Stock Options Trading 101 [The ULTIMATE Beginner's Guide]

option contracts allow traders to potentially make significant returns from stock price movements compared to simply buying or selling shares of stock however there are certain things that you need to be familiar with before trading options otherwise you could lose a lot of money from simply making mistakes based on misunderstandings that you have in this video you're gonna learn how to understand options intuitively which is going to lay a solid foundation for you as an options trader and help you make better options trading decisions so stay tuned now before explaining call options and put options to you there are a couple key characteristics that option contracts have that shares of stock do not the first option characteristic that you need to be familiar with is the expiration date so all option contracts have expiration dates in which they stop trading altogether after they received their final value the second characteristic that all option contracts have is a strike price now the strike price is the share price that the option can be converted into shares of stock should the option buyer choose to do so now the third thing that you need to know is that options are quoted on a per share basis and normal stock options are representative of 100 shares of stock so any price that you see an option quoted at the actual value of that option is actually a hundred times that value so for example if an option is quoted at three dollars and 50 cents that option is actually worth three hundred and fifty dollars so now that we've got that out of the way let's cover the two option types the first being the call option now a call options value is tied to its ability to purchase shares of stock at the call options strike price now as I mentioned earlier a strike price is the share price that a option can be converted into shares should the option be exercised now in the case of a call option let's say we have a call option with a strike price of $100 in that case that call option has the ability to buy shares of stock at the strike price of $100 and that ability is going to become more and more valuable as the share price increases the value of a call option is directly tied to the call options strike price but why is that as the share price increases more and more above the college strike price the call becomes more because being able to buy shares at that strike price gets more and more valuable as the share price increases so for example if we have a stock that's currently at one hundred and seven dollars and we look at the 105 call option the 105 call option can purchase a hundred shares of stock for one hundred and five dollars per share and since the stock price is currently at one hundred and seven dollars there's two dollars of value in being able to buy shares two dollars below the current stock price however if the stock price increases to one hundred and twenty dollars that 105 call option is even more valuable now because now with the stock price at a hundred and twenty dollars it has the ability to buy 100 shares of stock at a hundred and five dollars a share which is now fifteen dollars below the current stock price of one hundred and twenty dollars so call options become more and more valuable as the stock price increases because you're being able to buy shares at a deeper discount to the current stock price let's hop over to the tasty works trading platform and look at some real call options that are currently trading in the marketplace to demonstrate the concepts that I've just discussed with you now before getting to the tasty words trading platform I just wanted to let you know that if you open and fund your first tasty works trading account using the project option referral code we will give you full and lifetime access to one of our paid courses completely free now while the courses are educational in nature they do include tons of statistical analysis that is completely exclusive to these courses and we've developed full trading plans from the analysis that we've conducted to help ourselves trade more profitably and make better trading decisions overall so if you're interested in learning more about tasty works and our free course offer go ahead and check out the link below in the description and as I said we will give you one of our paid courses for free if you open and fund your first tasty works trading account using the project option referral code so I've just opened the tasty works trading platform and right now I am on the Facebook trade page and here we have all the different Facebook options listed out in terms of their expiration dates from April eighteenth twenty nineteen all the way through January fifteenth twenty twenty-one so what I'm gonna do is I'm just gonna open up the may 17 2010 cycle by clicking on the May 17 box right here and these options have 51 days until they expire and that is represented by this 51 d here right in the middle between the calls and the puts so there's a lot of information being displayed here but we're gonna stick to the absolute basics and we're gonna we're gonna be focusing on call options which is going to be on the left hand side here so in the middle we can see that this column says strike and these are the strike prices of every single option that we're looking at so if we look to the left of these strike prices we're looking at call options at that respective strike price so for example if we look at the 135 strike price and we go to the left this is going to show us the information for the 135 call option and as we can see here the bid price in the ask price for this 135 call option is right around $32 now if you're unfamiliar with bid prices and ask prices the bid price is the highest price someone is willing to pay for a stocker option and the ask price is the lowest price that someone is willing to sell that stock or option at so in the case of the 135 call option this 3185 bid price means that the highest price someone is willing to pay for this 135 face book call option expiring in 51 days is 31 dollars and 85 cents and on the ask side of the equation this 30 to 40 means that the lowest price someone is willing to sell this 135 call option for is 32 to 32 dollars and 40 cents now the main concept I want to focus on here is that call options with lower strike prices are more valuable than call options at higher strike prices and that's especially true when the calls strike price is below the current stock price so right now facebook shares are trading at 165 dollars and 87 cents and if we look at this 115 strike call option that expires in 51 days we can see that the 115 call is being valued around 51 dollars and 50 cents and that makes sense to me because this 115 strike price is just over $50 below the current Facebook share price of a hundred and sixty-five dollars and 87 cents now if we look up to the 160 call option so the call option with a strike price of 160 dollars this option is being valued around $12 which is significantly lower than the 115 call and the reason for that is that this 160 call has the ability to purchased Facebook shares at a hundred and sixty dollars a share but with Facebook at 165 87 this 160 strike price is only five dollars and 87 cents less than the current stock price whereas this 115 call has a strike price that is just over 50 dollars below the current share price so this 115 call is much more valuable than the 160 call because the 115 call has the ability to purchase shares of stock at 115 dollars whereas the 160 call has the ability to purchase Facebook stock at 160 dollars per share so this is a very clear explanation of why call options at lower and lower strike prices are more valuable especially when the stock price is above that strike price because that call option has the ability to purchase shares of stock at the college