Equities/Stocks Options - Introduction (Theory)

Decided to touch on equities/stock options as I'm sure many people out there might not be clear or even know what these do. Personally, I've only known the concept of call/put options but in truth, I wasn't sure how traders make money from these or why they do it. However, I've started to trade US equities and options as well, so I thought of sharing my strategies as I go. As usual, I will try to go through these as layman as possible, else it'd be pointless for me to cover it and I should just paste some website link.. lol

Introduction

There're 2 types of options; the Call Option and the Put Option. Typically a Call option gives the holder the right to buy the underlying stock while a Put option gives the holder the right to sell the underlying stock.

Will like to touch on some terms widely used in options trading; 

• underlying; the underlying stock of the options
• exercise; when the holder of the option decides to "execute" it
• strike price; where an option will be exercised upon expiry if the underlying stock price reaches there
• expiration date; the specific date when the option is rendered useless
• styles; American (can be exercised anytime between holding and expiration date) or European style (only can be exercised on the expiration date), most widely traded contracts are American
• contracts; per option contract represent 100 underlying stocks
• premium; the price you pay or get for the option (easily mean the price of the option)
• in-the-money (ITM); when the option gives you a profit when exercised 
• out-of-the-money (OTM); when the option doesn't give you any profit and if the exercise you lose money
• expired; losing the contract without exercising

Call Option

Basically, it gives you the right to buy the underlying stock at the pre-decided strike price before the expiration date. If you sold a call option, you give someone else a right to buy your stocks at a certain price before the expiration date. 

Traders buy a call option when they're bullish on the underlying. For example (figures used are est); 

• stock A is trading at 10USD, and you're bullish on stock A going higher and higher
• trader A buys a call option at 12USD that expires in 2 months at 0.20USD/stock which puts the contract at 20USD (per contract = 100 underlying)
• at the expiration date or close to, the underlying stock is at 15USD now meaning the trader is right on his call and the option is ITM
• by exercising this option, you can own the underlying at 12USD despite that it is trading at 15USD where the trader can either hold or sell it for a quick profit
• if the trader is still bullish, he will hold onto these stocks and wait for a good time to sell
• if trader wants to book profit, he can sell at the market price of 15USD and you earn 3USD per stock making it a whooping 300USD 
• however, the trader has to deduct the premium he paid for the option which is 20USD.. thus the trader earns 280USD
• if the stock price goes the other way or if it didn't hit 12USD, it will be expired (rationally, you won't exercise as you can buy the stock in the market for whatever price it is), so the premium is lost

A valid argument I'll hear is probably, why not buy the stock outright and if the stock didn't hit 12USD, you will still make the excess from where you bought it at 10USD. 

However, it is a good way for you to bet on bigger stock price names such as Alphabet (GOOGL) trading around 1890USD or Amazon.com (AMZN) trading around 3292USD. You can bet on these names at a fraction of the cost. 

Put Option

This is the opposite of the call option, it gives the holder a right to sell the underlying stock at a pre-determined price. 

This is usually executed when the trader is bearish of the stock and thinks that it will go down. 

• stock B is trading at 10USD, and you're bearish on stock B going lower
• trader B buys a put option at 8USD that expires in 2 months at 0.20USD/stock which puts the contract at 20USD (per contract = 100 underlying)
• at the expiration date or close to, the underlying stock is at 7USD now meaning the trader is right on his put and the option is ITM
• by exercising this option, you can sell the underlying at 8USD despite that it is trading at 7USD and the trader need to buy back the position at market
• by exercising the option, the trader will have a negative 100 stock of the underlying which he will be required to buy to close it at 0 position
• technically, the trader sold 100 stocks at 800USD but he needs to buy back at the market meaning paying up 700USD which puts his profit at 80USD (subtract the premium he paid for the contract)
• as usual, if the stock doesn't hit lower than 8USD, the contract expires and the trader loses the premium

While in the call option, it is possible to hold the stocks outright as long as you can afford them but to do it similarly to bet it going down, you'll need to short the positions (meaning to sell stocks that you don't own). This will give you cash as technically you're selling.. but you will be subject to interest and fees for shorting the underlying as technically you're "borrowing" the stocks to sell now and buy back later to return it.

Summary

I tried to keep this as basic and as easy as I can share.. do ask me anything in the comment. I will be back to post more basic knowledge here (it also helps me to serve as a refresher to see how I am learning as well). 

I'd like to post some widely use strategies and also my take on them.. and most importantly how I make money on a daily basis on Tiger Broker. 

Hope everyone had a good weekend, and I'll be off polishing my work shoes. 

Cheers.