Introduction
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. A Call gives you the right to buy an asset at a set strike price by a certain expiration date (bullish). A Put gives you the right to sell an asset at a set strike price by a certain expiration date (bearish). Mastering calls and puts is the key to successful options trading.
This course will cover the essentials: what they are, how they are priced, and practical use of options.
The Basics of Options
Options traders worldwide profit whether markets rise or fall. Options are powerful, flexible tools for informed investors, offering opportunities regardless of market direction. Options can be used to:
Gain exposure to stock price movements without owning the stock directly.
Generate monthly income from existing stock holdings.
Protect your stock portfolio and profit from market downturns.
At Share Navigator, we emphasize using options to reduce risk, not speculate. With the right strategies, options can actually be less risky than owning shares outright. Understanding the fundamentals of options is essential, no matter your goal.
What is an Option?
In the stock market, an option is a contract that gives you the right, but not the obligation, to buy or sell an asset at a set strike price by a certain expiration date. Options are derivatives—their value comes from the underlying asset.
Call Options: Give you the right to buy at the strike price. You profit if the stock price rises above the strike price plus the premium (the option's price).
Put Options: Give you the right to sell at the strike price. You profit if the stock price falls below the strike price minus the premium.
Key Option Terms:
Premium: The price you pay for the option contract.
Expiration Date: The date the option contract ends.
Strike Price: The set price you can buy or sell the asset.
ITM, ATM, OTM: Describes the option's profitability status (In-the-money, At-the-money, Out-of-the-money).
Everyday examples of an Option
Imagine securing your dream home with an option contract, similar to a call option. You agree to a Strike Price (e.g., €500,000) and an Expiration Date (e.g., 6 months). You pay a non-refundable Premium (e.g., €5,000) for this right.
If you secure financing, you buy the house at the lower, locked-in strike price. If not, you walk away, losing only your premium. This example perfectly illustrates the core principle: a right, not an obligation, to execute a trade at a specific price.
🏛️ Options Trade on an Exchange via option contracts
Options are standardized financial contracts that are bought and sold on organized exchanges, just like stocks.
The primary exchange for US stock options is the CBOE (The Chicago Board of Options Exchange).
Trading operates under a Bid/Ask system: the Bid is the highest price a buyer is willing to pay, and the Ask is the lowest price a seller is willing to accept. When the bid and ask prices meet, a trade is executed.
This exchange-based system provides liquidity and guarantees for the contract obligations through a clearinghouse.
Key Option Contract Elements:
Share Control: Options are traded in 'Contracts'. One Option contract controls 100 shares of stock.
3 Key Elements:
Strike Price: The price you have the right to buy or sell the shares.
Expiry: The date the contract ends.
Premium: The price of the Option.
Basic Call and Put Option Example: AAPL
You are bullish on Apple (stock price at $250). You buy an Apple call option with a Strike Price of $260 and a Dec 19th Expiration for a Premium of $7.30 per share. Your contract costs $730 ($7.30 x 100 shares).
If Apple rises above $260, you profit. If it falls, you simply lose the $730 premium, limiting your risk.
How are Options Priced?
The Option Premium is the price of the option and is the amount the seller receives. Since one contract controls 100 shares, a quoted premium of $2 means the contract costs $200 (100 shares x $2).
Basic Options Price Formula
While complex models like Black-Scholes exist, we simplify the pricing with this core formula:
Option Premium = Intrinsic Value + Time Value
Option Prices - In the Money, At the Money and Out of the Money
These terms describe the option's value relative to the current stock price, which determines its Intrinsic Value:
In The Money (ITM): The option is profitable to exercise immediately.
Call: Stock price is higher than the strike price (e.g., Stock $110, Strike $105).
Put: Stock price is lower than the strike price (e.g., Stock $110, Strike $115).
Out of The Money (OTM): The option is not profitable to exercise immediately and has zero intrinsic value.
At The Money (ATM): The stock price is very close to the strike price; its value is almost entirely Time Value.
Intrinsic Value (Real Value)
Intrinsic Value is the real value an option has if it were exercised immediately and profitably. It only applies to In-The-Money (ITM) options.
Intrinsic Value CALLS = Stock Price - ITM Call Strike Price
Intrinsic Value PUTS = ITM Put Strike Price - Stock Price
Call Example: Stock is $110, Strike is $105. Intrinsic Value = $5.
Put Example: Stock is $110, Strike is $115. Intrinsic Value = $5.
Time Value (Extrinsic Value)
Time Value (or Extrinsic Value) is the portion of the premium above its intrinsic value. It represents the potential for the option to become more valuable before expiration.
Time Value = Option Premium - Intrinsic Value
Factors Affecting Time Value:
Time to Expiration: Longer time = Higher time value.
Volatility: Higher volatility = Higher time value.
Time Decay: Time value shrinks as the expiration date approaches, accelerating closer to expiry.
Understanding Time Value is crucial, as option sellers often profit from this decay.
Volatility - Historical and Implied
Volatility is a key factor in option pricing—greater price swings mean a higher chance of the option becoming ITM, leading to a higher premium.
Historical volatility (HV) measures how much a stock's price has moved in the past. It's calculated using past price data and expressed as a percentage. HV shows historical price behavior but doesn't predict future volatility. A common calculation involves the standard deviation of daily returns. For example, a 2% standard deviation means the stock has typically moved up or down 2% daily over the measured period.
Implied volatility (IV), on the other hand, is a forward-looking measure of how much the market expects the stock price to fluctuate in the future. It's derived from current option prices and is a key input in option pricing models. High IV suggests the market anticipates large price swings, while low IV implies expectations of stability. Traders use IV to judge if options are expensive or cheap. High IV often means higher option premiums.
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 (Implied Volatility) Rank
IV Rank helps you quickly assess if the current Implied Volatility (IV) is high or low compared to its own historical range (e.g., the last 52 weeks).
High IV Rank: Current IV is near the top of its range. Options are relatively expensive; selling options is often considered.
Low IV Rank: Current IV is near the bottom of its range. Options are relatively cheap; buying options is often considered.
IV Rank is a valuable tool for determining if options are currently priced high or low relative to their past.
🏆 Course Summary & Next Steps
Congratulations! You've successfully completed the essential groundwork for options trading by mastering Options 101: The Basics.
You've mastered the fundamentals: You now clearly understand the difference between Call and Put options and know their core purpose (Calls are bullish, Puts are bearish).
You know the key contract elements: You can confidently identify the Strike Price, Expiration Date, and Premium on any options contract.
You grasp pricing: You can break down the Option Premium into its two components: Intrinsic Value (real value) and Time Value (potential value, including the influence of Volatility).
You speak the lingo: You are familiar with crucial terms like ITM, ATM, and OTM and understand how options are bought and sold on an exchange.
You have built a strong, disciplined foundation. Now it's time to put these tools into action with specific trading strategies!
Accelerate Your Success
Ready to skip the learning curve? Don't just follow a course—let an expert guide you. Try out our one-to-one mentoring service and receive personalized attention, tailored strategy advice, and expert feedback directly on your trades.
Test Your Knowledge - Quiz 1
CLICK HERE to test your knowledge.
Your Next Step: The Long Call Option Course
To immediately build on your new knowledge, we strongly recommend taking the next course: The Long Call Option Strategy. This course will teach you one of the most fundamental and direct ways to profit when you are bullish on a stock, using the knowledge you just gained about call options.
Learn to trade Options like a Pro!