strike price and as the stock price continues to increase that ability to purchase shares of stock at the strike price becomes more and more valuable as we can see reflected in these option prices so when you buy a call option you have to capture the stock price increase which means the stock price has to increase after you've purchased a call option for you to make money on that trait so with that being said why would anybody buy a call option as opposed to buying shares of stock when in both scenarios you need the stock price to increase to make any money now the answer to that question is leverage so when you buy an option you have the potential to make a significant return on the investment that you've made in those options for example if you wanted to buy a hundred shares of a 100 dollar stock a hundred times 100 is equal to ten thousand dollars so to buy a hundred shares of a 100 dollar stock you need ten thousand dollars or five thousand dollars if you're using a march which is a lot of money and if that stock price increases from $100 to 105 dollars the profit per share will be five dollars and if you own a hundred shares of stock the profit on that position would be five hundred dollars now a five hundred dollar profit on a ten thousand dollar investment is a five percent return which is quite low now on that same 100 dollar stock let's say you buy a five dollar call option and if the share price increases significantly in the near future the call option price increases to ten dollars now since every option controls 100 shares of stock a call option increased from $5 to $10 actually represents a five hundred dollar gain or 100% in the increase in the options price the reason people buy call options is because there's a lot of leverage involved and it's possible to have a significant return on your investment relative to just buying shares of stock outright so with that being said then why would anybody buy shares of stock when you can just buy a call option that has significant return potential relative to the amount that you invested when you buy a call option you need the stock price to increase for your position to not lose money it's very easy to lose a hundred percent of what you invested when you buy call options compared to just buying stock if you buy shares of stock to lose a hundred percent of what you invested you need the stock price to go down to zero dollars but when you're buying call options a very small stock price decrease can lead to your position expiring worthless which means that there's a higher likelihood of losing everything that you invest when you buy call options compared to just buying stocks for instance if you buy a call option with a strike price of $100 and you pay $5.00 or $500 in premium for that option and the stock price is at ninety five dollars when that option expires well that 100 call option is going to be worthless because at expiration there's no value in being able to buy shares of stock and $100 when the shares of stock are currently traded for ninety five dollars in the open marketplace so in other words there's no need or no value for that call option which means if you bought that call option for five dollars it will expire worthless and you'll have lost a hundred percent of what you invested now if you would have bought shares of stock at $100 and the share price fell to ninety five dollars you've only lost 5% of the share value whereas with options you might have lost a hundred percent of what you invested when investing in options or buying options there's the potential to have significant gains such as a hundred percent on what you've invested in those options but compared to buying stocks there's also a much higher likelihood that you lose a hundred percent of what you invested in the options if the stock price moves against your position so now that we've talked about the basics of buying call options let's talk about the basics of buying put options which are the other types of options that you can trade as an options trader now while a call option has the ability to purchase shares of stock at the college strike price a put option has the ability to sell shares at the puts strike price so while call options become more valuable when the stock price increases put options actually become more and more valuable as the share price decreases because with that strike price as the share price gets lower and lower there's more benefit in being able to sell shares of stock at the put strike price compared to the current stock price which is much lower so as an example let's say we have a 250 dollar stock and we're looking at a put option with a strike price of 275 dollars with the stock price at 250 there's 25 dollars of value in being able to sell shares at 275 dollars because the strike price of 275 is $25 higher than the current share price of 250 now if the stock price Falls to $200 now there's much more value in that 275 put because with the stock at $200 being able to sell shares at 275 dollars should be worth $75 or more so in the first scenario where we had the 275 put and the 250 stock price and that put option is worth at least $25 because being able to sell shares $25 higher than the current stock price has 25 dollars of value but if the stock price plummets to $200 now that 275 put is even more valuable because the ability to sell shares $75 above the current stock price is more valuable than being able to sell shares $25 above the stock price so put options become more and more valuable as the share prices decline so like we did before let's hop over to the tasty works trading platform and look at some put options that are currently trading in the marketplace right now now like we did earlier we are going to look at Facebook options for the put option explanation and since we've already covered the bid and ask price we can just cut straight to the meat of this discussion which is the fact that put options with higher strike prices are more valuable than put options with lower strike prices because as we've just discussed put options have the ability to sell shares of stock at the puts strike price which means that put options with strike prices significantly above the stock price are going to be more valuable than put options with lower strike prices and especially if the strike price is below the current share price so right now Facebook is at 165 dollars and 87 cents and if we look at the 200 put option so the put option with a strike price of $200 we can see that this option has a valuation right around $34 let's call it and if we look at the put option with a strike price of 170 dollars that put option has a valuation right around ten dollars so right off the bat we can see that this 200 put option is significantly more valuable than the 170 put option and that's because the 200 put option has the ability to sell shares of stock particularly Facebook shares at $200 a share which is more valuable than the ability to sell Facebook shares at 170 a share especially considering that Facebook is at 165 87 so much like buying call options when you buy put options you also need to capture the stock price change to profit from that options trade so with call options we established that to make money on a call option purchase the stock price needs to increase for your trade to make money now when buying put options the stock price has to decrease for you to make money because you need that option to become more and more valuable after you've purchased it to later sell it at a higher price and you're already going to know the answer to this one but what's the benefit of buying put options as opposed to shorting shares of stock now if you're unfamiliar shorting shares of stock means you sell shares of stock that you don't own hoping to buy them back late at a lower price now when you buy a put option your risk is completely