K-I-S-S Options Trading

[LN1_Casey]

Ho-kay, so I am going to try and make a threat that KISS's the options trading lingo, in the simpliest, barest bones way I can. I have gone to Investopedia.com, but once they start dipping into Theta, I'm out. So, here is my understanding, using examples, and I would greatly appreciate someone clarifying these if I got it wrong, or am missing parts.

An option is a bet that the Stock Price (SP) of a company will or will not reach a certain price by a certain date.

A call that person Bravo BUYS is a bet that the SP will reach a certain price (strike) by a certain date; they hope the price exceeds this price by that time. If it does, they get the option to buy the 100 shares at the strike price, which may be notably less than the current SP. If they lose the bet, they are out of the cost of the bet per share. They need enough money or margin (a loan) to buy all 100 shares, and they are still out the initial bet amount. He can also sell the bet itself at a profit before the date the bet becomes due, for pure profit.

Bravo has $1400, and wants Tesla stock, which is currently at $10. He thinks the SP will rise between now and Friday, so be bets $0.10 that the SP will reach $12 by then. If he wins the bet, and the SP goes to $14 by Friday, he would be able to buy the 100 shares at $12, for a savings of $200, but he would be out the bet amount of $10 regardless.

Alternatively, he can sell the bet when the SP reaches $13 on Thursday for $1, for a total of $100 and a profit of $90. The person buying this bet may be the seller of the bet, who regrets their selling of the bet and doesn't want to lose their stocks. He may do this if it turns out he only has $600, and does't want the cost of borrowing the extra $590 ($1200 - $600 cash -$10 bet) to meet the obligation to buy the shares.

If the SP is only $12.10, it is almost worthless, since it would cost you the same amount it saved you.

A call that person Alpha SELLs, is a bet that the SP will not reach a certain price by a certain date, and they hope it will not reach that price. If it doesn't, they get to keep the bet money, and the original calls. If the SP does meet the Bet price (called strike), than they either have to sell their shares (covered call) at that price, or they have to buy shares at the current price to meet the obligation.

Selling a call without having the shares is dangerous, because it may cost you far more than the call gained you from the bet.

Alpha owns 100 shares of Tesla, and the SP is currently $10. She sells a call for a strike price of $12, for $0.10; betting a total of $10 for the 100 shares that the SP will not reach $12 by Friday. If she loses the bet, she keeps the $10, and the $1,200 sell of her stocks, but misses out on the additional $200 the SP of $14 is worth.

Alternatively, on Thursday, Alpha may buy back her bet when the SP is $13, for $1, or a loss of $90, but she gets to keep her stocks. She may do this if it turns out she only has 50 shares, and it would cost her $690 (50 x $14, -$10 bet) to meet the obligation.

A put is a bet that the SP will or will not reach a certain price by a certain date, but on the downward scale. As such, the hopeful/fearful roles are reversed.

A put that someone BUYS is protection for their stocks. It is a bet made as insurance against the loss of their profits for the stock they have purchased. They hope the SP does not reach this price. If they win their bet, they get the strike price, which may be more than the current SP, and are still out their bet amount. If they lose their bet, they keep their stocks and are out the cost of the bet.

Alpha owns 100 shares of Tesla, which SP is currently $10. She purchased the shares for $5, and she fears that the SP will go back down by Friday and doesn't want to lose her gains, but would prefer to keep her shares in case it goes up. As such she buys the protection of a PUT for a strike price of $8 for $0.10, or $10, so if by Friday the SP is at $6, she can sell her shares for $8 and keep a profit of $300 for her 100 shares, a gain of $200 over the current SP. (If she doesn't have 100 shares, she would have to buy additional shares to meet the obligation.) If the SP is $9 on Friday, she is out only the $10 of the bet.

Alternatively, if she decides to keep her stocks regardless of the SP after making the bet, and the SP is at $7 on Thursday, she can sell the bet for $1, for profit of $90.

A put that someone SELLs is a bet to buy 100 stocks if they drop to a certain point, and pure profit if they don't. If they win their bet, they just take the profit, if they lose the bet, they have to buy the shares at whatever the strike price is, regardless of current SP. If they don't have the cash to buy all 100 stocks outright, they will have to find the cash or take margin to buy them if the SP reaches the strike price by a certain date.

Bravo has $1400, and the SP is currently $10. He doesn't think the SP will go down, or go down much, but knows some people want insurance for their shares, and is willing to buy 100 shares of Tesla for $8. He sells a put for $0.10, or $10, that the SP will not reach $8 by Friday.

If he loses the bet, and the SP goes to $6 by Friday, he spends an extra $190 ($200 - $10) to buy the shares he could otherwise get for cheaper. However, he can buy back the bet for $1 on Thursday when the SP is $7, costing $100, but saving the $90 he'd otherwise have to spend to buy the shares on Friday.

