Options Basics &

Using Options as Stock Insurance

Background

  • How I got interested in Options
  • Motivation
  • Disclaimers
    • Not good at Stock Picking
    • Have not traded options (yet)

Options

  • Options are contracts
  • Tradable like stock (have value apart from the underling)
  • Optional for the buyer
  • Obligatory for the seller (there are ways out)
  • Contract terms (1w, 1m, 3m, 6m, 1y, 1y+)
  • Can be exercised at any time
  • Sold in 100 stock units

Terms

  • The Underlying
  • Optionable
  • Premium
  • Exercising (American vs European)
  • Strike (At-the-money, In-the-money, Out-of-the-money)
  • Bullish / Bearish
  • Long / Short
  • Covered / Naked
  • Assignment

What is Stock

  • Ownership of a share in profits
  • Bullish Investment
  • Risky (Can lose entire investment)

 Option Types

Call & Puts

Buyers (long) & Sellers (short)

Calls

  • The right to buy stock (Call away)

  • Makes money when the stock price goes up

  • Typically a Bullish position

  • Mimics buying stocks (synthetic stock)

  • As a seller you must have the stock (covered) or a margin account

At-the-money call (40 Strike): $2 

Puts

  • The right to sell stock

  • Makes money when the stock price goes down

  • Functions like insurance

  • Typically a Bearish position

  • Mimics shorting stocks

  • Sellers require a margin account

At-the-money put (40 Strike): $2 

Functions like Shorting Stock without the risk

Question

What kind of options are company options?

(Calls or Puts)

Advanced Options Strategies

  • Combine 2 or more options trades
  • Make money any way a stock moves (up, down, stagnant)
  • Common Strategies
    • Spreads
    • Condors
    • Straddles
    • Strangle
    • Butterfly

Option Pricing Components

  • Intrinsic Value (amount in-the-money)
  • Time Value

Stock: $100

Option (110 Strike): $11

Intrinsic Value: $10

Time Value: $1

Problems with Stocks & Options

  • Always expire worthless
  • Overleveraging
  • Possible to have unlimited loss
  • Covered Calls effectively sort out winning stocks
  • Can become worthless
  • Impossible to time highs and lows
  • Limit orders are vulnerable to price gaps

Options:

Stock:

The Solution: Married Puts

  • Stock married to a Put Option (2 Leg investment)
  • a.k.a Protective Put
  • This create insurance on the stock price
  • Far out expirations loose Time Value slowly
  • Trade the option to capture gains (Rolling the Put)
  • This strategy works in IRAs
  • No margin account needed

Stock: $52 x 100 = $5200

Option (52 Strike): $4 x 100 = $400 

Total Investment: $5600

At Risk: $400 (7.14%) at Expiration 

More reasons to do this:

  • Prevent loss of already winning stocks
  • Lock in gains now and sell later (next year)
  • Trade stock knowing maximum loss
  • Potentially have a year to make sell desisions

1. "Rule No.1: Never lose money. Rule No.2: Never forget rule No.1"  -  Warren Buffet

Next Step

  • Find Married Puts
  • Find position adjustments
  • Make the trade riskless
  • Notifications

lets build the App!

Additional Strategies 

  • Sell Puts then Sell Calls

Options Basics

By Tim Santeford

Options Basics

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