What are Options?

• An Option is a contract sold from Seller (writer) to Buyer, which gives buyer the right (but not obligation) to purchase a stock at a specific price - Strike (if stock price is getting closer or breaking beyond the Strike - option contracts increase in value, if stock price goes away from the Strike - options contracts decrease in value), on or before the specified date - Expiration Date (the closer the Expiration Date is - the lower the value of the option contract is (option's time decay), once contracts expire - they become worthless).
  
  
• An Options trade or a position is opened when an option is either bought or sold, which is then closed with an opposite action or when option Expires.
  
  • BTO (Buy to Open): option contracts are purchased at Ask price. To close such trade, same type of options must be sold STC (Sell to Close) at Bid price unless contracts expire.
    
  • STO (Sell to Open): option contracts are sold at Bid price. To close such trade, same type of options must be bought back - BTC (Buy to Close) at Ask price unless contracts expire.
    
  • Premium: feed paid by buyer to seller for purchasing options (Premium = 1 contract price * 100).
  • Strike Price: predetermined price at which an option can be bought or sold when it's exercised/assigned.
  • ITM/OTM/ATM: ITM (In the Money): market price is beyond (Calls: above | Puts: below) the Strike Price. | OTM (Out of the Money): market price is outside (Calls: below | Puts: above) the Strike Price. | ATM (At the Money): market price is equal to Strike Price.
  • Expiration Date: option contracts become worthless at the end of trading session day on Expiration date, without reaching the Strike price.
  • BE (Break Even) Point: for an options seller, BE (Break Even) price is the stock price at which after contracts expire and the stock is sold(Covered Calls)/bought-to-cover(Covered Puts)/bought(Cash Secured Puts) - there will be no loss or profit. NOTE: When contracts expire the stock price by that point may already be beyond the BE (Break Even) price and not exactly at it, BE (Break Even) is still very useful as it can be used in combo with Technical Analysis. Also, if options contracts are still not expired, exiting out of the trade at BE (Break Even) price will incur a loss of buying the contracts back - BTC (Buy to Close).
  • Assignment: obligation to purchase or sell stock shares (100 shares per contract) at the Strike price (considering the stock price is at or beyond the Strike price). Assignment may occur at stock price breaking the Strike price before Expiration or will automatically occur at stock closing at/beyond the Strike price at Expiration date at the end of the trading session day (For example, for a typical regulated US broker (Charles Schwab for example), if a sold/STO (Sell to Open) option contract expires today and it is ITM (In the Money) at 5:30PM ET (NOTE: this is beyond market hours, so even after market closes - option contract may go from OTM to ITM and vice versa as price of the stock can still move afterhours!), options will be auto-assigned with 100 SPY shares per each contract at Strike price).
  • Extrinsic Value: Extrinsic value is the difference between the market price of an option, also knowns as its premium, and its intrinsic price, which is the difference between an option's strike price and the underlying asset's price. Extrinsic value rises with increase in volatility in the market.
  • Intrinsic Value: Intrinsic value is a measure of what an asset is worth. The intrinsic value of both call and put options is the difference between the underlying stock's price and the strike price.
• • An mentioned before, Option contract typically represents 100 shares of stock per each contract. There are different approaches on selling Options:
           - Covered Options: each options contract is backed up by a LONG or a SHORT trade of 100 shares of the underlying stock per 1 contract.
           - Cash Secured Options: options contract sold, without owning the underlying stock with available cash to cover the stock purchase in case of assignment.
           - Naked Options: options contract sold, without owning the stock or having enough cash to cover the stock purchase in case of assignment.
           - Mixed Options: there are various advanced options strategies out there, like spreads, butterflies and so on where different options contracts are bought and sold at the same time.
    

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Options Basic Examples

• • Call option contract: increases in price at stock rise (↑).
           - BTO [Buy to Open] - Buyers of calls options are usually expecting the stock to rise rapidly (if price rises slowly > option's time decay will eat away potential profits) in price to re-sell the options at a bigger price.
          
