One of the best ways to profit from stock options is understanding option premium and that it’s best to sell instead of buy it. Think of a casino and how the house is much bigger than those gambling. The same goes for you and I. We profit by selling assets, not buying. Yes, the market allows you to sell before we purchase!
Option premium is the price that a buyer pays for an option contract to a seller. Option premium is priced based off of one contract that is equal to one hundred shares of a stock. For example, a contract that costs .25 is actually $25.
Option premium is the current price of the option contract. For a buyer of an option, this is the price to which they will pay. For the writer, or seller, this is the price they will receive. You will often hear those experienced in selling options, call it; selling premium.
Learn how to sell premium and not ever own stock here in my eBook.
When an option is in-the-money, there is both intrinsic and extrinsic value. For out-of-the-money options, the price is only composed of extrinsic value.
Investors who buy call options, simply believe the stock will rise, giving them the option to purchase the asset at the strike price of which they purchased the option. On the other side of the market, investors who believe the price will drop, or want the added protection to be able to sell their shares at the strike price that they bought a put option for will have the option to do so.
You’re probably wondering how option premium is determined and what makes it higher and lower at times.
Overall, option premium is determined by multiple factors.
As you can see, there is not just one specific factor when options go up or down in price, or premium. The supply and demand, along with other factors create options premium to increase or decrease, thus making options a little more complex than just buying and selling stock.
I outline in detail, the best way to trade and invest in stock options here.
To define the break even points when buying or selling options, you must calculate differently depending on whether it is a call or a put option.
Call Option = Strike Price + Premium amount.
Put Option = Strike Price – Premium amount.
Or use this simple Option Price Calculator.
When investing or trading using stock options, the key is to remember that they expire at some point in time. This is called Time Decay or Theta.
Options are either in the money, or out of the money. This can change often due to the sudden change in price of the underlying stock, and therefor depending on the time frame, options can drastically change in value. As the expiration comes closer for the contract, the option eventually expires worthless if it is out of the money. This is extrinsic value.
If the option happens to be in the money, this is intrinsic value.
Example: You believe the stock price will move up, so you decide to buy 1 call option contract for $50 or .50 (Remember, 1 contract is equivalent to 100 shares) The stock price ends up dropping instead and the option is now the price of $45. Therefor a $5 loss. However, the stock then rises again, and the call option is now $60. You now are in the money, and the profit is now $10.
If you are looking to buy shares and then sell contracts against them, I would recommend my Treat Your Stocks Like Real Estate eBook.
If you are looking to just sell premium and not buy shares, I would highly recommend my How to Create Cash Flow without Owning Stock eBook.
A secret that is often used for determining the option volatility is comparing its Beta to the market. This is the comparison of the market fluctuation to the stock. If the market rises, then typically is the Beta is 1, then the stock will rise the same amount as the market.
Therefor, if we are in a bull market for the day, week or whatever time frame, then the stock itself should be flowing the same as the overall market for that time frame.
Another secret that I personally use, to determine a good entry or exit point when trading or investing stock options is the comparison of IV rank to the implied volatility of today. I tend to stick to selling options that are 40-50% IV Rank.
To me, this means the option is currently 50% higher than normal. So the correct evaluation or formula for finding IV Rank, Historical Volatility, or IV can be found here.
If options are not of 50% then I know that the option premium could be higher eventually and statistics show that when selling options at 40% – 50% or higher, the likeliness to be able to buy back at much lower and profit is much higher.
Overall, options investing can be very profitable for the trader or investor who understands the factors of how options are priced.
If you are wanting to jump ahead of taking years to learn options and gather the information all in one place, you found the right place!
Feel free to pick up my two eBooks that explain everything you need to begin you stock options trading and investing.
Or join my Investors Club and get Top Highest IV Options Lists Daily!
The strike price or also known as the exercise price, is the price to which a holder of a call option has the right but not the obligation to purchase the underlying stock at the strike price, up to the expiration date if exercised. A put option buyer, has the right to sell the underlying stock at the strike price up to the expiration date if exercised.
When you buy a put option, the strike price is the price at which you can sell the underlying asset. This is generally used as insurance.
