If you want to learn about stock option trading, you’re in the right place. My name is Amanda and in the next few minutes, I’ll introduce you to stock option trading and tell you how you can learn more through Raging Bull’s Options Academy.

Perhaps you’ve asked yourself, “What does it mean to trade stock options?”

Let me explain. When trading options you buy or sell the chance to make a profit from trading stocks—but without having to own the stocks outright. So instead of buying or selling shares, trading options is literally buying or selling A CHANCE.

Does that make you wonder how someone can BUY A CHANCE?  

Here’s how it works. Option trading is based on option contracts. Contracts are usually based on the size of 100 shares of stock, and each contract establishes three things: the option type, its strike price, and its expiration date.

The first characteristic, the option type, is either a call or put. This tells you what kind of stock trade you have the chance to make. Traders buy CALL options to have the chance of owning shares, and they buy PUT options for the chance of selling shares short.

The second characteristic of a contract is the strike price. This tells you what the PRICE of the shares would be if you decided to exercise your right to take that chance.

The third characteristic is how much time you have to take that chance. Each option contract has a specific time and date when it will expire.

Let me give you an example. If I tell you that I want to buy a November 21st, 150, CALL option contract on Apple, then you know that I want to have the chance to buy 100 shares of AAPL stock at the price of 150 dollars per share, and I want to be able to do so any time until November 21st. 

With these three characteristics defined, you can see how options can create a specific window of opportunity. Stock movement during this window is the chance. The VALUE of the chance will change in response to stock moves.That change in VALUE, is the BENEFIT that option traders seek.

If you are interested to learn how option values change, then you’ll want to watch the remaining videos in the Beginners Guide to Options Trading. 

These options academy videos are designed to be a source of quick information you need to know before you get started trading options.

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You can get a better idea of how call and put prices change in the next part of this guide.
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When a trader buys a call option contract, they buy the chance to own shares they bought at the strike price on or before the expiration date. The contract gives you the right to take that chance if you want, or to let the contract expire. For most option traders, however, their goal is to benefit from the change in value of the option itself. Let’s take a closer look at how that happens.

Suppose a trader buys a call option on XYZ stock with a strike price of $100. Let’s also suppose that at the time of purchase, the option has 30 days left until it expires. The setup might look something like this:

At the moment this chart depicts, the 100 call option contract can be purchased for a price of $2.00 per share. This implies that the trader would spend $200 dollars to buy the contract because the contract includes the chance to buy 100 shares. This might not seem like a very interesting proposal to have the opportunity to buy the stock at a higher price than it is trading right now, but that’s often how option traders operate. They look for a stock they think has an opportunity to move significantly higher within the option contract’s window of time.

They hope to see the stock make a big move in their favor. Imagine if the stock moved more than eight dollars higher in two weeks. If that scenario played out, the option buyer now has the chance to buy XYZ at $100, even though the stock is worth $108. If the option buyer wanted to exercise their right to buy the stock at $100, they could do so.

If they exercised their right, they’d pay $10,000 to acquire the shares which are now worth $10,800. They spent $200 to buy the option which means they have a $600 net gain on the trade.

However, most option traders don’t operate this way. Most option buyers instead choose to sell the option back into the market. . They can sell their option anytime until the market closes on the date of expiration.

After a few days, the option price is priced at $9.10 per share. If the call option buyer sells the call option back into the markets (rather than exercising it) they get $910. That means the net profit from the trade is $710 instead of $600. A favorable outcome such as this is, of course, what every option buyer hopes for.

But anything can happen and the share price might only rise a small percentage, or it might even go lower. Let’s consider how the outcome of this trade might play out in either of these scenarios.

First, let’s suppose that XYZ only rose to a price of $103 per share. In this scenario the option might be priced as high as $3.80. This represents an opportunity for the option trader to generate a net profit of $180 by selling the option. The alternative would be for the option buyer to exercise their right to buy the shares at $100. They would forgo the profit they might have had from selling the option, and would tie up more capital, but they no longer have to worry about the expiration date of the contract. The trader can now own the stock by purchasing it at a bit of a discount compared to what they would have had to pay if they just bought the stock when it was priced at $99.50.

Trading doesn’t always work out like we hope it will, so now let’s consider how the trade plays out when the move is unfavorable to the trader. In this scenario we’ll imagine that the price of XYZ trended lower after the initial purchase.

In this scenario the price of the stock falls to $98 and the price of the call option decreases as well. Notice that taking the opportunity to exercise their contract to buy the stock at the strike price of $100 is not in the trader’s best interest right now, but they have two additional alternatives at this point.