So ends my understanding of options.

I know theta exists... which is a cost that degrades over time?

I know that there exists LEAPs, but whatever they are, I've no idea.

I know you can roll your calls/puts, mostly for profit, but I've only a vague idea that you buy/sell the same call or put for a later date? Maybe?

Spread calls and puts... uh, staggers the purchase/sell price? I don't know if it's over the 100 shares in the singular call or put, or if it's a multiple calls/puts.

I know you can buy/sell a call that's in the money (or already past the strike price), but as to why you'd do this I can only guess. You want the shares or the sale, but may want to profit off the bet if it continues to go up or down?

So.... plz halp?

Also, @Krugerrand maybe these basket weaving lessons will help you too.

 

[Krugerrand]

My mind kind of started to get lost at the part where buying a put is insurance against my shares.

Probably because I have paid insurance my entire life and the couple of times I needed it the insurance companies tried real hard to screw me. In fact, in the end I did not get my insurance monies worth, ever.

So, the idea of buying insurance for my TSLA shares seems like it’s probably just one big, fat lie.

I’m going to live on an island or I’m not based solely on how dominate Tesla becomes. End of story.

 

[LN1_Casey]

My mind kind of started to get lost at the part where buying a put is insurance against my shares.

Probably because I have paid insurance my entire life and the couple of times I needed it the insurance companies tried real hard to screw me. In fact, in the end I did not get my insurance monies worth, ever.

So, the idea of buying insurance for my TSLA shares seems like it’s probably just one big, fat lie.

I’m going to live on an island or I’m not based solely on how dominate Tesla becomes. End of story.

Well, in the example Alpha is still out the 200$ from the high of the stock price. So it's still screwing her in a way, lol.

 

[Krugerrand]

Well, in the example Alpha is still out the 200$ from the high of the stock price. So it's still screwing her in a way, lol.

Alpha technically got screwed twice. I think she was happy with the first from Neegan, not so much the second time from Carole.

I’ve gone off topic, haven’t I?

I’ll have to re-read your post a few times to get past my preconceived notions of insurance to get a better understanding of PUTS. But I appreciate the way you’ve laid it out.

 

[adiggs]

My mind kind of started to get lost at the part where buying a put is insurance against my shares.

Probably because I have paid insurance my entire life and the couple of times I needed it the insurance companies tried real hard to screw me. In fact, in the end I did not get my insurance monies worth, ever.

So, the idea of buying insurance for my TSLA shares seems like it’s probably just one big, fat lie.

I’m going to live on an island or I’m not based solely on how dominate Tesla becomes. End of story.

This is how I feel about buying insurance on my TSLA shares - never really made sense to me, but I've got a 10+ year investment horizon. I am as indifferent (today) to a $400 share price as a $4000 share price (that might be a small white lie on the high side - that'd be retirement money, though possibly not private island money).

Therefore - SELLING insurance! I figure there's a reason so many very large companies are in the insurance business . Sort of how there are a bunch of people in the casino business. The sellers of those services make out very well (mostly - not always). I find that I like being the house (or at least playing along with the house), instead of playing against the house.

 

[ggr]

I know that there exists LEAPs, but whatever they are, I've no idea.

How Long-Term Equity Anticipation Securities – LEAPS Work. Note that the S is part of the acronym, not a plural. They are just options with an expiry more than a year away from today, or when they were first issued, depending on context. For example, last Friday a lot of LEAPS expired, because they were bought more than a year before, but by the time they actually expired, they were just like all the other options that expired that day.

I know you can roll your calls/puts, mostly for profit, but I've only a vague idea that you buy/sell the same call or put for a later date? Maybe?

Rolling (to me) refers to selling an existing contract while simultaneously buying a new one that's related... maybe same date but different price, maybe later date but same or similar price, or some other relationship that makes sense to the trader. (My most recent was to sell call options (actually LEAPS) that had gone deep in the money for twice as many for the same date but a higher strike price, still in the money, plus got enough cash out of the transaction to buy 4 more shares. See next answer.) But really, rolling is just a special case of a multi-leg trade. Instead of placing two orders, one to sell, and one to buy (or more...) you just tell the broker "Sell these, buy those, and I want it to cost me no more than $xx/share" ($xx can be negative, returning money to you), and their computers figure out how to make it work (or not, just like any kind of limit order).

Spread calls and puts... uh, staggers the purchase/sell price? I don't know if it's over the 100 shares in the singular call or put, or if it's a multiple calls/puts.

Another kind of multi-leg trade, although often just done as independent orders. The resulting contracts might be "a spread" in the trader's mind, but to the broker and the exchanges they are just different lots.

I know you can buy/sell a call that's in the money (or already past the strike price), but as to why you'd do this I can only guess. You want the shares or the sale, but may want to profit off the bet if it continues to go up or down?

