Understanding the Basics of Options for Traders: The Ultimate Beginners Guide in 2023
This is my easy, step-by-step guide to learn about the basics of option trading and how to make money from it. For +1 years, I’ve been trading & making money from it–this is the best way to start to learning the basics of option trading in 3 topics
You’ll learn the basics of option trading within these 3 topics. Click right here to jump straight down to part #1 and begin now.
The Ultimate Beginner’s Guide to Learning the Basic of Option Trading:
If you’re ready to take the leap and learn about option trading that can grow your trading account, then let’s dive in.
The Basics of Options
First, it’s important to understand what options are.
Options are contracts that give you the right to buy or sell the stock at a specific price by a specific date–when you buy an option contract, you don’t own anything from that a stock; unlike stock/equity, where you actually own a small piece of ownership in a company.
Also, one option contract represents 100 shares of a stock. Here’s an example, let’s say that I purchased an option contract for $COIN for $75 strike price.
If the stock price is equal to the stock price or is higher, than you have the right to buy 100 shares of $COIN in the strike price you chose–or not.
Calls vs Puts
There’s two main types of option contracts, calls & puts.
Calls are a bullish type of contract–buy calls when you believe the price of a stock will go up.
Puts are a bearish type of contract–buy puts when you believe the price of a stock will go down.
When you’re looking at an option chain like the image above–using Webull brokerage–you will see that you can look at both calls and puts or just filter by one or the other.
If you’re looking at both at the same time, calls are on the left side of the strike column, and puts can be found on the right side of the strike column.
Options Premium
Believe it or not, option contracts are not free. On the option chart, it may show that contract is worth a fraction of the stock price, but you have to remember that an option contract represents 100 shares of the underlying stock.
This means you have to multiply the price of the option contract by 100.
For example, the image above shows an option chart for $T (AT&T) & it shows that you can buy a call contract at a strike price of $18.5 at a cost of 15¢. Grab the price, and now multiply it by 100 and it will cost you $15 to purchase a single option contract for $T.
Brokerages will do the math for you before hitting the buy button, and it will make it easy for you to see how the total cost is.
Expiration Dates
Every option contract has an expiration–which means that option contracts can become worthless(a.k.a lose all your money) if you don’t sell them or exercise before the expiration date. Unlike stocks/equity that do not have an expiration date and can be held forever.
On the Webull app, you can find the expiration date on the left hand side & find how many days are left in the strike column.
Any expiration date less than 30 days are considered weekly’s, and anything 30 days or above are considered monthly contracts. These expiration dates play a big role for your trades because the closer you get to the expiration the more volatile the contract are.
Strike Price
This is where an option may be exercised at the strike price that was chosen.
For example, if you bought a contract for $T (AT&T) for $18 and the stock hypothetically goes to $21 by the end of expiration day–you have the right to buy 100 shares for $18.
Most of the time, I prefer to take the gain from my contract & move onto the next trade.
In, At, & Out of the Money Contracts
A common term when buying contracts are ITM (in the money), ATM (at the money), & OTM (out of the money)–on Webull, it shows the current price action of the stock in the middle of the option chain with a black horizontal strip. As the price moves, it will represent how far and closer it moves to the price action.
In the money – Strike price is below (calls) or above (puts) the stock price.
At the money – Strike price is at the stock price
Out of the money – Strike price is above (calls) or below (puts) the stock price.
Understanding the Greeks
Delta, Theta, & Gamma are terms known as the Greeks in option trading. Will go over what each one means, and how they work, and how you can use them to become profitable with them.
I will admit, that I learned the greeks in a later stage of my trading career–which caused me to run into so many losing trades.
Learnings the Greeks helped me understand how price movement affects my contracts; so this section is extremely important, let’s dive in!
What is Delta and How It Works
Measures the change in option price when the price of a stock moves a dollar up or down.
For example, if you were to pick up a call option contract for $AAPL (Apple), you can see how much the contract can move per dollar raise–or how it can fall per dollar dropping.
Remember to multiply by 100…
When the strike price is getting further away from the stock price (out of the money), you can see that the Delta value is gets lower. Vice versa, when the strike price gets deeper in the money, the Delta value continues to increase because it’s considered more valuable.
The value of Delta is also affected by the Gamma, which will talk about next!
What is Gamma and How It Works
Measures the change in Delta when stock prices moves a dollar up or down. There are times where the stock is getting an insane amount of volume from buyers or sellers that it can increase the Delta value drastically in seconds.
As it helps move the Delta up, you make more money quicker.
What is Theta and How It Works
Measures the rate at which an option contract declines in value as the expiration date gets closer. In short, every day the goes by Theta will eat the option premium of your contract by the given volume.
I wrote an in depth article about Theta that you can read here: “An easy guide to Theta in options with examples“
How to Pick Option Contracts
You don’t just pick option contracts because just to get in a trade. You need to answer the following questions before buying a contract…
- Am I doing a weekly or a monthly contract?
- Does the contract have enough liquidity?
- Are other traders very interested in the same contract that I’m looking at?
To answer these questions, you need to learn about the fundamentals of what makes a contract to choose.
Expiration Dates
Before jumping into a trade, you need to ask yourself if you’re going to do a scalp, day trade, short swing, or a long trade.
If you’re going to do a scalp trade or even a day trade, you may want to pick a weekly, as weekly have more liquidity than a monthly contracts.
If you’re going for a short swing or long swing trade, you may want to pick a long call option contract–monthly contracts will protect you from getting stopped out so quickly.
Short trades are anything less than 30DTE (days to expiration). Long trade are anything 30DTE or higher.
If you’re a beginner, I highly recommend to not trade 0DTE as they’re highly volatile due to high Theta.
Volume
Volume is an extremely important contract factor if you’re picking a short term trade.
Volume is what helps make your contracts move nicely as the price of a stock goes up and down. As a scalp trader or day trader, you’ll need liquidity to be able to buy and sell your contracts as quickly as possible.
When seeking for a contract with good volume, you’ll want to look at the volume column of the option chart and find a contract that has a minimum of 500–the higher the better.
For short or long swing trades, the volume indicator is not as important, since you’re not looking to sell your contract right away. You will also notice that monthly contracts have less volume than weekly’s and that’s perfectly fine.
Bid & Ask Spreads
This is an important factor that not a lot of traders think about before purchasing a contract, and that is the spread of the bid & ask.
Let’s cover the basics of what bid & ask mean:
Bid – The price that a buyer is willing to buy it for
Ask – The price at which someone is willing to sell it for
Most of the time, stocks that do not have a lot of volume/liquidity tend to have very large spreads.
Here’s an example of a large spread for $SE (Sea), the bid & ask 20¢ apart. What tends to happen is that brokerages tell you how much your gaining based on the ask–which is always higher.
When you go sell for a market order, you may actually fill on the bid pricing. selling a contract at $1.79 (bid) is a big difference from the ask price of $2. So you want to make sure that the bid & ask prices are tight–no more than 5¢ apart.
Open Interest
This is a great all around metric for either day trades to long swing trades. Open Interest shows the number of contracts being held for a given strike price.
This becomes a more important metric for short or long swing trades.
I like to tweet about stocks and post helpful swing trades. Follow me there if you would like some too!