The first alternative is that they might decide to wait and hope that the price will rise over the remaining two weeks before expiration. The second alternative is that they might decide to simply sell their option contract to someone else while it still has value. The value of the option contract is $.90 per share (or in other words $90). That’s because the option still has some time left before it expires. Both the time decay and the price decline have had an influence on the price of the option contract, so the price is significantly lower than it was when first purchased.

The value of the call option increases when the price of the stock moves higher, and decreases when the stock price moves lower. Call options give the buyer the chance to buy a stock at a set price, but they don’t need to take that chance unless the stock’s move makes it favorable to them to do so. These examples demonstrate how a call option contract can both capture benefit and limit risk depending on the movement of the underlying stock.

Buying call options offers a way to capture the opportunity behind an upward move in a stock price, while maintaining a limited amount of risk. A common way to depict this relationship is through the use of a risk profile graph.

This depiction shows how the option price changes based on the movement of the stock price. Once a call option is purchased, the value of the option will tend to increase as the stock price rises. Theoretically, this increase is not limited. However if the stock price falls, the value of the call option can only go to zero, so the amount of loss is limited to the purchase price of the option.

In summary, buying a call option allows the trader a chance of owning a stock if they choose to do so. The cost for having that chance is the price of the option. If the stock moves favorably, they can benefit by exercising the option or by selling the option to someone else. If the stock moves unfavorably, they will lose some or all of the money they used to purchase the option, but their risk is limited to that amount of loss.

One of the most successful investment professionals in the world today spoke these wise words: “Some people with high IQs are terrible investors because they’ve got terrible temperaments. That is why we say that having a certain kind of temperament is more important than brains.”

Think about that. According to Charlie Munger, Warren Buffet’s most trusted advisor, trading in a way that matches your temperament may be more important than how much you know about the markets. Options are extremely versatile instruments and can be used in many different ways. Experienced option traders tend to select and refine a trading style that is most effective for their temperament.

One simple way to understand the most commonly used option trading styles is to learn a little bit about something called option Greeks. These are the power tools of the option trading world. They are measures that help traders better anticipate the way option prices might move. There are many of these measures, but the three most commonly used ones are Gamma, Theta and Delta. Here is a simple definition for each.

Delta measures how sensitive an option is to its underlying stock’s price movement. So a high delta score means the option and the stock move similarly. A low delta score means the stock has to move more dramatically to change the option price.

Theta measures the amount of time decay an option will experience. Theta scores are negative numbers and they become more negative for an option as the expiration date approaches. 

Gamma measures the potential for price acceleration of the option. The higher the gamma score the more the Delta score of an option will change as the stock price moves. 

To help new traders get properly introduced to the key aspects of option trading, Options Academy has sorted option trading into three distinct styles based on each of these three measures. These three measures align well with the three factors discussed in part two of this Beginner’s Guide. Factor number one, Market Action, aligns closely with Gamma, while factor number two, time decay, aligns with Theta, and factor number three, the underlying stock movement, aligns with Delta. If you take a closer look at each of these trading styles you may begin to understand why it is important to learn more about them.

Trading Style # 1: Gamma

Gamma measures the potential for option price increases to accelerate. The gamma style of trading seeks to buy options that could become more valuable at increasing rates. Gamma style trading seeks to capture unexpected and significant moves. This works well for those who want to approach the market as option buyers. This trading style can be done in short, intermediate, or even longer trading time frames, but usually works best in short-term or intermediate trading. 

Trading Style # 2: Theta

Theta measures the amount of time decay an option should expect for one day. The rate of decay is not linear. It starts off slowly and accelerates as the expiration date approaches. Theta style trading usually works well for those who want to approach the market as sellers. Since time decay works against the option buyer, but works in favor of the option seller, the strategies that best work with this style typically focus on collecting time value rather than paying it. 

Trading Style # 3: Delta

Delta style trading balances risk and reward to have a better than even chance of winning. This style of trading helps traders seek the most effective ways to leverage stock moves. That’s because Delta measures the sensitivity of an option’s price to movement in the underlying stock. The strategies that work with this trading style effectively trades the swings of stock prices. Traders who specialize in Delta-style option trading may approach the market as either a buyer or a seller. Whichever they choose, they will often rely on shorter timeframes for their intended outcomes. 

Option traders who select one of the three trading styles and study its strategies in depth may find that they can learn about option strategies faster and more effectively. The next part of the Beginner’s Guide will discuss which option strategies are aligned with each of these three option styles.