                 * If stock goes up > buyer can profit by re-selling options at a bigger price before Expiration (can also purchase the stock at Strike price, which usually never happens as buying and then re-selling naked calls is a pure speculation trading approach).
                 * If stock goes sideways > options will decay by losing its value over time.
                 * If stock goes down > options will go down in price + lose value over decay. Options - Buying Calls Example
    (Click or Tap to expand)

    Buying then selling calls is often used as a day trading strategy (LONG trades). With very tight Strike and 1-3 days Expiration date, it allows for more rapid changes in the contract price with minimal stock price movements.

    
    In the given scenario, an AMD call option with a $50 strike price is available for a $5 premium and expires in 3 days. Each call contract, representing 100 shares, costs $500 ($5 premium x 100 shares).
    
    For every $1 increase in the stock price above the $50 strike price, the option's total value increases by $100. The breakeven point, where the option starts to earn money or becomes "in the money," is $55 per share ($50 strike price + $5 call cost). Between $50 and $55, the buyer recoups part of the initial investment, but the option doesn't show a net profit.
    
    Once the option is in the money or above the breakeven point, its value is unlimited because the stock price could continue to climb. If the stock trades below the strike price, rendering the option out of the money, it becomes worthless, capping the investor's maximum loss at the initial outlay of $500.
    
    

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           - STO [Sell to Open] - Sellers of covered calls (secured by 100shares per each contract) options are usually expecting the stock to go sideways/rise (→↑).
          
                 * If at Expiration stock ends up beyond the Strike price > seller keeps the premium received for selling the option contracts and then gets assigned, therefore profiting from premium + difference from selling the stock at a higher price and is left with cash.
                 * If at Expiration stock never reaches the Strike price > seller simply profits from premium received for selling the option contracts and is left with stock shares.
                 * If at Expiration stock goes below the Stock Purchase Price > seller profits from premium received for selling the option contracts and is left with stock shares, if the stock continues declining > seller may go into an unrealized loss for a long while or even at a complete loss if the company of the stock goes out of business. Options - Selling Covered Calls Example
    (Click or Tap to expand)
    In the given scenario, AMD stock is trading at $50 a share, and calls with a $50 strike price can be sold for a $5 premium, expiring in 1 week. Each call contract, representing 100 shares, is sold for $500 ($5 premium x 100 shares).
    
    As each contract stands for 100 shares, for every $1 increase in the stock above the strike price, the option's cost to the seller rises by $100. The breakeven point for the call is $55 per share, calculated as the strike price plus the cost of the call. Beyond this point, the call seller begins to incur losses, and potential losses are unlimited. If the stock trades between $50 and $55, the seller retains some premium but not the full amount. If the stock trades below the strike price, the option's value flatlines, capping the seller's maximum gain at $500.
    
    Call sellers can receive at most the contract premium ($500), but they must be prepared to deliver the stock at the strike price if called by the buyer. Potential losses theoretically have no upper bound if the stock price continues to rise, exposing call sellers to more significant losses than their initial position's premium.
    
    

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  • Put option contract: increases in price at stock decline (↓).
           - BTO [Buy to Open] - Buyers of puts options are usually expecting the stock to decrease in price rapidly (if price falls slowly > option's time decay will eat away potential profits) to re-sell the options it bigger price.
          
                 * If stock goes down > buyer can profit by re-selling options at a bigger price before Expiration (can also purchase the stock at Strike price, which usually never happens as buying and then re-selling naked puts is a pure speculation trading approach).
                 * If stock goes sideways > options will decay by losing it's value over time.
                 * If stock goes up > options will go down in price + lose value over decay. Options - Buying Puts Example
    (Click or Tap to expand)

    Buying then selling puts is often used as a day trading strategy (SHORT trades). With very tight Strike and 1-3 days Expiration date, it allows for more rapid changes in the contract price with minimal stock price movements.

    
    AMD, currently valued at $50 per share, has put options with a $50 strike price available for a $5 premium, expiring in 3 days. A single put contract is priced at $500 ($5 premium x 100 shares).
    
    Given that each contract represents 100 shares, for every $1 drop in the stock price below the strike price, the option's total value increases by $100.
    
