or in-the-money lessens. It tends to accelerate as the expiration date of an option draws closer because there's less time left to earn a profit from the trade
-Always negative for a single option since time moves in the same direction
-Good for sellers and bad for buyers
-Always negative for long options and will always have a zero time value at expiration since time only moves in one direction, and time runs out when an option expires

Gamma

-Measures the rate of changes in delta over time
-Delta values constantly change with the underlying asset's price, and the gamma is used to measure the rate of change and provide traders with an idea of what to expect in the future
-Gamma values are highest for at-the-money options and lowest for those deep in- or out-of-the-money
-Useful for determining the stability of delta, which can be used to determine the likelihood of an option reaching the strike price at expiration
-Essentially measures the stability of an option’s probability

Vega

-Measures the risk of changes in implied volatility or the forward-looking expected volatility of the underlying asset price
-Focused on changes in expectations for future volatility
-Higher volatility makes options more expensive since there’s a greater likelihood of hitting the strike price at some point
-Tells us approximately how much an option price will increase or decrease given an increase or decrease in the level of implied volatility
-Can increase or decrease without price changes of the underlying asset, due to changes in implied volatility
-Can increase in reaction to quick moves in the underlying asset
-Falls as the option gets closer to expiration

Debit and Credit Spreads

Two Legged Options

-Composed of two legs: a long call and a long put
-Effective for traders who know a security's price will change but aren't confident of which way it will move
-Breaks even if the price goes up by net debit—the price they paid for the two contracts plus commission fees—or decreases by their net debit, profits if it moves further in either direction, or else loses money
-Loss is limited to the investor's net debit

Margin

-Money borrowed from a broker to purchase an investment
-The difference between the total value of an investment and the loan amount
-Refers to the practice of using borrowed funds from a broker to trade a financial asset, which forms the collateral for the loan from the broker
-Standard brokerage account in which an investor is allowed to use the current cash or securities in their account as collateral for a loan
-Leverage tends to amplify both gains and losses
-If there is a loss, a margin call may require your broker to liquidate securities without prior consent

Limited risk

-Limited risk is an investment strategy that puts a ceiling on the potential loss an investor can face
-The maximum an investor usually stands to lose is the initial investment
-Limited risk involves purchasing stocks that move in the opposite direction from each other, or are immune from economic downturns
-Buying options is another limited risk strategy
-The opposite of limited risk is unlimited risk, which investors who borrow funds or securities are particularly vulnerable to

Multi Legged Options

Iron Condor

-A delta-neutral options strategy that profits the most when the underlying asset does not move much
-Can be modified with a bullish or bearish bias
-Composed of four options of the same expiration: a long put further out of the money (OTM) and a short put closer to the money; and a long call further OTM and a short call closer to the money
-Profit is capped at the premium received while the potential loss is capped at the difference between the bought and sold call strikes and the bought and sold put strikes
-Utilize more than one option to create a position
-Option contract that is taken out at the same time as one or more other contracts to build one position
-Ex: Seagull option: a three-legged currency options trading strategy to minimize risk. It is implemented using two puts and a call or vice versa. If there is no significant movement on the exchange rate, then returns might be modest using this trading strategy

Implied Volatility

Earnings price action

-A systematic trading practice aided by technical analysis tools and recent price history where traders are free to take their own decisions within a given scenario to take trading positions, as per their subjective, behavioral and psychological state
-Many day traders focus on price action trading strategies to quickly generate a profit over a short time frame - in this case, they do it on company earnings
-Other cases where they may look for a simple breakout from the session's high, enter into a long position, and use strict money management strategies to generate a profit

Price Fluctuation

-Stock prices change everyday by market forces
-Share prices change because of supply and demand
-Changes in stock prices; short term fluctuations (usually more
-technical) vs long term fluctuations (usually fundamental)
-Fundamental factors drive stock prices based on a company's earnings and profitability from producing and selling goods and services
-Technical factors relate to a stock's price history in the market pertaining to chart patterns, momentum, and behavioral factors of traders and investors

Intrinsic Fluctuation

-Intrinsic value assesses the worth of an asset based on future cash flows, not the current market value, but this value can vary by the company, sometimes significantly, from a company's stock price
-Usually prices changes alongside with company performance/corporate decisions
-Amount of fluctuation depends on the industry and business model, and how much of the company’s intrinsic value changes

Market Makers

-A firm or individual that stands ready to buy and sell stock on a regular and continuous basis at a publicly quoted price; they buy and sell securities for its own account
-Provide the market with liquidity and depth while profiting from the difference in the bid-ask spread
-Brokerage houses are the most common types and they provide purchase and sale solutions for investors
-Compensated for the risk of holding assets because a security's value may decline between its purchase and sale to another buyer
-While brokers compete against one another, specialists post bids and asks and ensure they are reported accurately