When a trader buys a put option contract, they buy the chance to create a short-sale of a stock at the strike price. This short-sale opportunity will only be available until the option expires. Selling short allows a trader to profit when stocks go down.

A put option contract gives a trader the right to take that chance to sell short if they want, or to let the contract expire. As with call option traders, most put option traders attempt to benefit from the change in value of the option. Let’s take a closer look at how that happens.

Suppose a trader buys a put option on XYZ stock with a strike price of $98. Let’s also suppose that at the time of purchase, the option has 30 days left until it expires. The setup might look something like this:

At the moment this chart depicts, the 98 put option contract can be purchased for a price of $1.00 per share. This implies that the trader would spend $100 dollars to buy the contract because the contract includes the chance to sell short 100 shares of XYZ. Put traders may choose to buy an option with a strike price below the current price of the stock because they know that there is a chance the price might go lower. If they buy the put option contract now, they can benefit from this move. They look for a stock they believe could move significantly lower within the option contract’s window of time.

A put option trader hopes for a drop in stock value. Consider this scenario where the put option buyer has the chance to sell short 100 XYZ shares at $98 when the stock first falls to that price. Since the original cost of the option was only $1.00, the trader would have only had to spend $100 to purchase the option. Now as the stock price has drifted lower to $98, the value of that put option has increased by more than double.

The put option buyer now has two alternatives. The first alternative is the chance to exercise their right to sell the stock short at $98 per share. But in doing so, they give up the value of the option. This creates a net loss of $100 at that moment, but they wouldn’t have to worry about the expiration date of the option contract. This would allow them to hold onto the short position as long as they like.

The second alternative is to simply sell the put option, and benefit from the increased value of the contract. That would create a net profit of $110 before commissions. However, most put option traders hope for a stronger down move. Here is what that might look like.

Notice in the chart above, the put option price is depicted as being $4.70 per share after the share price moves down to $94.25. The move of the stock is the biggest influence on the price because a stronger move lower means the option value increases more dramatically. If the put option buyer simply sells the option now (rather than exercising it) they give someone else the chance to sell XYZ short at $98 and they receive $470 for doing so. That means the net profit from the trade is $370. This outcome, or something even better, is what every put option buyer hopes for.

But option traders must be aware of the risks they take and the stock can move in any direction including unfavorable ones. In this example let’s consider what would happen to the put option if the share price rose instead of falling.

If XYZ traded as high as $103 per share two weeks later, it could create a scenario where the price of the put option falls dramatically. In that scenario the put option might be priced as low as $.40, losing more than half its value.

The trader can still take the chance of selling short the stock at $98, but doing so would put them in a position of losing $5.00 per share at the outset. Even though the put option has lost value at this point in the trade, it is worthwhile to consider the alternative. The value of the option has lost only $.60 per share by comparison. This is an example of what makes option contracts attractive to some traders. In this scenario, even though they lose a larger percentage of the money they spent on the trade, their loss is a smaller net amount than they might have lost from making a short sale trade.

When a put option trade doesn’t work out like we hope it will, it happens because the price of the stock moves higher.

The value of a put option increases when the price of the stock drops and decreases when the stock price rises. Put options give the buyer the chance to sell a stock short at a set price, but the buyer doesn’t need to take that chance unless the stock’s move makes it favorable for them to do so. These examples demonstrate how a put option contract can both capture benefit and limit risk depending on the movement of the underlying stock.

Buying put options offers a way to capture the opportunity behind a downward move in a stock price, while maintaining a limited amount of risk. A common way to depict this relationship is through the use of a risk profile graph.

This depiction shows how the option price changes based on the movement of the stock price. Once a put option is purchased, the value of the option will tend to increase as the stock price falls. Theoretically, this increase is not limited until the stock price becomes worthless. However if the stock price rises, the value of the put option can only go to zero, so the amount of loss is limited to the purchase price of the option.

In summary, buying a put option allows the trader a chance of shorting a stock if they choose to do so. The cost for having that chance is the price of the option. If the stock moves favorably, they can benefit by exercising the option or by selling the option to someone else. If the stock moves unfavorably, they will lose some or all of the money they used to purchase the option, but their risk is limited to that amount of loss.

Once a trader understands the basics behind how buying options works, it becomes important to see the opposite approach to options–that of being an option seller. The next part of the Beginner’s Guide discusses the two opposing approaches to option trading: buying and selling.