Onlyoptionstrades - options trading training guide for begineers PDF

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options trading training guide for begineers...

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BECOMING AN OPTIONS PRO OnlyOptionsTrades

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TABLE OF CONTENTS CHAPTER 1 OPTIONS – THE BASICS Why Options? Options Defined Call Option Put Option Moneyness (ITM, ATM, OTM) Option Value – Intrinsic vs. Extrinsic CHAPTER 2 THE GREEKS Delta Gamma Theta Vega CHAPTER 3 TRADING STRATEGIES Covered Call Married Put Credit Spread Debit Spread Long Straddle Long Strangle Iron Condor CHAPTER 4 REVERSAL CHART PATTERNS Double Top Double Bottom Head and Shoulders Inverse Head and Shoulders Rising Wedge Falling Wedge CHAPTER 5 CONTINUATION CHART PATTERNS Falling Wedge Rising Wedge Bullish Rectangle Bearish Rectangle Bullish Pennant Bearish Pennant

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CHAPTER 6 BILATERAL CHART PATTERNS Ascending Triangle Descending Triangle Symmetrical Triangle CHAPTER 7 CANDLESTICK PATTERNS Candlestick Basics Open/Close/High/Low Bullish Single Candle Patterns Two Candle Patterns Multiple Candle Patterns Bearish Single Candle Patterns Two Candle Patterns Multiple Candle Patterns CHAPTER 8 TYPES OF ANALYSIS Sentiment Analysis Fundamental Analysis Technical Analysis - Important Indicators CHAPTER 9 HEDGING Tillio’s Strategy CHAPTER 11 GLOSSARY All Trading Terms

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CHAPTER 1: OPTIONS – THE BASICS What are Options? Definition: An option is a contract giving the buyer the right, but not the obligation, to buy (in the case of a call) or sell (in the case of a put) the underlying asset at a specific price on or before a certain date. Options are comprised of 4 key elements: 1. The Underlying Security: Each option contract is based on an underlying security (security is a fancy name for stock). This means that an option for Apple is linked to Apple’s stock and the price of the option will rise and fall with the price of the stock. 2. The Right, Not Obligation: Owning an option gives you the right, but NOT the obligation to buy or sell the underlying stock at a specific price. *Most people will sell the option back to the market when they see profit since the price of the option fluctuates with the movement of the stock. 3. Specified Price: Options give you the right to buy or sell a stock at a specified price – the Strike Price. The strike price is often in the middle of the option chain (look at fig. 1) and it represents the set price that an option contract can be bought or sold at if the stock price rises above or below the strike price. 4. Time: All option contracts expire on a given date. This date is called the expiration date, after the date has passed the option does not exist anymore. You have to decide what you will do with the option before the expiration date because it will be worth nothing afterwards. Option contracts are comprised of 100 shares of the underlying stock in which investors may buy or sell the contract depending on their beliefs about the underlying stock. You may exercise your option rights upon expiration but more often than not, at OnlyOptionsTrades we will sell the contract back to the market, keeping the profit and having no ties to the stock afterwards. Options are a very powerful tool to use because of their wide range of uses. They can be traded daily for income, used for downside risk against your current holdings, or wagering on the future direction of a stock. If you are still confused on options at this point, perhaps the following reallife example will help: Example 1: A Cash Deposit

Suppose you are trying to buy John’s Mustang that is not local but also not far enough to take a plane. John wants $20,000 but you won’t be able to drive to him for another week. You offer John $1,500 as a cash deposit to hold the car until you can finally get off of work one week from now and he promises to give you the car for the agreed upon $20,000 – despite the higher bid’s that may come in. Your cash deposit is essentially the same thing as buying an option contract because it has given you the right to buy the car by a specific date at a specific price. Now let’s make it even more like an option contract.

5 Now suppose Ford decides to discontinue their Mustang line, making the Mustangs current value increase to $50,000. Now you have two choices: (1) you could buy the mustang for $20,000 and then turnaround and sell it for $50,000 or (2) you could find another Mustang enthusiast who is interested in the car that would pay you back the $1,500 and a little more since the value of the deal has gone up – then you’ve made money by giving the deal to someone else without ever owning the car. -

Choice 1 is the equivalent to Exercising the option. Although lucrative, it requires a lot of capital up front. Choice 2 is equivalent to selling the contract back to the market when the options price has gone up, all without ever owning the stock.