The point is to get extra, relatively safe, leverage, and also to use less capital. Example in round numbers:

I have $10k cash in my account.
I can buy 10 shares of Tesla @1000.
OR I can buy 1 TSLA July 10 $895 call, currently selling for $9,690*.

Now, on July 10, let's look at a couple of scenarios.
$TSLA $800: shares, still worth $8000. Call option, effectively worthless, and becomes truly worthless at end of day.
$TSLA $900: shares, still worth $9000. Call option, worth about $500 during the day, and if you hold till end of day... well, unless you have lots of money available, don't hold till end of day. You've made a big loss.
$TSLA $1000: Shares, no change. Call option, worth $10,500 (WARNING: I used a real price for the call option that corresponds to TSLA at $968, not $1000. In reality you would make a loss here, of about $1000, because of the time decay, which is small compared to the total for options fairly well into the money.)
$TSLA $1100: Now we're talking. Shares now worth $11,000. But the option is worth $20,500 if you sell it close to the close. The reason is simple: the option represents the profit on 100 shares, not just 10. This is what leverage buys you.

* option based on $968 current price. So $73 of intrinsic value ($968-$895), $23.90 is the two weeks of time value (Theta).

 

[Krugerrand]

This is how I feel about buying insurance on my TSLA shares - never really made sense to me, but I've got a 10+ year investment horizon. I am as indifferent (today) to a $400 share price as a $4000 share price (that might be a small white lie on the high side - that'd be retirement money, though possibly not private island money).

Therefore - SELLING insurance! I figure there's a reason so many very large companies are in the insurance business . Sort of how there are a bunch of people in the casino business. The sellers of those services make out very well (mostly - not always). I find that I like being the house (or at least playing along with the house), instead of playing against the house.

That’s actually a brilliant way of looking at: SELL insurance. Hmm....

 

[Krugerrand]

How Long-Term Equity Anticipation Securities – LEAPS Work. Note that the S is part of the acronym, not a plural. They are just options with an expiry more than a year away from today, or when they were first issued, depending on context. For example, last Friday a lot of LEAPS expired, because they were bought more than a year before, but by the time they actually expired, they were just like all the other options that expired that day.


Rolling (to me) refers to selling an existing contract while simultaneously buying a new one that's related... maybe same date but different price, maybe later date but same or similar price, or some other relationship that makes sense to the trader. (My most recent was to sell call options (actually LEAPS) that had gone deep in the money for twice as many for the same date but a higher strike price, still in the money, plus got enough cash out of the transaction to buy 4 more shares. See next answer.) But really, rolling is just a special case of a multi-leg trade. Instead of placing two orders, one to sell, and one to buy (or more...) you just tell the broker "Sell these, buy those, and I want it to cost me no more than $xx/share" ($xx can be negative, returning money to you), and their computers figure out how to make it work (or not, just like any kind of limit order).


Another kind of multi-leg trade, although often just done as independent orders. The resulting contracts might be "a spread" in the trader's mind, but to the broker and the exchanges they are just different lots.


The point is to get extra, relatively safe, leverage, and also to use less capital. Example in round numbers:

I have $10k cash in my account.
I can buy 10 shares of Tesla @1000.
OR I can buy 1 TSLA July 10 $895 call, currently selling for $9,690*.

Now, on July 10, let's look at a couple of scenarios.
$TSLA $800: shares, still worth $8000. Call option, effectively worthless, and becomes truly worthless at end of day.
$TSLA $900: shares, still worth $9000. Call option, worth about $500 during the day, and if you hold till end of day... well, unless you have lots of money available, don't hold till end of day. You've made a big loss.
$TSLA $1000: Shares, no change. Call option, worth $10,500 (WARNING: I used a real price for the call option that corresponds to TSLA at $968, not $1000. In reality you would make a loss here, of about $1000, because of the time decay, which is small compared to the total for options fairly well into the money.)
$TSLA $1100: Now we're talking. Shares now worth $11,000. But the option is worth $20,500 if you sell it close to the close. The reason is simple: the option represents the profit on 100 shares, not just 10. This is what leverage buys you.

* option based on $968 current price. So $73 of intrinsic value ($968-$895), $23.90 is the two weeks of time value (Theta).

This post was:

Helpful
Then unhelpful
Then huh?
Then informative
Then unhelpful
Then huh?
What?
Wtf?
Squirrel!
Laundry is done
And finally I’m just stupid

 

[adiggs]

That’s actually a brilliant way of looking at: SELL insurance. Hmm....

Come visit us in 'the wheel' thread. We're mostly selling options, and mostly selling both sides, but it's evolved into more of a sell options than the wheel (which is sell put until you get shares. then sell calls until your shares go away. repeat until tired of all the winning(*))

(*) That's an exaggeration. You will need to do your own diligence and evaluation, blah blah disclaimers. We're all big cats here.

