Dive into the exciting world of options trading! Options are powerful tools that let investors profit from market moves and protect against risk. This introductory course focuses on the two core types of options: calls and puts.

Mastering calls and puts is key to successful options trading. This course will cover the essentials: what they are, how they're priced, and practical trading strategies. Whether you're brand new to options or looking to sharpen your skills, this course will empower you to confidently navigate the options market.

Options traders worldwide profit whether markets rise or fall. Even in down markets, opportunities exist if you know how to leverage options.

Options are powerful tools for informed investors. They offer the flexibility to profit regardless of market direction, with strategies ranging from conservative hedging to more aggressive approaches.

Options can be used to:

At Share Navigator, we emphasize using options to reduce risk, not speculate. While some associate options with high risk, the truth is, with the right strategies, options can actually be less risky than owning shares outright.

No matter your investment goals, risk tolerance, or experience level, understanding the fundamentals of options is essential. This chapter covers the basics of option contracts. Contact us with any questions!

In the stock market, an option is a contract that gives you the right, but not the obligation, to buy or sell an asset (like a stock) at a set price (the strike price) by a certain date (the expiration date). Options are derivatives—their value comes from the underlying asset. There are two main types: calls and puts.

Here are some key option terms:

Options can be used for hedging, speculation, and generating income. They offer flexibility, but options trading is complex and riskier than stock investing. It's crucial to fully understand options and their risks before trading.

Options Trade on an Exchange

Share Control

Let us look at the definition of an option again. An option is the right, not the obligation, to buy or sell a stock at a specific price on or before a specific date.

There are 3 key elements to an Options Contract:

Imagine buying a house with an option contract. You find your dream home but need time to secure financing. You want to lock in the property.

You could create a contract with the owner giving you the right, but not the obligation, to buy the house. This is similar to a call option.

Here's how it might work:

If you can't get financing, you walk away, losing only the €5,000 premium.

Why would the owner agree? They keep the €5,000 premium regardless of whether the house sells, making some money upfront.

This house example helps illustrate how a call option works. Now, let's look at how this applies to stocks.

Just like the house purchase example, a stock call option lets you control an asset without buying it outright. Let's say it's April, and you're bullish on Apple (currently at $100), but you'll have cash available in July. You want to lock in today's price. You buy an Apple call option.

Here's how it works:

So, your call option contract gives you the right to buy Apple at $100 until July 17th for a $5 premium.

Between now and July 17th, two things can happen:

Exercising an option means using your right to buy (call) or sell (put) the underlying asset at the strike price.

Options trade on exchanges just like stocks do. You have a bid and ask price for each Options, like stocks, are traded daily. Understanding how options are priced is crucial, so we recommend reviewing this section carefully.

The option premium is simply the price of the option. It's also the amount the option seller receives for taking on the contract's obligation.

In the U.S., one option contract typically controls 100 shares of the underlying stock. The quoted premium is per share. So, a July 30th call option quoted at $2 means one contract costs $200 (100 shares x $2/share = $200).

We'll keep options pricing simple for this course. For those interested in the complex math, the Black-Scholes model is a great resource.

While many factors influence option premiums, two are key:

So, the basic formula is:

While other elements exist, this simplified formula is a good starting point. Let's explore Intrinsic Value and Time Value in more detail.

In options trading, "ITM," "OTM," and "ATM" describe the relationship between the stock price and the option's strike price. They help traders quickly assess an option's status and potential profit.

An option's ITM, OTM, or ATM status can change as the stock price moves. Traders use these terms to evaluate risk and potential profit. Each status has different implications for options strategies.

Intrinsic value, also called real value, is the value an option has if it were exercised immediately and profitably. It only applies to in-the-money (ITM) options.

Calculating Intrinsic Value:

Intrinsic value is the difference between the stock price and the ITM strike price.

Understanding the difference between time value and intrinsic value is essential. Use this document and the course videos as resources.

An option's time value (also called extrinsic value or premium) is the part of its price above its intrinsic value. It reflects the potential for the option to become more valuable before it expires.

Here's a breakdown:

Factors Affecting Time Value:

Time Value and Option Pricing:

Trading Strategies:

In short, time value represents the potential value of an option before expiration. It's influenced by time, volatility, interest rates, and dividends. Understanding time value is key for both buyers and sellers.

A key factor in option pricing is the underlying stock's volatility – how much its price fluctuates. Greater price swings mean a higher chance the option will become in-the-money, increasing the option's price. In short, higher volatility usually leads to higher option premiums.

Options traders use two main types of volatility: historical volatility (HV) and implied volatility (IV). These metrics help assess expected price fluctuations and are vital for option pricing and trading strategies.

So, HV looks back, while IV looks forward. Traders often compare them. If IV is much higher than HV, options might be considered expensive. If IV is lower than HV, they might be seen as cheap. Both HV and IV are important tools for options traders.

IV Rank helps you understand if an option's current implied volatility (IV) is high or low compared to its past. It's a percentage that shows where the current IV sits within its historical range (often a 52-week range).

Here's how it works:

Interpreting IV Rank:

IV Rank helps traders see if IV is currently high or low historically. However, it's just one tool; use it with other analysis for informed trading decisions.

In short: IV reflects future volatility expectations, while IV Rank compares current IV to its past range, helping traders determine if options are relatively expensive or cheap. Both are key to managing risk and trading options effectively.

Rearranging that Formula you get:

This is really important to get your head around as the Time Value in an option will largely dictate option strategies that you pick later on.

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