Bullish

There are two different types of options; Calls and Puts.

Buying Puts

Selling Puts

Selling Calls

Bearish

Buying Calls

“Bullish” is the belief that the price of a stock will rise while “Bearish” is the belief that the price of a stock will drop.

Figure 1: These are the 4 different ways to use options to your advantage

Call Options: Give the option holder the right, but not the obligation, to buy 100 shares of the underlying stock at a specified price (the strike price) within a specific time period. -

Call options increase in value as the underlying security’s price increases Call option buyers believe the underlying stock will rise in price (bullish) Call option sellers believe the underlying stock will decrease or stay around the same price (Bearish or Neutral). A “Long Call” means you’ve purchased the call. A “Short Call” means you’ve sold a call.

Example: You bought a call option with a strike price of $100 because you assumed the price would go higher. Apple is trading at $110 at expiry and the options cost the buyer $2, the profit is $110 – ($100 +$2) = $8. So, one contract equals $800 ($8 x 100 shares), or $1,600 if they bought 2 contracts.

Figure 2: Long Call Profitability

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Put Options: Give the option holder the right, but not the obligation, to sell 100 shares of the underlying stock at a specified price within a specific time frame. -

Put options increase in value as the underlying stock price declines Put option buyers believe the underlying stock will decrease in price (Bearish) Put option sellers believe the underlying stock will increase or stay the same (Bullish or Neutral)

Example: Stock currently trading at $277. Investor bought a put for $0.72 or $72 (premium =$.72 x 100 shares) with a strike price of $260. Stock drops to $250 and investor sells the option. Consequently, the investor makes $1,000 (100 x ($260-$250), minus the premium paid. Net profit = $1,000 - $72 = $928

Figure 3: Long Put Profitability

Reading an Option Chain Below is the option chain for Apple (Ticker: AAPL). An option chain is a list of all of the currently available option contracts for the underlying stock you are looking at. At the time of this screenshot, Apple was trading at $132.03. 1 = Call option purchase price 2 = Call option selling price 3 = Strike price at which the option can be exercised 4 = Put option selling price 5 = Put option purchase price 1

Figure 4: Apple option chain on 1/20/21

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7 Moneyness Moneyness is a description of an option relating its strike price to the price of the underlying asset. Moneyness describes the intrinsic value of an option in its current state making it an indicator as to whether the option would make money if it were exercised immediately. Long Calls and Puts do not have to be ITM in order to see profit. Any reasonable increase in the underlying stock will raise the options premium.

The 3 Types of Moneyness: ITM (in-the-money) o Calls: stock price is above strike price o Puts: stock price is below strike price OTM (out-the-money) o Calls: strike price is above the stock price o Puts: strike price is below stock price ATM (at-the-money) o Strike price and stock price are equal

OTM

ITM

OTM

ITM

OTM

ITM

ATM

ATM

ITM

OTM

ITM

OTM

ITM

OTM

Figure 5: Facebook option chain 1/20/21

Option Value There are several factors that contribute into an options value. The value represents the option premium or the price an option can be bought or sold at. The option premium is primarily made up of two value types: Intrinsic and Extrinsic value. -

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Intrinsic Value: How much the option would be worth if it were exercised right now. Extrinsic Value: Time Value and Implied Volatility (IV). Everything that is not intrinsic value

As the option nears its expiration date, the time Figure 6: Intrinsic vs. Extrinsic value value will edge closer and closer to $0, while the intrinsic value will closely represent the difference between the underlying securities price and the strike price of the contract.