limited to what you pay for the put option whereas when you sell or short shares of stock your upside loss potential is theoretically unlimited because there's no limit to how much a stock price can increase so for example if you buy a put option with a strike price of $100 for five dollars in premium or you pay five hundred dollars to buy that put option the most you can lose no matter how high the stock price goes is five hundred dollars which is the premium that you paid for that put option however if you short shares of stock at a hundred dollars and the share price goes up to two hundred dollars you'll have lost $100 per share of stock if you shorted a hundred shares of stock that would mean that you just lost ten thousand dollars of your money whereas if you would have purchased that $5.00 put option you would have only lost five hundred dollars and just like buying call options another benefit of buying put options is the concept of leverage so for example if you invest seven dollars and fifty cents into a put option and the stock price plummets and that put option increases to $15 you've just made seven hundred and fifty dollars on a seven hundred and fifty dollar investment which means you've just made a hundred percent return on the risk that you've taken all right so you've just learned the basics of buying call options and put options so let's go ahead and recap what you've learned up to this point first all options have a strike price which is the share price that the option can be converted into shares of stock the first type of option is called a call option and the call option has the ability to purchase a hundred shares of stock per call contract at the call strike price and as a result of that call options become more and more valuable as the share price increases because the ability to buy shares of stock at the college strike price becomes more and more valuable as the share price increases further and further above that calls strike price now the other type of option is called a put option and a put option has the ability to sell shares of stock at the puts strike price now more specifically one put contract has the ability to sell 100 shares of stock at the puts strike price now as a result of that put options become more and more valuable as they decline further and for below the put strike price because that ability becomes more and more valuable as the shares decline so for example if we have a put option with a strike price of $95 and the stock price is at $90 there's five dollars of value in being able to sell shares at $95 when the stock price is at ninety because there's five dollars of value in being able to sell shares five dollars above the current stock price now if the stock price plummets to $75 that same 95 foot is now worth at least $20 because there's 20 dollars of value in being able to sell shares $20 above the current stock price so in short when traders buy call options they want the stock price to increase as much as possible and as short a time period as possible now when traders buy put options they want the stock price to decrease as much as possible in as short a time period as possible because that will result in the greatest profits for the put buyer so up to this point we've talked about buying put options and buying call options but there's a counterparty to every single trade and that means that if someone buys an option another person has to sell that option at the exact same price for that transaction to take place so let's switch gears and talk about selling options first we'll talk about selling call options and then we'll talk about selling put options so as I mentioned earlier a call option does not really have any real value when the calls strike price is above the stock price because there's no value in being able to buy shares above the stock price so if you can buy shares of stock and $100 right now without any options there's no real value in buying a 105 call and purchasing a hundred shares of stock at 105 dollars a share because you can just buy shares of stock for $100 in the open marketplace without using the option now with that said it's possible to make an options trade that profits when the stock price remains below a certain price as time passes and one way to do that is by selling call options so as I discussed earlier call options increase in value as the stock price increases but on the other hand they actually lose value as the stock price decreases or as time passes while the stock is low the cause a strike price so one trade that traders make sometimes is called selling a call option or shorting a call option which means they sell the call option without owning it first now the way that trade makes money is if the stock price remains below the called strike price as time passes and the best case scenario is that the stock price is below the call strike price at expiration because we know in that scenario the call option will expire worthless so as an example if we have a 100 dollar stock and a trader sells the 110 call for 2 dollars and 50 cents if that stock price remains below the 110 calls strike price of 110 dollars that option will steadily lose value over time because there's less and less probability that the stock price will increase therefore resulting in the 110 call becoming valuable at some point now ad expiration if the stock price is below the called strike price of 110 dollars that option will be worthless because as we discussed earlier there's no value in being able to buy shares above the current stock price and at expiration an option with no real value will be worthless now if the stock price does increase significantly there's immense loss potential so let's go ahead and hop over to the tasty works trading platform and I'll show you exactly what I mean by that all right so as I've mentioned selling a call option is a strategy that can be used when you want a profit from a stock price not exceeding a certain price in the future but on the other hand of things if the stock price does increase significantly selling a call option all by itself which is referred to as selling a naked call option is an extremely risky strategy and I'm going to demonstrate that right now by looking at a facebook short call trade so right now Facebook just closed at 165 dollars and five cents and the trade I'm going to queue up is selling the 170 call that expires in 51 days and to do that I'm going to click on the bid price of six dollars and actually it queues it up for me at a mid price of six dollars and five cents which is just the halfway point between the bid and ask price so let's say I wanted to sell this 170 call option for six dollars and five cents as no that means I'm actually collecting six hundred and five dollars and as we can see here it says my maximum profit potential on this trade if I were to make it would be six hundred and five dollars and it also says my maximum loss potential is negative infinity and that's because there's no limit to how much a stock's price can increase and with that being said there is no limit to how much this 170 call option could be worth in the future so we are unable to quantify a maximum loss potential for this position because we can't do so without knowing the stocks upper limit and since there is not an upper limit we cannot quantify the maximum loss potential so I'm going to go to the curve view analysis is already activated and I'm just going to visualize the risk profile of this position as we can see here this little red flag is right over the 165 price level and that's telling me that Facebook is currently trading right around 165 dollars now as we can see here at every point to the left or below this 170 calls strike price we see that the maximum profit potential of 605 dollars would be realized if Facebook were to be below the 170 price level at expiration