Three Things Every Master Trader Knows About Options

The last two weeks have seen significant market action in both directions. And it’s just more proof that you need options in your portfolio to help cut your risk and boost your potential returns. Traditional buy-and-hold investors have been taken to the cleaners by whip-saw markets.

I don’t want that happen to you.

While I expect this increased volatility to continue as we head into September and October, things seem to have settled down for the moment, and the markets have, for the time being, resumed their upward march.

So I want take this opportunity to reexamine some of the fundamentals of options to help reinforce your understanding of the more sophisticated topics we’ve been covering lately. It’s crucial that you have a strong grasp of the fundamentals, especially if you’re new to the material – you won’t be a master trader until you have this stuff down.

If you’re familiar with options, this a great opportunity for your to brush up on the basics – you may even learn something new. If you’re new to options trading or to Power Profit Trades, you’ve picked the perfect time to join us.

So let’s take a step away from the market chaos and get back to basics…

The Difference Between Calls and Puts

Let’s start from the beginning with a very simple definition – an option is a contract that gives the owner the right to buy or sell a financial product at a specific price on or before a specific date. When dealing with equity options like we do here at Power Profit Trades, that financial product is usually a stock or an ETF.

There are two different kinds of equity options:

callA call option gives the owner the right (but not the obligation) to buy the underlying instrument on or before the expiration date. You profit on a call when the underlying instrument increases in price.

A put option gives the owner the right (but not the obligation) to sellthe underlying instrument on or before the expiration date. You profit on a put when the underlying instrument decreases in price.

putCalls and puts are bought to establish a long position, or sold (also known as writing) to establish a short position. However, selling-to-open an options position obligates the seller (or writer) to fulfill their end of the contract.

If you sold calls, that means you must sell the underlying; if you sold puts, that means you must buy the underlying. When you sell calls, you have no control over whether or not a contract is exercised.

Writing options is very risky unless you put on a simultaneous long play to cut that risk. My Money Calendar Alert subscribers do this all the time with my recommended “loophole” trades.

Strike Price

The term for the specific price at which an option contract is exercised is the strike price. The number of available strikes (options) on a given stock or ETF is dependent on a multitude of factors.

For one, the range in which an instrument has recently traded plays a part. If you have a stock that has traded between $50 and $100 over the past six months or so, there will be strike prices around both of those prices and in between. How in-demand the options are also speak to the number of strikes as well as which expiration months are made available.

For stocks priced from $5 to $25, the strike prices are usually listed in increments of $2.50. For stocks priced from $25 to $200, the strikes are usually found in $5 increments. From $200, they are typically listed in $10 increments.

Depending on demand, you may see strike prices listed in $1 increments. When demand is really high, there can be as little as $0.50 separating one option from the next.

Below is a snapshot of the September 18, 2015 call options for FedEx Corp. (NYSE:FDX) as listed on Yahoo! Finance. As you can see, the prices reflect the stock’s trading range over the last few months, and the strike prices are mostly in $5 increments (especially at the high and low end, where there is less demand). Where demand is higher, the strike prices are in $2.50 increments.

Strike prices for call options on FDX from Yahoo! Finance

An option’s strike price helps to determine its intrinsic value. That’s the difference between the strike price of your option and the market price of the underlying instrument at any given time- if the difference is negative, your option has no intrinsic value. However, that can change over time.

  • In the Money (ITM): Your option has intrinsic value and is worth exercising. For calls, that means the strike price is less than the market price of the underlying instrument. For puts, that means the strike price is more than the market price for the underlying. Having in the money options doesn’t mean you’ll profit, just that your options have intrinsic value.
  • At the Money (ATM): Your option’s strike price is exactly equal to the price of the underlying instrument. While your option has no intrinsic value, it can easily gain value if the option becomes in the money. However, it can also become out of money quite easily. ATM options are extremely volatile for this reason.
  • Out of the Money (OTM): Your option has no intrinsic value and it’s unlikely that it will be in the money by expiration. For calls, that means the strike price is more than the market price of the underlying. For puts, that means the strike price is less than the market price of the underlying

Expiration and Exercising Your Option

Expiration is the last date on which you can exercise your option. For all intents and purposes, expiration occurs at the close of market on the third Friday of the month. Technically, they settle accounts the following Saturday, but since the markets don’t trade on Saturday, expiration is considered Friday. For example the September 2015 standard option expiration is going to be the close of market on September 18.

I say standard because nowadays there is such a demand for options trading that weekly expirations have been created. In fact the first weekly option expiration contracts (or weeklies) were started by the Chicago Board Options Exchange (CBOE) in October of 2005 and as time went by they decided to write weeklies on more and more stocks.

They operate the same way as the standard options do, but since they aren’t as actively traded as the standard option expiration contracts they tend to have less liquidity – and wider spreads (here’s why that’s a problem) – than the standard strikes do.

There will almost always be options available on the current month and the next month out regardless of which option cycle the stock is on. There may also be weekly options and there may be LEAPS options available, too.

LEAPS stands for Long-Term Equity Anticipation Securities. These are the longest expiration contracts available. LEAPS also operate much in the same manner as the shorter term ones do, but these have expirations as far out as three years, giving your trade a long time to work itself out.

