A Simplified Guide to Trading Stock Options

Marco Anthony

Smashwords Edition

Copyright 2009 Marco Anthony

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What You Need to Know Before Reading:

• This E-book has been written without taking into account any fees.

• Fees may vary depending on your broker.

• Options are extremely risky and you may want to contact your financial advisor before trading.

• Near each Investment objective is a risk/reward rating. The higher the risk the higher the reward.

• Risk/Reward rating extends from 1-5, where 1 is lowest and 5 is highest (in parenthesis).

• Equity options always settle (expire) on the third Saturday of the month, meaning the last day to trade them is the third Friday of the month.

• The phrase “In the money” means the value of the underlying symbol is ABOVE the CALL strike price or BELOW the PUT strike price at the time of the expiration.

• For most option contracts trading below $3 a share ($300 per contract), the minimum bid increment is a nickel ($5 per contract); however more liquid option contracts may have pricing bid increments of a penny ($1 per contract). Most option contracts trading above $3 a share: minimum bid increment is usually a dime ($10 per contract); however more liquid option contracts may have pricing bid increments of a nickel. This is extremely important to know when buying/selling options.

• 1 option contract is for 100 shares of a particular stock.

• If the price of an option is $1, then the premium for buying/selling an option is $1 a share or $100 per contract.

• The examples in this document assume the order gets filled every time, I will show this by bidding the ask price and asking the bid price for the option contract(s). In real trading I do not suggest this, but you may bid/ask what you are willing to lose or accept.

• In this document some prices may be shown as .50 a share. This means 50 cents a share.

• The pictures used in this E-Book are from OptionsXpress.com’s option chain, and although the symbol is the same for all brokerages, the way of entering the symbol may be different. OptionsXpress is a great brokerage for learning how to understand the option chain, and options in general, as they offer a Real Time Virtual Trading Account Absolutely Free! They also have a very good trading platform available for FREE download.

• When opening a new position, you will need to buy or sell to “open”, and when closing the position [if desired] you will need to buy or sell to “close”.

• Open Interest relates the number of contracts currently open. As contracts are opened the number becomes greater, and as contracts are closed the number becomes smaller.

• Volume refers to the number of contracts traded on any particular day.

• You will need to read all documents thoroughly before signing up to trade options.

• Options are always available on equities for the coming two option expirations. In other words, if it is January and there is one week until expiration, all equities will have the January and February option contracts open for trade. On the Monday following the January options expiration, the March contracts on all options will open, making the two nearest option contracts available for trade the February and March contract expiration months. There will be many other contract months listed on all equity options at any given time, but it depends on the cycle.

• Currently there are three common option cycles: A (JAJO), B (FMAN), and C (MJSD).

• Contracts trading on the A (JAJO) cycle will always have the two nearest option months as well as: January, April, July, and October options available for trade.

• Contracts trading on the B (FMAN) cycle will always have the two nearest option months as well as: February, May, August, and November options available for trade.

• Contracts trading on the C (MJSD) cycle will always have the two nearest option months as well as: March, June, September, and December options available for trade.

How Options Are Priced:

• Options are priced by using Greeks, which are tools for risk management. The most important Greeks are listed below.

• Delta is the change in price of the option with respect to the change in price of the underlying stock. This is known also as price sensitivity. For call options, minimum Delta is 0.00 and maximum Delta is 1.00; for put options, minimum Delta is -1.00 and maximum Delta is 0.00. If the Delta is 0.50, and the underlying stock trades $1 higher, the option contract will increase by 0.50 or $50 per option contract. If the underlying stock trades lower by $1, the option contract will decrease by 0.50 or $50 per option contract.