in 51 days now as we can see here this looks like a very favorable strategy because with Facebook at 165 dollars it's already right at the maximum profit point because if Facebook is still at 165 dollars in 51 days this 170 call will be worthless because there's no value in purchasing shares with the call option at 170 dollars when we can just buy shares at 165 dollars just buying shares outright and not using any options so the best case scenario is that Facebook stays below than 170 calls strike price and at expiration if Facebook is below 170 dollars this call option will expire worthless and if I sold it for six dollars and five cents or six hundred and five dollars in premium that would mean my profit on the trade would be six hundred and five dollars now on the other hand if Facebook were to increase significantly we can see that we can get into quite a bit of trouble so let's say some news came out and Facebook went from hundred and sixty-five dollars up to $200 before this option expired if that were to happen it's telling me that my estimated pl at expiration is a loss of two thousand three hundred and ninety five dollars and that's because at expiration if Facebook were to be at $200 this 170 call option would be worth thirty dollars which is three thousand dollars in premium but since I collected six hundred and five dollars when I sold it my P&L would be a loss of two thousand three hundred and ninety five dollars which is that three thousand dollar value at expiration less the premium that I received which is six hundred and five dollars so that's just if the stock price went to 200 but as we can see here if I keep going to the right the loss gets progressively larger because as the stock price increases that one seventy call option will increase with that stock price and since there's no limit to how much a stock's price can increase selling a call option all by itself or selling a naked call option has unlimited loss potential in theory so I've just shown you one example of how selling an option can be used to profit when a stock price does not exceed a certain price level as time passes now I will say that selling a call option by itself which is referred to as selling a naked call option is an extremely risky strategy because like shorting shares of stock there is no upside potential or upside limit for a stock price so if a stock is currently at $100 there's nothing stopping in that stock from going to $1,000 at some point in the future so now that we've talked about selling call options let's flip over to the other side of the equation and talk about selling put options now as we've discussed a put options value stems from its ability to sell shares of stock at the puts strike price compared to selling shares of stock at the current market price now with that being said it's possible to profit on options trades by selling a put option in which case you'll make money if the stock price does not drop below the puts a strike price over time and ultimately you'll keep a hundred percent of the profits if the stock price is above the put strike price at the time of expiration so let's hop over to the tape Stewart's trading platform yet again so I can show you how selling a put option works and the risk and reward associated with that particular option trade so to keep things consistent I'm going to stay with Facebook options and first let's go ahead and look at the chart of Facebook by clicking on this chart button right here now as we can see here in recent months Facebook has rebounded from the 160 dollar price level numerous times and if you're a trader who believes in technical analysis support and resistance levels and whatnot maybe one trade you would look at would be to sell a put option with a strike price at a hundred and sixty dollars or maybe slightly below it if you wanted to give yourself some room but let's go ahead and looking at selling the 160 put option so if I go back to the trade page and I have the 50 one-day options opened up if we go to the 160 strike price and look at the put option we can see that the 160 put option expiring in 51 days is currently being valued at five dollars and fifty cents let's call it so if I wanted to sell this put option I would just click on the bid price because that is the highest price someone is willing to pay for that option and me being a seller I want to sell this option for as much as possible which means I am going to click on the bid price now when I do that it queues up this position right here and it entered a price for me of five dollars and 47 cents which is the midway point between the five dollar and forty cent bid price and the five dollar and fifty five cent ask price so let's go ahead and actually visualize the risk and reward potential of this trade by clicking on the curve tab and then activating analysis so when I do that this brings up a visualization of the profit and loss potential of this particular trade now if I'm selling the 160 put option remember that in 51 days at the time of this puts expiration date if Facebook is above the strike price of 160 dollars this put option will be worthless because there's no value in using this put option to sell shares of stock at 160 dollars if Facebook is at a price higher than 160 dollars like it is now and that's because I can just sell shares of stock right this second for a hundred and sixty-five dollars I don't need the 160 put to help me with that so one way you can profit by selling put options is that if you believe a stock price will stay above a certain price through the future or through some specific date in this case being May 17 2011 and if the stock price remains above that put strike price over time and through expiration you will keep a hundred percent of what you sold that option for so for example if I sell this option for five dollars and forty seven cents in actual dollar terms this option is worth five hundred and forty seven dollars and if we look here it says my maximum profit is five hundred and forty seven dollars which stems from the fact that if I sell this put option for five hundred and forty seven dollars and it expires worthless or with a value of zero dollars at expiration then I will keep a hundred percent of what I sold the option for so if I sell this one sixty foot the best-case scenario is that Facebook is above one hundred and sixty dollars at expiration in which case this put option will expire worthless and I will keep a hundred percent of what I collected for selling this option however as we know put options get more and more valuable as the share price decreases so if Facebook were to fall to let's just say a hundred and forty dollars at the time of this options expiration in 51 days then the loss on this position is estimated to be about fifteen hundred dollars just for selling one put option and that's because at one forty this put option is going to be worth twenty dollars because it has a strike price that's $20 above the stock price if Facebook were to be at 140 and since I sold it for five dollars and 40 cents or five dollars and 50 cents an increase in the options value to $20 would represent a loss of about fifteen hundred dollars now while selling put options using a lot of leverage and a lot of contracts can be immensely risky when you compare selling one put option to purchasing 100 shares of stock selling a put option compared to buying 100 shares stocke is less risky in 100% of cases because you collect a premium for selling that put option whereas if you just purchase a hundred shares of stock you don't collect any premium and you don't have any downside protection so when comparing a hundred shares of stock to selling one put option selling one put option is always going to be less risky than purchasing 100 shares of stock which is one practical application of using options in addition to your long stock