8 The total value of an option can be broken into two parts: (a) Intrinsic Value + (b) Extrinsic Value = (c) Total Option Value Or, phrased differently... (a) Current value + (b) [Time + Volatility Value] = (c) Total Option Value Intrinsic Value Calls are in the money (have intrinsic value) if the strike price is below the current stock price. The calculation to find the intrinsic value for a call option looks like this: Stock price – Strike Price = Intrinsic Value Example: If TSLA is trading at $166.24, and we buy a call at a strike price of $160.00, then the intrinsic value would be $6.24 (or $624). So, $166.24 - $160.00 = $6.24 (Intrinsic Value) Puts are in the money (have intrinsic value) if the strike price is above the current stock price. The calculation to find the intrinsic value for a put option looks like this: Strike Price – Stock Price = Intrinsic Value Example: Let's say TSLA is trading at $166.24, and we sell a put at a strike price of $170.00. To find the intrinsic value of the put, we would calculate it like... $170.00 - $166.24 = $3.76 (Intrinsic Value) Extrinsic Value As it was said before, the easiest way to think of extrinsic value is: extrinsic value is everything that is not intrinsic. Extrinsic value is made of (1) Time value and (2) Implied volatility. Time Value (Days To Expiration): The longer an option has until it expires, the more time it has to reach the desired strike price – so you have more time value on the contract due to the time it has left. Implied Volatility (IV): IV effectively measures how much the stock price may swing over a specific time frame. The higher the Implied Volatility, the higher the ‘expected move’ for the stock. As time expires, an options Extrinsic value will move to $0.00, leaving only Intrinsic value. If IV decreases, the Extrinsic value will also decrease. Meanwhile if an option has a longer time until expiration and a higher IV, the Extrinsic value will increase.

“In the money” is the same as sayin “the option ha Intrinsic value”

9 CHAPTER 2: THE GREEKS Option “Greeks” - a set of risk measures so named after the Greek letters that denote them, which indicate how sensitive an option is to time-value decay, changes in implied volatility, and movements in the price its underlying security. -

The four important Greek risk measures are known as Delta, Theta, Gamma, and Vega.

Delta: represents the rate of change between the option’s price and a $1 change in the underlying asset’s price. In other words, the price sensitivity of the option relative to the value of the underlying. - Delta of a call option has a range of 0-1 - Delta of a put option has a range of 1-0 o Example: assume an investor is long a call option with a delta of 0.50. Therefore, if the underlying stock increases by $1, the options price would increase by 50 cents. Theta: represents the rate of change between the option price and time. Also referred to as time sensitivity or time decay. - Theta indicates the amount an options price would decrease as the time to expiration decreases – all else equal. - Theta increases when options are ATM and decreases when option is ITM or OTM o Example: if an investor is long an option with a theta of -.50, the option’s price would decrease by 50 cents every day that passes – all else equal. Gamma: represents the rate of change between an option’s delta and the underlying asset’s price. - Gamma indicates the amount the delta would change given a $1 move in the underlying security. - Gamma used to determine how stable an option’s delta is. - Higher gamma values indicate that delta could change dramatically in response to even smaller movements in the underlying’s price. - Gamma is higher for options that are ATM and lower for options that ITM/OTM - Gamma values are generally smaller the further away from the date of expiration; options with longer expirations are less sensitive to delta changes. - As expiration approaches, gamma is typically larger as price changes have more impact. o Example: an investor is long a call option of stock $XYZ. The call option has a delta of .50 and a gamma of .10. Therefore, if stock $XYZ increases or decreases by $1, the call option’s delta would increase or decrease by 0.10. Vega: represents the rate of change between an options value and the underlying asset’s implied volatility. - Options sensitivity to volatility - Indicates the amount an options price changes given a 1% change in implied volatility - Because increased volatility implies that the underlying stock is more likely to experience extreme values, a rise in volatility will correspondingly increase the value of an option. Conversely, a decrease in volatility will negatively affect the value of the option. o Example: an option with a Vega of 0.10 indicates the option’s value is expected to change by 10 cents if the implied volatility changes by 1%.