Example: You currently own 100 shares of Under Armour and had bought them at 32. You would then buy a PUT Option at the 32 strike price. If the price of the stock drops less than 32, you can then exercise the put option that you had bought, and can still sell your shares at the price of 32 instead of what the stock has dropped to.
When you buy a call option, the strike price is the price at which you can purchase the underlying asset, or stock.
Example: You buy an option for Under Armour at the 32 strike price, and the current price of Under Armour is 32. If Under Armour rises to $40 at or before expiration, you can exercise the option for $32, and would be assigned 100 shares for $32 each. The total cost is $3,200 plus the bought call contract. You could then turn around and sell the shares for $40 each or the full 100 shares for $4,000 for a profit of $800 minus the purchased call option that you originally purchased. Remember 1 option contract is 100 shares.
As you can see, this is when an option hits the strike price depending on if it is a call or put option. Call option buyers have the right but not the obligation to purchase the underlying asset, while put buyers have the right but not the obligation to sell the underlying asset.
If the strike price is not hit, then the value of the option contract expires worthless. Sometimes the contract is still worth pennies, but overall worthless or less than you originally had purchased it for. If you are selling premium, then you would have to buy back the contract for more than you originally sold it for.
Options can be exercised or not exercised and just sold and bought for higher or lower prices as well. The exchange of options contracts is also a strategy that most investors and traders use as well.
It’s also important to note, that the farther away from the strike price, the value of the options become less. This is due to the market based off of risk to reward. The statistics are applied, and the farther away from a strike price an option is the less likely it is to hit that price.
While there is no correct way when choosing the right strike price when selling or buying options, it is often associated with your risk tolerance. Each investor or trader has a a different strategy when choosing the correct strike price depending on their investment tolerance, size of portfolio, end investment goals, and the nature of of the strategy itself.
There are also factors that include that the majority of the professionals use, and that is RSI, MACD, Implied Volatility, IV Rank, and other various strategies, indicators and statistics.
I would highly recommend picking up copies of my Treat Your Stocks Like Real Estate and How to Create Cash Flow Without Owning Stock. I cover the advanced techniques that I have used over the years to pick the best strike prices and more in the eBooks.
You’ve probably have asked yourself what are put options in the stock market, or how do put options work?
A put option is an option contract in which the holder or buyer has the right but not the obligation to sell a specified quantity of a security at a specified price (strike price) within a fixed period of time (until its (expiration).
In contrast, the writer of the put option has the obligation to purchase the the underlying security if the option is exercised by the buyer. This typically happens if the stock price is at-the-money (ATM) or in-the-money (ITM). The writer is paid a premium for the associated risk on possibly taking on the obligation.
Example: If you write or sell PUT options or 1 put option on Amazon for $600 at the 1776 strike price and Amazon is currently at 1890, the full $600 is paid to you as the writer. If the stock does not drop before or at expiration to 1776, you keep the $600 profit. If the stock does drop, and the buyer chooses to exercise the put option, then you are assigned 100 shares at 1776. (100 x 1776 = $177,600) less the $600 that was paid to you.
As we understand what a put option is, and what are put options in the stock market, we will know why buy put options and how put options fully function in terms of traders or investor needs. As an option seller, you have the obligation to purchase the shares if the put options buyer has exercised the their contract or contracts.
Remember, 1 option contract is equal to 100 shares. So when buying or selling options, keep this in mind.
You also have time decay, or Theta on your side when selling options, or in this case selling put options. The buyer has time or Theta working against them. This is because options have an expiration.
Unlike shares, options eventually expire either with intrinsic value, or extrinsic and out of the money. and worthless.
The reason investors or traders in the stock market want to buy put options is to secure their current position or shares that they own on a particular stock.
Put Options Example: If you own 100 shares of Under Armour, and think that the stock will drop after their earnings report. You would purchase 1 PUT Option. Depending on the price to which you bought your 100 shares, or the price you are willing to sell or let go of your shares, you would purchase the put option. This allows you to sell the 100 shares at the contracted price that you bought the put option for. If you bought 100 shares at 32 (32 x 100 = $3,200) and the current price is at 34 you could buy a put option at 33. This would allow you to sell your shares at 33 even if the stock drops to 16.