 

[Buckminster]

Not sure that all of this is that simple. Beginners would ideally stick to buying ITM LEAP Calls on cheaper stocks than Tesla.

 

[LN1_Casey]

OK, so I spent a bit of time trying to study this post and the links, so I could properly respond and see if I can KISS it down a bit.

How Long-Term Equity Anticipation Securities – LEAPS Work. Note that the S is part of the acronym, not a plural. They are just options with an expiry more than a year away from today, or when they were first issued, depending on context. For example, last Friday a lot of LEAPS expired, because they were bought more than a year before, but by the time they actually expired, they were just like all the other options that expired that day.

BLUF: it's a usual call or put, but just at least a year away before it expires. So someone can buy a call to buy stock at $10 in 2021, and slowly accumulate the funds to cover said purchase by then if they don't have it initially. So, like layaway, but for stocks.

...Dunno why they got their own name, actually.

Rolling (to me) refers to selling an existing contract while simultaneously buying a new one that's related... maybe same date but different price, maybe later date but same or similar price, or some other relationship that makes sense to the trader. (My most recent was to sell call options (actually LEAPS) that had gone deep in the money for twice as many for the same date but a higher strike price, still in the money, plus got enough cash out of the transaction to buy 4 more shares. See next answer.) But really, rolling is just a special case of a multi-leg trade. Instead of placing two orders, one to sell, and one to buy (or more...) you just tell the broker "Sell these, buy those, and I want it to cost me no more than $xx/share" ($xx can be negative, returning money to you), and their computers figure out how to make it work (or not, just like any kind of limit order).

So, to roll is actually selling a current bet, for another bet, and pocketing the difference between the two. A squish of a term to simplify the explanation of the situation (like "getting ready for bed" generally includes changing to PJs, brushing teeth, hygiene routines, bathroom trips, and night caps)

Example: Alpha has a call for TSLA at $10 share to expire by Friday, the shares are currently at $15 on Tuesday, for a profit of $500. She rolls the bet to a call of $20 for the same date, which costs $1, so she gains $400 ($500- $100 cost) to keep, but also still has the option to buy the shares on Friday if they reach $20, or to sell the current bet if it reaches $20 by Thursday. She may lose this bet, and lose the $100 cost, but she still keeps the $400 profit from the roll.

Alternatively, she may bet all the profits into future $20 calls and shout "YOLO" on wall street bets on reddit.​

Another kind of multi-leg trade, although often just done as independent orders. The resulting contracts might be "a spread" in the trader's mind, but to the broker and the exchanges they are just different lots.

So, uh.... it's just.... multiple calls in stepping order? $10, $15, $20, all set to expire by the same date? Theoretically then, you'd buy them to sell the bets, not buy the shares, since that'd be in the multiple hundreds of shares?

The point is to get extra, relatively safe, leverage, and also to use less capital. Example in round numbers:

I have $10k cash in my account.
I can buy 10 shares of Tesla @1000.
OR I can buy 1 TSLA July 10 $895 call, currently selling for $9,690*.

Now, on July 10, let's look at a couple of scenarios.
$TSLA $800: shares, still worth $8000. Call option, effectively worthless, and becomes truly worthless at end of day.
$TSLA $900: shares, still worth $9000. Call option, worth about $500 during the day, and if you hold till end of day... well, unless you have lots of money available, don't hold till end of day. You've made a big loss.
$TSLA $1000: Shares, no change. Call option, worth $10,500 (WARNING: I used a real price for the call option that corresponds to TSLA at $968, not $1000. In reality you would make a loss here, of about $1000, because of the time decay, which is small compared to the total for options fairly well into the money.)
$TSLA $1100: Now we're talking. Shares now worth $11,000. But the option is worth $20,500 if you sell it close to the close. The reason is simple: the option represents the profit on 100 shares, not just 10. This is what leverage buys you.

...whut?

So... if you had bought the 10 shares of TSLA, you'd have 'made' $1000 if they closed at $1.1k by the 10th, very simple.

However, if you instead bet your $10k on a call that's currently in the money, you'll lose the bet and not gain any shares or cash unless they close a couple hundred above the strike price, which is already a hundred below the current SP.

However, if they do close a couple hundred above the strike price, you'll gain significantly more, because it's per 100 shares, not your measly 10. You'd want to sell the bet, not cash in, because you don't have enough cash (theoretically) to cover the 100 shares cost, even at the lower amount.

I don't quite understand the last bit though--since its a call, the shares would be worth $110,000 ($1.1k x 100). The bet, which you paid $10k for, is now doubled in value to $20k, so you earned $10k over all?

* option based on $968 current price. So $73 of intrinsic value ($968-$895), $23.90 is the two weeks of time value (Theta).

There's that elusive Theta.

Is Theta like rent on a call? The more you have it, the more the rent takes away some of the value?