Options Trading For Beginners: A Complete Step-By-Step Trading Guide To Profit In Options Trading

Introduction

Options trading is not about long-term investing or even something like swing trading over the course of months.

This guidebook focuses on options trading and how it will work. We will start with some of the basics that come with options, such as how they work and what they are all about and the benefits of trading these rather than working with some other investment types. We will then move on to some of the best strategies that you can go with when trading options, and how you can pick a good strategy that will help you to earn a profit, no matter how the market is doing. Then we move on to discuss a lot of information on how to reduce your risks and some tips that will increase your chances of being successful in this market.

The aim of this book is to explain the main concepts of options trading and how it works, and various strategies to help you make money in the market and definitely you will make profit. You will need to start by considering which type of underlying asset you are going to want to pursue, if stock market options don’t sound that appealing to you. With this out of the way, you will then need to consider the current state of the market in question and how you can craft a plan to take advantage of those specifics.

It is my sincere hope that this book helps you gain all the knowledge you need to get started with options trading and trade profitably, so let’s begin without further ado.

Chapter 1

Getting Started

Brief History of Options Trading

Trading Options dated back to 332BC, when a man known as Thales bought the right to purchase olive before harvesting, reaping a fortune. Options then reappeared during the 1636 tulip mania, where tulip options were commonly bought to gamble on the rising tulip quality. In London, at the end of the seventeenth century, a market was developed to deal with both call and put options.

This was the first case of both call selling and putting calls on an exchange. By 1872, Russel Sage launched the unstandardized and illiquid US over the Counter call and put options market. The introduction of options trading as we know it today came with the formation of the Chicago Board Options Exchange (CBOE) and Options Clearing Corporation (OCC) in 1973, where structured listed exchange call options were launched. By 1977, the CBOE has launched put options, and since then, the stock market has taken on the structured traded form of exchange that we are familiar with today.

What are Options?

Options are an attractive investment tool. They have a risk/reward framework, which is unlike any other. They can be used in a multitude of combinations that make them very versatile. The risk factor involved can be diluted by using these options with other financial instruments or other option contracts, and at the same time, opening more avenues for profits. While many investments have an unbound quantum of risk attached, options’ trading, on the other hand, has defined risks, which the buyers know about. At no point will the buyer lose more than the option's price, the premium, as the right to sell or buy the underlying asset at a particular price expires on a given date. But an uncovered option seller may be presented with a very significant amount of risk.

Options are derivatives, the prices of which are linked to an underlying asset or security. To present stock options more formally, it is a contract between two parties in which the option holder (buyer) purchases the right (while not being bound) to sell/buy the shares of an underlying stock at a predetermined price to/from the option writer (seller) within a particular period.

In simpler words, for people who are not interested in investing in stocks to a great extent, options exist. It is an agreement between two parties to buy or sell the rights to an underlying stock. For instance, a person purchases an option and pays a premium to the seller, hoping/speculating that the stock price may increase before the agreement's expiration.

Options provide you the opportunity to implement a multitude of strategies with limited or unlimited risk. The potential for limited or unlimited profit can also be created by practicing these strategies. Hedging and other speculative can also be done.

Option Pricing

In the world of finance and stock trading, the price of an option is termed as premium. No matter what happens to the underlying security involved, the buyer can never lose more than his or her initial premium. So, the buyer's risk is always limited to the amount paid for the option. But as far as the profit potential is considered, it is unlimited at least theoretically.

The seller of the options often assumes to have a risk to deliver (in case of a call option) or taking a delivery (in case of a put option) of the stock shares in return for the premium that is received from the buyer. The loss of the seller can be open-ended; that is, the seller can even lose much more than the premium he has received until and unless that option is covered by any other option or a position in the underlying stock.

Option Types

There are two basic styles of options: the American and the European style. Any trader on a beginner’s level should always be aware of the two.

The American style of options trading is generally exercised between the expiration date and the purchase date. Exchange-traded options are mostly traded in the American way, and so are all the stock options, whereas all European style option can only be traded on the day of expiry. Index options are generally traded in the European way.

There are another two terms that every beginner should be associated with, out of money and in the money. The current price of any stock plays the deciding factor here. In the case of a call option, when the strike price of the option is more than the current price, it is said that the call is out of money. And when the strike price stays below the current stock price, it is said that the call is in the money. But in the case of put options, it is just the opposite. Here, when the strike price is above the current price, the put is in the money. Similarly, when that strike price is below the current price, the put is out of money.

The expiration date is the date when a stock gets expired. Every option has an expiry date of its own. In case of normally listed options, this expiry date can be up to nine months from the date they were first listed. There is another term called leaps, referred to as the option contracts with longer terms. These can even have expiration dates up to two or three years from the listing date.

The official expiration day of an option is the Saturday after the third Friday of the expiration month. But the third Friday is generally considered the expiration day as most of the broker becomes unavailable during the Saturdays and the exchanges get closed on Saturdays. The Saturdays are usually taken to settle the broker to broker deals.

Stocks usually have a three day settlement period. But in the case of options trading, it is settled the next day. So to settle on the date of expiry, the traders will have to trade the options by the end of Friday.

Call and Put Option Explained

Generally, there are two main types of option trades: call and put options.

Call Option

A call option is a contract or agreement that gives the investor/holder the right – but not the obligation – to purchase/buy an asset at a specified price within a specified time. The main difference is that the call option gives you the right to purchase or call in an asset. When the price of the asset increases, you can profit from the call.

The writer of the call option, also referred to as the seller, has an obligation to sell the security/asset if the investor exercises the option. The seller receives a premium for taking on the risk associated with the obligation.

Put Option

This option gives a buyer the right to SELL an asset/security at a given strike price before the expiry date. The writer/seller of the option has an obligation to purchase the security/asset if the strike price is exercised.

How to Read Options Table

When options trading began in 1973, the market only had a few tradable securities. Decades later, due to the growing number of indexes, LEAP’s, and option stocks, it became difficult to create unique symbols using the 3-5-character system