Introduction to Options trading

I know a lot of readers of my blog comes from United States. As I am located in United Kingdom myself, I dont know a lot about broker possibilities in US, but gonna list some brokers what I have heard over a time. These are top, professional brokers to trade Options, also other securities, like stocks.

Actually there is not a big choice if you wish to trade US options. I am using Interactive Brokers account and as far I have used it and other platforms, IB is the best choice in UK. And its possible to open account internationally.

Interactive Brokers is professional broker with a lot of possibilities. Review to follow soon.

Recently Interactive Brokers teamed up with Tradestation Global and now you can connect Tradestation Global platform to your IB account. That is good opportunity to get a better charting software, cause charting in IB Traders Workstation asks for improvement. 

In my trading I am not giving a big attention to GREEKS. One I use the most is DELTA, when I swing trade – THETA.

Lets have a look what each of these means.

Information taken from INVESTOPEDIA

DELTA 

Delta represents the rate of change between the option’s price and a $1 change in the underlying asset’s price. In other words, the price sensitivity of the option relative to the underlying. Delta of a call option has a range between zero and one, while the delta of a put option has a range between zero and negative one. For example, assume an investor is long a call option with a delta of 0.50. Therefore, if the underlying stock increases by $1, the option’s price would theoretically increase by 50 cents.

THETA

Theta represents the rate of change between the option price and time, or time sensitivity – sometimes known as an option’s time decay. Theta indicates the amount an option’s price would decrease as the time to expiration decreases, all else equal. For example, assume an investor is long an option with a theta of -0.50. The option’s price would decrease by 50 cents every day that passes, all else being equal.

GAMMA

Gamma  represents the rate of change between an option’s delta and the underlying asset’s price. This is called second-order (second-derivative) price sensitivity. Gamma indicates the amount the delta would change given a $1 move in the underlying security. For example, assume an investor is long one call option on hypothetical stock XYZ. The call option has a delta of 0.50 and a gamma of 0.10. Therefore, if stock XYZ increases or decreases by $1, the call option’s delta would increase or decrease by 0.10.

VEGA

Vega represents the rate of change between an option’s value and the underlying asset’s implied volatility. This is the option’s sensitivity to volatility. Vega indicates the amount an option’s price changes given a 1% change in implied volatility. For example, an option with a Vega of 0.10 indicates the option’s value is expected to change by 10 cents if the implied volatility changes by 1%.

RHO

Rho represents the rate of change between an option’s value and a 1% change in the interest rate. This measures sensitivity to the interest rate. For example, assume a call option has a rho of 0.05 and a price of $1.25. If interest rates rise by 1%, the value of the call option would increase to $1.30, all else being equal. The opposite is true for put options. Rho is greatest for at-the-money options with long times until expiration.

Main tool to trade options is Options Chain. Here you can see all data about options. I gonna show you how I have set up my Options Chain layout on Interactive Brokers Traders Workstation.

I have set it up so I got Expiry dates in Tabbed view, easier for me to browse through expiry dates like that. You can change it where is the tabbed view option. At the current setting it is showing all strikes, cause TSLA used to move even more than $100 a day so you need to view more strikes.

• Calls is on Left side, Puts Right side. Sides can be configurable in settings.
• Strike price in middle. So you just can click right or left side of strike what you are planning to trade.

Layout columns

• VOLUME – contracts traded for a day
• BID/ASK – Bid and ask prices
• SPRD – spread size. To me very important to know. Usually not taking bigger than 0.3
• DELTA – strike price change per $1 of stock price change

1. I trade only naked calls and puts, no spread trading or other strategies yet. Willing to learn it in future but just not yet. Buying naked calls or puts means, that I buy calls if I think stock price gonna go up, or puts if stock price is due to go down. Quite simple, similar to buying shares, just a bit more complex.
2. One option contract cost x 100 it’s price. So if you are buying 1 contract per $3.43 strike price, you need $343 to buy it.
3. ITM, OTM. In the money, out of the money strikes. The more strike is out of the money, the slower moves it gonna make. Out of money strikes is good if you are planning to hold it for longer time, if you are planning that stock gonna reach strike price after some time. Can buy more contracts as it’s cheaper but also have bigger possibility to expire worthless. In the money strikes is strike prices at or inside of current stock price. These gonna be more expensive but also gonna bring bigger gains, just use your stops accordingly.
4. Always before placing a trade watch the SPREAD. I have burned myself a loads of times because of this. If you just buying naked calls or puts then spread size is very important. By buying naked calls or puts you always gonna get in at ASK price and SELL at BID price. So it means, if you take trade with huge spread, by selling it straight after you gonna be down the spread amount.
5. Don’t hold naked calls, puts through earnings. Volatility before earnings makes the option price gain value, but just right after earnings volatility premium comes crashing down, lowering the value of all options. So your options bought for high price before earnings now can end up worthless.
6. Be patient on opening trades on Mondays, Fridays, after news or Earnings. Usually we start Mondays with some sort of GAP and you shouldn’t open trades straight at open. You need to give a little time for option prices to settle. 5-10 mins usually is fine. Same goes for spreads, after some events, gaps, weekend, earnings you need a little time to let it settle. Fridays usually is expiry days and option price drops. If the stock price closes and opens next day same price, if the option expiry day is close enough option prise not gonna be the same as of previous days close.
7. Expiration. Plan your trades so they don’t expire worthless and wait for setup and only then execute. Have a look how big are daily movements on underlying stock. If stock is a slow mover, bigger float, you will need longer expiration.
8. I need to see option chart when I am trading. Its easier to see my stop levels by looking at 5 min stock chart and 5 min option chart. If my stop on stock is just below previous 5 min candle low, same goes for option, with just few cent wiggle room.
9. Always plan your trades and trade from stock charts. Pick proper option strike based on delta price.
10. Option DELTA. I use it to manage my trade, so I know I am not loosing more than I should. Delta is showing how much option price gonna change in every 1$ underlying stock price move.