Here’s Your Trading Lesson Summary:

Before you get started trading options, it’s important to know the basics:

  • Call options give you the right to buy the underlying at a specific price on or before a specific date, while put options give you the right to sell the underlying at a specific price on or before a specific date.
  • The strike price is the price at which you can exercise your option.
  • Expiration is the last date on which you can exercise your option.

I’ll be back with you soon.

Good trading,

Tom Gentile

Americas #1 Trader

25 Responses to “Three Things Every Master Trader Knows About Options”

  1. I agree with Marvin and Alan. One good comment you did make concerning those options is that when one begins going toward a loss, the sooner you get out, the better. I have done that with a gain by getting out very soon. Thanks for your work. I’m not giving up. Gene Vaughn

  2. FIRST, let me apologize for completely missing your posts above. I update open positions in the majority of videos that accompany the weekly trades. TLT was an exit for a profit on the day that the 1000 point drop occured, we sent an exit alert out on it. That really covered the SPY trade, which was also exited earlier this week for a loss. That being said, we do have FFIV, AMZN, and SNDK that went from profits to losses in the last week. Alpha stocks that can jump in an instant, and I have seen them come back as well. BUT i am taking your comments and instructing my team to send out exit emails individually on each exit day for a trade reminding subscribers to exit positions. This should definitely help with communication on exits!

    I am confident that the Money Calendar over the long term will win out over most other forms of monthly trading. That being said, nothing is 100% and drawdowns to occur. Though I am not happy with a few of the trades for August, the risks are minimal using options vs owning the stock outright. A note on stops… the problem with stops is that in periods of high volatility like we see now, stops will definitely get hit.

    Before 2 weeks ago, we could rely on sitting for a double or an exit date. Now with volatility nearly triple what it was last month, we have to change things up a bit. What we will be doing through the next month is concentrating on either lower correlated stocks to the overall market AND more low cost loophole trades. The other is limit orders to insure better fills in this swing environment. About every 7-10 years something like this occurs, we just have to adjust for it.

    Next update this weekend…

  3. Thanks everyone for your comments. I have had some problems posting lately so it you think I am silent, I am not. My apologies for my posts not getting to you.

    Marvin, Alan, Paul, and Gene, I send out exit instructions even before the entries are placed, and as for TLT and SPY, those exit instructions went out. TLT the day of the crash (for a profit), and SPY earlier this week (for a loss). NEM was exited out for a slight loss. As for FFIV, AMZN, and SNDK, they are more like alpha stocks, meaning they can move greatly in a short time. Problem was that a week ago they were green, now they are slightly red.

    I also think we need to send out reminder exits on each specific position on their specified day. I have instructed our team to do from now on, not just on the weekend or video updates. Thanks for the comments.

    And one more thing… I apologize for my posting problems. You would think that a guy who can create a software product like the Money Calendar could figure out how to post a comment here!

    Happy Labor Day Weekend!

  4. I bought aapl @1.31 3c 112 sep 11/15 and same day put on stop limit @1.10, not better but for practice it was good because it went down 0.94
    so I save couple of $ doing that but what is your opinion was ok or I should have stop limit on sep.11 itself so more chance go up and get profit?

  5. I am very new to options trading and any additional information I can gather is useful. I tried to print these comments but was unable to. Any way you can”fix it” so I can print them? I’ve been in your program for several months but have yet to make a trade. I am still not comfortable with the process
    and would like to at least appear like I know what I’m doing with my broker. I missed some of your earlier training videos, but I’m trying to catch up on info I’ve saved. Thanks

  6. With a lot reading and gaining a lot of information gathered about Options , I have wanted to start trading Options , opened a brokerage account but I cannot lie in the Options Agr. as a novice in Options. Some questions that need to be answered have placed me in level 1. So when I followed the instructions you give : Action to Take and submit my position it was rejected for reason that it is advanced category for my account level. I am only allowed to do covered calls and write puts on it. Would you have Actions to take for BEGINNERS like me who are willing to trade but will not be allowed per brokerage rules for those who do not have enough experience but still like to do Options trading. Thank you for your reply ASAP.

  7. Mangubhai Patel

    Tom, You are superb teacher to teach A to Z lessons. I am not a tech savvy Medical Doctor. But under your perfect training and guidance I am doing great. If I can do anybody can do and succeed. Old MG bless you from my heart. Thanks

  8. I’ve been in the same position as Gloria and Douglas since mid September being novice options trader. I haven’t had the benefit of taking advantage of loopholes and your appointments are getting more advanced. Where do I go from here?

  9. Ngerikl Baules

    Hi Mr Gentile,

    Thanks for the email. Yes if possible I would want to learn more and perhaps take advantage of the blackbox you’ve mentioned.

    please lead the way and I will follow and learn everything you have in mind..



  10. Charles Baker

    Being new to options trading, it would be helpful if there were a (sort) list of online brokers to select from. It took some trial and error to find the broker I’m comfortable with for stocks and ETFs, but they don’t handle options. On the hunt.

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