Buying put options is just like insurance on an asset. If the stock drops you have the right to sell the stock at the strike to which the option you bought, and the seller of the put option has the obligation to buy those shares for that strike price. Or, you can sell the contract for a higher price than you originally paid and keep your shares.
Scenario 1: You own a $40,000 vehicle. You go and buy an annual insurance policy. The vehicle is neither damaged or stolen, and the insurance seller (PUT Option Seller) has just collected your premium without any payouts. You’re happy to have just paid insurance for protection on your asset or vehicle (PUT Option Buyer).
Scenario 2: You are involved in an accident requiring $10,000 in repairs. You make a claim (exercises your put option) and the insurance pays you the claim. You’re happy you purchased protection for the loss or damage.
Scenario 3: You have a total loss claim or the vehicle gets stolen and again you exercise your put option. You get to have the full amount of your asset or vehicle at the $40,000 coverage. The PUT Option Seller pays you the full amount or in stock market scenario, they take ownership of your shares.
As you can see the benefits of buying PUT options allows you to lower your losses on a down market when you own shares. This is also called protective puts.
Of course you can just buy put options without owning shares but there is a much larger risk associated when doing so.
Buying put options is also in comparison to shorting the stock, but with less risk to the upside. Hence, when buying, the amount of total loss equals the amount to which you paid. If you are shorting shares, there is an unlimited amount of risk to the upside, as the stock could always go up to any amount.
The amount of profit potential when buying a PUT, is maxed if the stock reaches zero. The amount of profit when shorting shares, is only the amount you short.
On the flip side there is a strategy to selling put options that has much more benefits that buying put options and that can be covered in my eBook How to Create Cash Flow Without Owning Stock.
A secret to know when to buy put options is knowing when to first cover your assets, or shares that you own and believe that the stock price will drop. Also buying put options when implied volatility is low. A rise in implied volatility will cause the value of the option contract to rise and allow you to sell at a higher price than you bought the option for.
Of course there is more to buying and selling options than just looking at the implied volatility. All of that is covered in How To Treat Your Stocks Like Real Estate.
One of the best ways to profit without owning stock is knowing when to sell put options. Selling put options can both land you profits without owning or dealing with shares or it can hedge you into a position if you’re already looking at buying shares of a certain stock.
Example: If you’re already looking at buying 100 shares of Amazon, one of the best ways to pick up shares at a lower price all while picking up profits, is to sell a put option. Amazon is currently trading at 1776. Thus buying 100 shares would cost you $177,600. We would sell a put option at 1770 and depending on the price of the option and expiration it could allow you to profit before buying. If the price of the put option is $1,000 and expiration is 30 days out, then you could profit $1,000 without taking ownership if the price does not drop to 1770. If it does, then you would still take in the $1,000 and take over the 100 shares at $177,000 less the $1,000 equaling $176,000.
Remember that when dealing with stock options there is time decay (Theta) on all options. Buyers are affected by this Theta negatively, as their contracts are always decaying as time goes. Option sellers however benefit from time decay or Theta due to the option needing to expire worthless to capture and remain on the premium they sold.
Knowing when to buy and sell put options come with learning as you become more experienced.
My goal here at InvestingWithChris is to educate you the best way possible and to get you profiting sooner than it took me over the course of my investing and trading career.
If you this article has helped you, please comment down below!
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A call option is an option contract that allows the buyer of the option the right, but not the obligation to buy a stock, or an asset within the stock market at a specific price within a specified time, or within an expiration period of time.
In contrast, a put option allows the buyer of the put, the right but not the obligation to sell their stock at a specific price on or before the expiration period. This decision is affected by the strike price of the underlying on or before the expiration.
As we understand what a call option is, we must now understand how they work. As an option buyer, you have the right to buy the asset or stock at the agreed price before the expiration. This is called exercising the option.
The key take away or thing to remember is that 1 stock option contract equals 100 shares.
So the reason we would want to buy call options instead of shares is to be able to possibly get into a position without spending as much to do so.