portfolio or your long term investments so let's hop over to the tasty works platform and I'll compare those two strategies side-by-side to demonstrate exactly what I mean so as I've mentioned when selling a put option your risk is going to be less than if you purchased a hundred shares of stock at that put strike price in a hundred percent of scenarios so let me go ahead and prove that to you so first I'm gonna look at the loss potential and let's just say I buy a hundred shares of Facebook stock at a hundred and sixty-five dollars per share as we can see here it says my maximum loss potential is sixteen thousand five hundred dollars which stems from the fact that if I purchase a hundred shares of Facebook stock at a hundred and sixty-five dollars a share I am purchasing sixteen thousand five hundred dollars worth of stock and if Facebook goes out of business and the share price goes to zero dollars my loss is going to be a hundred percent of what I invested which is sixteen thousand five hundred dollars now let's go ahead and look at what my maximum loss potential would be if I sold the 165 put so if I sell the 165 put I'm collecting seven dollars and fifty five cents or seven hundred and fifty five dollars and that means my maximum loss potential is fifteen thousand seven hundred and forty five dollars which stems from the fact that if Facebook shares go to zero dollars this put option with a strike price of one hundred and sixty-five dollars will be worth a hundred and sixty five dollars since if the stock price goes to zero this strike price is a hundred and sixty five dollars above the stock price of zero in which case the put option has a hundred and sixty-five dollars of value because it can sell shares of stock one hundred and sixty-five dollars above Facebook's stock price if it were to go to zero now since I've collected premium for selling this put option I've collected let's just say 750 dollars that means that my loss potential is actually 750 dollars less than if I were to just purchase a hundred shares of stock at the strike price of 165 as opposed to selling the 165-foot so at this point in the video we've covered the four most basic options trades that anyone can make in their portfolio and we'll make as an options trader those trades are buying a call option selling a call option buying a put option and selling a put option when you combine those trades you can create more complex option positions such as vertical spreads or iron condors or short straddles all of which are completely separate option strategies that you'll become familiar with in the future so let's recap those basic options trades that we've just discussed in this video the first basic options trade is buying a call option and as we've discussed in this video call options increase in value as the share price increases further and further above the call strike price when a trader buys a call option they want the stock price to increase as much as possible in a short time period as that will result in the most significant profits for that trader now on the other side of that trade is selling a call option so when a trader sells a call option all by itself that trader wants the stock price to remain below the cause strike price as time passes and ultimately they want the stock price to be below the call strike price when that option expires as that will result in that short call trader keeping a hundred percent of the premium that they collected when selling that call option now the other option type that we've discussed in this video is the put option now when a trader buys a put option all by itself that trader wants the stock price to decrease as much as possible in a short time period because we know that put options increase in value as the share price decreases further and further below that put strike price because that puts ability to sell shares of stock at the put strike price becomes more and more valuable as the share price declines further and further below that puts a strike price when a trader buys a put option they want the stock price to decrease as much as possible and as fast as possible as that will result in the most significant profits for that trader now on the other side of the equation a put seller wants the exact opposite when someone sells a put option all by itself they want the stock price to remain above the puts a strike price as time passes and ultimately they want the stock price to be above the put strike price when that put option expires if the stock price is above the put strike price when the put option expires that put option will be worth nothing and that put trader that sold the put option will keep a hundred percent of the options price that they collected when they initially sold that option so now that we've covered the most basic transactions that options traders will make now we need to talk about another critical concept that you need to understand as a beginner options trader which is the concept of intrinsic value and extrinsic value all option prices have to price components one being intrinsic value or the real value of that options ability to buy or sell shares of stock at the strike price as opposed to the current share price and the second price component is extrinsic value which is any value the option has that exceeds its intrinsic value now we're going to talk about each of these concepts in depth so let's start with intrinsic value intrinsic value can be interpreted as an options real value or the value of that options ability to buy or sell shares of stock at its strike price as opposed to buying shares of stock at the current share price so for instance if we have a stock that is at a hundred and forty dollars and we look at the call option with a strike price of a hundred and thirty dollars that 130 call has ten dollars of intrinsic or real value because there's ten dollars of value in the ability to buy shares of stock at a hundred and thirty dollars when the stock price is currently ten dollars higher at a hundred and forty dollars now if that same stock increased to a hundred and fifty five dollars that same call option with a strike price of one hundred and thirty dollars now has twenty-five dollars of intrinsic value because there's twenty-five dollars of value in being able to buy shares of stock at a hundred and thirty dollars when the stock is currently $25 higher at a hundred and fifty five dollars so in other words a call options intrinsic value is equal to the current stock price minus the calls strike price so if the current stock price is a hundred and eighty dollars and the college strike price is one hundred and sixty-five dollars one hundred and eighty minus 165 is fifteen dollars now it's important to note that options do not have negative intrinsic value as they either have zero intrinsic value or they have positive intrinsic value and an options value is never negatively intrinsic so if you calculate that the option does not have intrinsic value but the option is still worth something then a hundred percent of that options price is extrinsic so extrinsic value is the portion of the options price that exceeds the intrinsic value that it has so for example if we have a call option that has 12 dollars of intrinsic value but the call options overall price is 17 dollars then that additional five dollars over the intrinsic value is the options extrinsic value now what is extrinsic value well extrinsic value can be thought of as the options potential to become more valuable before it expires for instance if you look at an option with 60 days before it expires and that option has no intrinsic value it doesn't necessarily mean that the option is worthless because there's still 60 days left for the stock price to move up or down which could cause the option to become more valuable and eventually become intrinsically valuable which means for