10 CHAPTER 3: TRADING STRATEGIES Long Put: Buying a put option When to use: expecting stock price to decline and have a greater return potential. Unlike a short put a long put caps the max loss to the debit paid to open the trade, where shorting the stock as unlimited loss potential. Example: BA is trading at 140. If you think BA will drop you can buy a 120 put with a given expiration date. As long as BA drops you can see profit, this is based on many factors though such as the Greeks, IV and the days until expiration. For options trading the breakeven does not matter as much to the buyer who is just looking to flip the premium on the contract. Figure 7: Long Put Profitability

Long Call: Buying a call option When to use: Similar to the long put except profit comes from the increase in stock price. Buying to open a call position will give a much better return when the stock price increase rather than owning the shares directly. Your max loss is also capped to the debit you pay. Example: BA is trading at 140. If you expect the stock price to rise you can buy to open a 150 call with a given expiration date. You will profit based on how much BA rises as well as the value of the Greeks, IV and day until contract expiration. Break even once again does not matter on long calls too much unless you plan to exercise your right and purchase the shares.

Figure 8: Long Call Profitability

Short Put: Selling a put by itself. When to use: Bullish strategy. Used to help generate income by collecting the premium if you believe the stock price will be above the strike price at expiration. This is also used by skilled traders who are looking to purchase the shares for a cheaper price. As long as the stock price remains above the strike price the short seller collects the premium, if it falls below the strike price the seller can buy the underlying stock at a discount to the strike price by using the premium to reduce the overall price.

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Example: Ba is trading at 140. A trader can short BA at the 100 strike price with a given expiration collecting premium. As long as BA is above 100 the premium is kept.

Figure 9: Short Put Profitability Graph

Covered Call: purchasing the underlying stock as you normally would, and simultaneously write (sell) a call option on those same shares. - A safer option strategy - Popular because it generates income and reduces risk of being long on the stock alone. - Investors may choose this strategy when they have a short-term position in the stock and a neutral opinion on its direction. - Investor might be looking to generate income through the sale of the call premium or protect against a potential decline in the underlying stock’s value. When to use: Similar to the short put, covered calls can be a good strategy used by skilled traders to generate income while owning the shares if they believe the stock price will remain flat. It can also be used by traders who are looking to exit a position and sell a call at a strike they would like to exit at for the underlying stock, while profiting the premium. Example: for every 100 shares of stock $XYZ an investor buys, he would simultaneously sell one call option against it. In the event that $XYZ rapidly increases, this investor’s short Figure 10: Covered Call Profitability Graph call is covered by the long stock position. Married Put: purchasing shares of a stock and simultaneously purchasing put options for an equivalent number of shares. - An investor may choose to use this strategy as a way of protecting their downside risk when holding a stock - This strategy functions similarly to an insurance policy; it establishes a price floor in the event the stock’s price falls sharply. The Investor would also be able to participate in upside rallying because of the 100 shares being held.

12 The only disadvantage is that if the stock does not fall in value, the investor loses the amount of the premium paid for the put option. Example: suppose an investor buys 100 shares of stock and buy one put option simultaneously. In the event that the stock drops, the value lost in the 100 shares will be recouped, or protected, by the gain in the put option. -

Figure 11: Married Put Profitability Graph

Debit Spreads: Buying an option while simultaneously selling an option that is farther OTM. When to use: These are directional plays that allow traders to get some skin in the game while reducing overall cost but capping max returns. There are bullish (call) and bearish (put) debit spreads. Cost is reduced on these types of trades because you collect a premium on the short leg while paying a debit on the long leg. Max loss is always the debit paid, and max gains is always the difference between the strike prices minus the debit paid. Example: Bullish debit spread - Buying a call and selling a call at a higher strike price. If BA is trading at 140 and you believe the price will increase but you want to minimize risk, you can enter a call debit spread. If you think BA will reach above 155 by expiration you can buy th e 150 call and sell the 155 call. Your max risk will be the total debit and max return upon expiration if BA is above 155 would be 500 ($5 difference between strikes x 100) minus debit paid.

Figure 12: Bullish Debit Spread

Bearish debit spread - Buying a put at one strike and selling another at a lower strike. If you are bearish on BA that is trading at 140 you can buy a 130 put and sell a 129 put. If BA closes below 129 upon expiration your max profit will be 100 ($1 difference between strikes x 100) minus debit paid.

Figure 13: Bearish Debit Spread

13 Credit Spreads: Selling an option while simultaneously buying an option farther OTM When to use: Credit spreads are similar to debit spreads, but you receive a credit upon entry rather than paying a debit. This is a great strategy to implement for growing a small account, or just a general strategy to u...