For example: If you are looking to buy Amazon (#AMZN) but not willing to spend the full amount of the 100 shares, you could pay a fraction of the cost, for the call option.
A single share of Amazon is around 1776, at the time of this post. So you would have to spend $1,776 in order to own just 1 share of Amazon.
However, for this example, if the call option is priced 65.00 (65.00 X 100) we could move into the position of the contract for $6,500. As you can see this is a lot cheaper than paying $177,600 for 100 shares.
The takeaway is that we only would have so many days for it to move in our favor. This is called the expiration.
If the stock price moved in your favor and you chose to exercise the option, then the stock would get assigned to you at the agreed price of the option contract, minus the cost of the purchase of that option. You would then own 100 shares and be able to sell them right away for a profit, depending on the price of the shares now.
The alternative, is not exercising, and just selling the option contract for more than you purchased it, BEFORE expiration. This is only if the stock price has moved up.
The price of options are determined by a few things like the volatility, time left before expiration, the movement of the stock price and more.
Another Example of Buying Call Options: Think of buying real estate. Here we will treat our stocks like real estate.
You are wanting to buy a home from a home developer who builds and then sells homes. The house down the road is currently being built and you want to go ahead an invest before it is finished.
The developer is selling a contract to purchase the house for $20,000. The home is currently appraised for $200,000. You believe that by the time the developer is finished with building the house, the area and the house will be worth more.
Therefore, you go and purchase the contract for the $20,000 for the right to buy the home upon completion for the remaining amount, $180,000. ($200,000 – $20,000)
Scenario 1: The house is complete and the market did go up. The house is now appraised for $400,000. The developer wrote you the contract and has to sell the house to you for the $200,000. You already paid $20,000, so that means you owe the remaining amount of $180,000 and get to take ownership of the house.
You get to either sell the house at the now appraised house at $400,000 and of course profit $200,000 or keep the house, and rent it out. This relate to selling covered calls, which is down below in why sell call options.
Scenario 2: The house is complete and the market crashed. The house value is now less than the original $200,000 and is now worth $100,000. You get to walk away as the contract was wrote for $200,000 so therefor you wouldn’t want to take anymore of a loss other than the $20,000 that you purchased the contract for.
As you can see the power of buying options and the possible returns that they can bring in, and why the are appealing to the advanced investors who understand stock options.
The reason that we would sell call options is to be able to sell premium or write them for a profit. When selling, you can sell naked call options (not owning any shares to cover) or selling covered calls (owning shares to cover). Depending on whether or not you’re covered or naked, determines risk to reward.
As mentioned above with the real estate scenario, you can be the developer or person writing options if you are covered, or naked.
If you for example, you own 100 shares of one particular company, you can sell 1 covered call against it, IF it is optionable (having options).
Example: If you own 100 shares of Under Amour, and you had bought the shares at $32, you could write a covered call option for $35. You would take in a premium and sell your shares at 35 for a profit if the stock price would go up to 35 or more by an expiration period. (Premium + Difference = Profit)
If the stock was to drop in price, you would still profit from the covered call that you sold or wrote. You would then keep your shares, and adjust your covered call price the next time if you wanted, and do this over and over again to treat your stocks like real estate.
Writing a naked call, or selling naked options, is doing the same thing as a covered call but without having any shares to cover. The risk here is the amount you would have to come up with if the price was to go up to the strike price of the option you had sold premium toward.
Example: If you sold 1 naked call on a 35 strike price call and the price at expiration was 35 or more, then most likely the option buyer on the other side would exercise the option to take possession of the shares. Your broker would require you to have the cost amount to cover the loss on your side. That amount would be $3,500. Remember 1 option contract is equal to 100 shares.
So now that we know what call options are, why sell call options, and why buy options, hopefully you begin to invest wisely and become more profitable with your stock options strategies. The goal is to maximize returns in the most successful and easiest ways, while minimizing risks.
After reading this, I hope you understand when to buy a call option and when to sell a call option. However, the exact understanding of those two strategies, comes with other areas to learn like implied volatility, historical volatility, IV Rank, and the option Greeks.
Please leave a comment down below if this has helped you better understand what is call options and any questions that you may have!
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