Options Trading
Options Trading (and the Greeks)
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Disclaimer: Stock options are an extremely speculative security and are not recommended for the average investor.
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Of all the great Empires of old, few are more renowned, respected, revered than the Ancient Greeks. Their contributions to science, literature, the arts, and military strategy through centuries of antiquity have been numerous, and the effects they have had on western society as a whole are still present to this day. (Trust me this becomes relevant)
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One of the biggest contributions has come from the Greek alphabet (seriously, this gets relevant), in particular, the letters Delta (Δ), Theta (Θ), and Gamma (Γ). To those reading who are still awake, these letters are very important in the volatile world of options trading.
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A more contemporaneous look of Greece shows us a completely different picture. Their education and healthcare systems are some of the worst in Europe, and the country is in hundreds of billions of dollars in debt... and so can you if you start options trading!
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Options In a Shellnut
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All jokes aside (for now), trading options is not something you should take lightly, and is one of the most risky investing strategies you can use, and something you should attempt only if you can afford to lose literally every single penny you put into it (I mean this literally, while it is unlikely in actual stock trading, it is absolutely possible for your options to become worthless).
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Options trading can be defined as contracts that allow a buyer to buy (calls) or sell (puts) shares of a stock at a set price at or before the expiration date of the contract (the third Friday of each month, but you can buy options months ahead of their expiration date).
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In most circumstances, buying options closer to the expiration date is considered riskier.
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In more defined terms:
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Calls: You enter a contract (you don't actually own the stock) to buy a stock in the future. Think of buying the call as a down payment on a future asset, with the possibility that your down payment could expire worthless. You buy calls when you think a stock will go up. If the stock doesn't go up before it expires, you lose the down payment.
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Puts: You enter a contract to sell a stock in the future. Think of buying a put as an insurance policy premium for home insurance on a house, but instead of a house it's a stock. You buy puts when you think a stock will go down. If the stock doesn't go down before it expires, you lose the premium.
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You can sell your option before the expiration date, which I recommend, as the closer it gets to expiration, the more the price decays and the riskier the contract becomes. (More on that below)
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The Greeks (without the history lesson)
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It is important to understand the four big Greek letters, and how they relate to your puts and calls and their values.
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Delta: Essentially how volatile the option is. The higher the delta, the more the contract's value will shift based on the stock's movement. Delta isn't constant, and changes as the option's price fluctuates.
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Theta: Theta is price decay. A higher value means the option will be worth less as time passes.
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Gamma: Gamma is similar to Delta, but is a constant value. Gamma is essentially how much the Delta will move based on price changes in the stock.
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Theta and Delta are by far the two more important Greeks to consider when trading options, but Gamma may be important to keep in mind as well.
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The Strike Price
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The strike price is easy to explain in simple terms.
If you're buying calls, you think the stock will go up, and in most situations buy a strike price that is higher than what the stock is currently trading at.
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If you're buying puts, you think the stock will go down, and in most situations you will buy a strike price that is lower than what the stock is currently trading at.
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The Smart Way to Trade Options
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The best way to trade options, and the way I do it, is to use options trading as a sort of hedge on equities that you already own, using small amounts of money. I own a share of a company, but I think that for whatever reason the next week will be a rocky one for them and buy puts below the strike price expiring a month from now just to be safe. The stock dips during the week, I sell my puts for a profit with weeks to spare. Congratulations, I just made money, and although my stocks dipped, I cut out some of my losses at the cost of a little risk.
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Options are inherently speculative, and as you can see, there's no safe way to play them, but in small amounts it is a reasonable hedge to use for stocks that you already own shares of.
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Uhhhh, My Options Expired?
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Not only did your options expire, but now you have an expiration date too and owe a lot of people a lot of money. Run.
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Just kidding, but you're a dumbass for not selling them before they expire. Most of the time you will lose money doing this, and if your options didn't cross the strike price, your options have expired worthless and you will have lost all of your money. Shame on you.
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Conclusions
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Options are a whole 'nother thing to deal with in the stock market, and definitely not something you should be playing around with. I do not recommend them, and instead suggest buying and holding stocks with good fundamentals long-term and MAYBE using the occasional puts as a hedge every now and then, only when you have good suspicion that a stock that you own will dip.