call options the stock price increases above the strike price and for put options the stock price falls below the strike price so just because an option doesn't have any real or intrinsic value right now it doesn't mean that the option is completely worthless because as we've discussed earlier all options have expiration dates and if an option has 60 days until expiration just because it doesn't have any real or intrinsic value right now there's still 60 days left for that option to potentially become intrinsically valuable and therefore more valuable overall so extrinsic value can be thought of as the potential for that option to become more valuable in the future now at the time of an options expiration date the option will have no more extrinsic value remaining because that options final value is now known so when the unknowns become known there is no more extrinsic value in the option because we know it's final value because it just reached expiration and we can take the difference between the stock price and the strike price to determine that options value so in other words at expiration options will only consist of intrinsic value or their real value and they will have no more extrinsic value remaining because the uncertainty around what they will be worth is now known because they've just expired now extrinsic value is such an important concept to understand because it is the foundation of what options trading is all about and more importantly as time passes and as an option approaches as expiration date the extrinsic value that remains in that option will seemingly wither away which is sometimes referred to as time decay or extrinsic value decay now in the context of actually trading options extrinsic value is great for those who sell options because traders who primarily sell options as a strategy want their option prices to decrease now since extrinsic value comes out of option prices as time passes extrinsic value decay or time decay works in the favor of traders who sell options so if I sell an option for five dollars and it's currently out of the money meaning it has no intrinsic value as time passes that five-dollar option will approach zero dollars and the decrease and that option price is going to generate profits for me as an option seller because as an option seller my goal is to sell options at a price that is higher than what I pay for to close it later now while extrinsic value decay benefits options sellers extrinsic value decay or time decay actually works against option buyers which is why option buying can be a very very risky trade and in theory it is a low probability trade meaning that if you buy an option in theory you have a less than 50% probability of may on that position now that's one of the reasons selling options is so popular as an option strategy because as you sell an option time is working in your favor so if you sell options each day that passes without a change in the stock price is going to result in small decreases in the option price through extrinsic value decay which is going to generate profits for you as an option seller so as an option seller it's possible to make money without doing anything and just letting time pass which is why theoretically selling options is a high probability trading approach which means that when you sell options in theory you have a higher than 50% probability of making money on that trade now I'm going to leave a link in the description below to a video on intrinsic and extrinsic value since I feel it's such an important concept I want you to watch a specific video just on that topic so you can further learn about intrinsic value and extrinsic value as it relates to options up next we're going to talk about exercise and assignment which are two critical options trading concepts that you need to understand as an options trading beginner now another critically important piece to options trading is the understanding of the fact that options can be exercised by the option buyer now what that means is if someone buys an option and they exercise the option that means that they are making the decision to convert the option contract into shares of stock at the options strike price as we've discussed earlier so for example if we have a call option with a strike price of 110 dollars that means that if the option buyer exercises that 110 call option they are saying that they want to purchase a hundred shares of stock her call option for a hundred and ten dollars per share so as I just mentioned if a call buyer exercises the call option they are making the decision to buy 100 shares of stock her call option at the call options strike price so exercising a call means you are buying shares of stock at the calls strike price now on the other hand if a put buyer exercises their put option they are making the decision to take their put option and convert it into short shares of stock or sell shares of stock at the puts strike price so for instance if a trader buys 95 put option and they later exercise that option with a 95 strike price they are saying that they want to sell a hundred shares of stock per put option for $95 a share which is the puts strike price so when a trader exercises they put they are making the decision to sell a hundred shares of stock per put contract at the puts strike price now with that being said it's important to note that option buyers rarely exercise their options because when an option is exercised the trader who exercised the option essentially burns the extrinsic value that is remaining in that option so for instance if I have a call option that has two dollars of extrinsic value in it or 200 dollars of that options price is extrinsic if I make the decision to exercise that call option I'm effectively giving up that two dollars of extrinsic value which means that if I exercised that option I'm essentially flushing two hundred dollars down the toilet just by exercising that option the only time an option is really exercised is when the option has very little extrinsic value meaning as close to zero dollars as extrinsic value as possible so if an option has lots of intrinsic value and very very little extrinsic value that's a more likely scenario to see the option get exercised compared to a scenario where the option has three or four dollars of extrinsic value remaining in which case if the trader did exercise that option they would effectively be flushing three to four hundred dollars straight down the toilet now as we've discussed earlier there's a counterparty to every single trade and for every option buyer there is an option seller so what happens to the option seller when the option buyer exercises the option the answer is that when somebody exercises their option somebody who is short that option or sold that same option that was exercised is chosen at random and is assigned the opposing share position as the person who exercised the option now I know that's confusing so let me give you a concrete example to demonstrate exactly what I'm talking about let's say we have a call option that has a strike price of a hundred and twenty five dollars if the option buyer exercises that one twenty five call they're gonna purchase a hundred shares of stock her call option that they exercised for 125 dollars per share now since that option exerciser buys a hundred shares of stock per contract at a hundred and twenty-five dollars a share that means somebody who was short the 125 call or sold that 125 call as an opening trade they will end up with a share position of negative 100 shares or they will short a hundred shares of stock / 125 call that they were assigned on so it's a 125 call buyer exercises the option they're gonna buy a hundred shares of stock her call contract at a hundred and twenty-five dollars a share but unfortunately some trader that was short that option is selected at random they will