    Put options start to become profitable, have intrinsic value, or be considered "in the money" when they fall below the break-even point. The break-even point is determined by subtracting the put's cost from the strike price, resulting in $45 in this case ($50 - $5 = $45). If the stock trades between $45 and $50, the option retains some value but doesn't yield a net profit.
    
    On the other hand, if the stock remains above the $50 strike price, the option is deemed "out of the money" and becomes worthless. Consequently, the option value remains flat, limiting the investor's maximum loss to the premium paid for the put, which is $5 per share or $500 in total.
    
    

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           - STO [Sell to Open] - Sellers of covered puts (secured by 100shares per each contract) options are expecting the stock to go sideways/decline in price (→↓).
          
                 * If at Expiration stock ends up beyond the Strike price > seller keeps the premium received for selling the option contracts and then gets assigned, therefore profiting from premium + difference from short-selling the stock at a lower price and is left with cash.
                 * If at Expiration stock never reaches the Strike price and never goes above the Stock Purchase price (as there is a still short trade open) > seller simply profits from premium received for selling the option contracts.
                 * If at Expiration stock goes above the Stock Purchase Price > seller profits from premium received for selling the option contracts and is left with stock shares, AND with an open short trade, which is at loss, since it is a short-sold stock, which went up in price since purchase. With stock never declining below the short-sell price - it will have to be bought-to-cover (basically close the trade) at a loss as if stock continues going up - the loss can grow unlimited! Options - Selling Covered Puts Example
    (Click or Tap to expand)
    AMD, trading at $50 a share, has put options with a $50 strike price that can be sold for a $5 premium, expiring in 1 week. One put contract is sold for $500 ($5 premium x 100 shares).
    
    Each contract, representing 100 shares, results in a $100 increase in cost to the seller for every $1 decrease in the stock below the strike price. The break-even point is $45 per share, calculated as the strike price minus the premium received. The maximum profit for the put seller is capped at $5 premium per share, totaling $500. If the stock remains above $50 per share, the put seller retains the entire premium. As the stock declines, the put option incurs increasing costs for the seller.
    
    Unlike put buyers, put sellers have limited upside and substantial downside. The maximum amount the put seller can receive is the premium of $500. However, if the buyer exercises the put option, the put seller must buy 100 shares of stock at the strike price. Potential losses could exceed the initial investment, reaching the entire value of the stock if it goes to $0. In this scenario, the put seller could incur a loss of up to $5,000 ($50 strike price paid x 100 shares) if the underlying stock reaches $0, as illustrated in the graph.
    
    

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           - [Sell to Open] - Sellers of cash secured puts options are expecting the stock to go sideways/rise to simply collect the option premium.
          
                 * If at Expiration stock never reaches the Strike price > seller simply profits from premium received for selling the option contracts.
                 * If at Expiration stock ends up beyond the Strike price > seller keeps the premium received for selling the option contracts and then gets assigned, therefore profiting from premium, while obtaining 100 shares per each contract at the Strike price. NOTE: If at Expiration stock ends up below the Strike price (actually below and not exactly at it) - seller ends up holding a stock at unrealized loss and if the stock will not recover above Strike price soon - seller may end up at an unrealized loss for a long while or even at a complete loss if the company of the stock goes out of business.
    Options - Selling Cash Secured Puts Example
    (Click or Tap to expand)
    AMD, trading at $75 a share, has put options with a $50 strike price that can be sold for a $230 premium ($2.30 premium x 100 shares), expiring in 1 week.
    
    If, at expiration, the stock is valued above $50 per share, the put option likely expires worthless, and you keep the premium. There's no obligation to purchase 100 shares of AMD, and you don't participate in additional profits if the stock continues to rise.
    
    If the stock is below $50 at expiration, the contract is likely assigned, and you will buy 100 shares of AMD. The shares are automatically purchased at the strike price of $50, but since you received $2.30 per share from selling the contract, your effective purchase price is $47.70 per share. After this, your gain or loss is based on the movement of AMD shares relative to your purchase price.