be assigned a hundred shares of short stock at a hundred and twenty-five dollars a share when that option is exercised in short when someone exercises as an option somebody who is short that option is chosen at random and will get assigned the opposing share position as the person that exercised the option so in the case of a put option being exercised somebody is selling a hundred shares of stock at the put strike price when they exercise the put option and that means that someone who is short that put option or sold that put option as an opening trade will get selected at random and they will actually purchase a hundred shares of stock at the puts drag price if they are assigned on that short put option now being assigned it just means somebody who owned the option exercised the option and being assigned means you are assigned the opposing stock position that the exercising party just took on so here's a diagram that shows all of the potential scenarios for option buyers and sellers when an option is exercised now being assigned on a short option position is perhaps the greatest fear of all beginner options traders because you cannot control when you are assigned on that short option now as I mentioned earlier options are rarely exercised because the person who exercises the option is forfeiting or essentially burning all of the extrinsic value that exists in the option and because of that options are rarely exercised and since options are rarely exercised it is quite rare to get assigned on a short option I've personally been trading options for over six years now and I've been assigned on a short option maybe two or three time's over that entire period so with that being said you should not fear getting assigned on a short option and if you do get assigned on a short option that does not automatically increase your risk substantially because in most cases the risk of your position after you get assigned a short stock position is actually going to be the same as when you actually have that option position up so if you are assigned on a short option position do not worry your risk has not increased substantially and at the end of the day you can just close that stock position that you got assigned and you can get rid of it and therefore take all of your risk off the table if you are uncomfortable so to finish things up we need to cover one more critical concept which is that all options have expiration dates so what happens to an option when it reaches its expiration date so first we'll start with the easiest outcome which is that if an option does not have any intrinsic or real value at expiration that option will expire worthless meaning that it will expire with a value of $0 because as we discussed earlier at expiration an option will only consist of intrinsic value and if the option does not have any intrinsic value at the time of expiration it expires worthless and will just disappear from the traders account who had that option so to recap what that essentially means is that any call option with a strike price above the current stock price at expiration will not have any intrinsic value because there's no value in using that call option to buy shares of stock at the strike price when the strike price is above the current stock price so at expiration any call options with a strike price above the stock price will expire worthless and they will just disappear from all the traders accounts that have those call options now on the put side of the equation put options have no intrinsic value when their strike prices are below the current stock price because there's no value in using the put option to sell shares of stock below the current stock price or at the puts strike price so for instance if the stock price is at 100 dollars and a put option has a strike price of $90 that 90 strike put option will have no intrinsic value and at expiration if the stock is at $100 that put option with a stray price of $90 will expire worthless and it will just disappear from the accounts of the traders who have that option now on the other hand if an option does have intrinsic value at expiration meaning that for call options the strike price is below the stock price and for put options the strike price is above the stock price now those options that do have intrinsic value at expiration will be automatically exercised meaning they will be automatically converted to the corresponding stock position based on the option position in that traders portfolio so for example anybody who owns a call option that is in the money or has intrinsic value at expiration if they hold that option through expiration they will end up with a hundred shares of long stock per call option that expired in their portfolio so for example if a trader had five call options that expired with intrinsic value that trader will end up with 500 shares of long stock on the following trading day because that call option that had intrinsic value at expiration was automatically exercised leaving that trader with 500 shares of long stocks since they had five call options that they allowed to expire in the money now really quickly if a trader has a short call option that is in the money at expiration that trader will end up with a hundred shares of short stock or negative 100 shares per call option that they allow to expire in the money or with intrinsic value on the aput side of things if a trader owns a put option that they allow to expire when it has intrinsic value that put option will be automatically exercised into negative 100 shares of stock or short 100 shares of stock per put contract so if a put trader owns three put contracts and that put contract has intrinsic value at the time of expiration that trader will end up with 300 shares of short stock or negative 300 shares at the put strike price at expiration and lastly if a trader has short put options that have intrinsic value and they hold those short put options through expiration that means that the trader will end up with a hundred shares of long stock per put contract that they allowed to expire in the money or with intrinsic value so for example if a trader has seven put contracts that they sold and those seven put contracts have intrinsic value through expiration and the trader holds those put options through expiration they will end up with 700 shares of long stock at expiration because they allowed seven short put contracts meaning they sold seven put contract and they allowed them to expire with intrinsic value that means that those put options are automatically going to be exercised and since that trader sold those put options they will actually own 100 shares of stock per put option if they hold those short puts through expiration and those short puts have intrinsic value when they expire now one exception to this automatic exercise clause that I've just discussed is that if you're trading cash-settled options such as fixed options or SPX options those options do not ever convert to shares of stock because those products don't have shares of stock in which case those options just settle to their cash value or their intrinsic value at the time of expiration and will never be converted to shares of stock all right so we've covered a ton of content in this video and it's perfectly normal if your head hurts I know I was there when I was first learning about options every time I would watch a video I'd have no idea what was going on my brain would start to hurt and I'd want to give up but I'm telling you if you continue with it it's going to get significantly easier as you get more exposure to options so with that being said I want to quickly recap all of the main points that I have discussed in this video so you can have clean takeaways from all of the key sections that we've just discussed first there are two types of options first is a call option and the second is a put option call options become more valuable as the stock price increases because call options have the ability to purchase shares of stock at the strike price and that ability to purchase shares of stock at the collège strike price becomes more and more valuable as the stock price increases further and further above the calls strike price now on the other hand call options decrease in value when the share price Falls because that ability to buy shares at the college strike price becomes less and less valuable as the share price decreases and as a result of that traders who buy call options as a trading strategy want the stock price to increase as much as possible in a short time period because that will result in significant gains for that call option buyer on the other hand people who sell call options as a trading strategy want the stock price to decrease as much as possible or at least remain below the calls strike price as time passes as we know that will result in extrinsic value decay which is going to generate profits for the call options seller now the other type of option a put option becomes more and more valuable as the share price decreases because a put option has the ability to sell shares of stock at the put strike price and that ability to sell shares of stock at the puts strike price becomes more and more valuable as the share price decreases further and further below the puts a strike price now as a result of that traders who buy put options want the stock price to decrease as much as possible in a short period of time because that will result in significant gains for the trader who buys the put option now on the other hand traders who sell put options as a strategy want the stock price to increase or at least remain above the put strike price as time passes because we know that if the stock price remains above the put strike price as time passes that put options value is going to decrease because it is all extrinsic and as time passes extrinsic value decreases out of option prices until it reaches zero dollars at the time of expiration next all options have prices and all option prices consist of two components the first being intrinsic value and the second being extrinsic value intrinsic value is the ability to buy or sell shares of stock at the options strike price instead of the current share price that is being traded in the market place call options have intrinsic value when the stock price is above the called strike price because there's value in being able to purchase shares at the cause strike price when the stock current price is higher than the calls strike price now on the other hand put options have intrinsic value when the stock price is below the put strike price because there's value in being able to sell shares of stock at the puts strike price when the stock price is below or at a discount that puts strike price and options extrinsic value is the portion of the options price that exceeds any intrinsic value that it has an extrinsic value can be interpreted as the options potential to become more valuable before it expires so just because an option is worth five dollars and has zero dollars of intrinsic value it doesn't mean that the option is worthless because let's say it has 60 days until expiration that means there's 60 days left for the stock price to move up or down in which case that option could become more and more valuable and hopefully take on intrinsic value before it expires extrinsic value is sometimes referred to as time value because options with more time until expiration have more extrinsic value which just means that with more time until expiration there's more time for the stock price to move around which means there's more time for that option to become intrinsically valuable and significantly more valuable than it is right now now that means that options with less time to expiration have less extrinsic value which means that the option has less time to become more valuable since it expires very very soon on the other hand options with lots of time until expiration have lots of extrinsic value because there is lots of time left for that option to become more valuable as the stock price changes now at the time of an options expiration date the options value will be 100% intrinsic as all of the extrinsic value withers away as time passes and as that option approaches its expiration date now for that reason the passage of time and the decrease in extrinsic value is sometimes referred to as time decay or extrinsic value decay now if an option doesn't have any intrinsic value at the time of its expiration date that option will expire worthless and it will simply disappear from the account of the trader who has that option in regards to exercise and assignment call options and put options can be exercised which means the person who bought that call or put option is making the decision to buy or sell shares of stock at the options strike price thereby converting the option into shares of stock when a call option is exercised the option buyer is purchasing a hundred shares of stock at the call option strike price and when a put option is exercised the put buyer is selling a hundred shares of stock at the put options strike price in both cases when an option is exercised the option buyer is converting the option into long or short shares at the options strike price now since there's a counterparty to every single trade when somebody exercises their option a person who is short that same option contract is assigned the opposing share position as the trader who exercised the option so for example if a trader buys an option and later exercises it they are purchasing a hundred shares of stock per call contract at the college strike price which means somebody who is short that call option will be assigned a hundred shares of short stock at that same strike price now as I mentioned earlier fortunately for us option sellers options are rarely exercised because the option buyer essentially burns any extrinsic value that exists in that option which means in most cases it does not make any logical sense for the option buyer to exercise the option and if they're not exercising the option that means we're pretty safe as option sellers lastly when options reach their expiration date any options that don't have any intrinsic value will simply expire worthless and disappear from the accounts of the traders who had positions in those options now the options that do have intrinsic value at expiration are automatically exercised which means any traders who have positions and those options will end up with the corresponding share positions that we discussed earlier if they hold those in the money options or they have options that have intrinsic value and they'll hold those options through expiration that's gonna do it for this video on call options and put options everybody my name is Chris Butler from Project option comm and I really hope you enjoyed this video feel free to check out some more of our options trading videos that you're gonna see popping up in just a second and be sure to subscribe to this channel so you can get all of our options trading videos in the future once again I'm Kristin Project option and thank you for watching this video [Music] [Music]

Channel: projectfinance

Views: 931,425

Keywords: options trading 101, options trading, stock options, options trading explained, options trading for beginners, options for beginners, options basics, how to trade options, call options explained, put options explained, intrinsic value options, extrinsic value options, buying call options, selling call options, buying put options, selling put options, understanding option prices, projectoption, tastyworks, introduction to options, what are options, stock market, chris butler

Id: 3bELT5FZCic

Length: 62min 27sec (3747 seconds)

Published: Fri Apr 05 2019