Options Trading Basics
Understanding the fundamental concepts of options trading is essential for successful trading.
What Are Options?
Options are contracts that give the holder the right, but not the obligation, to buy or sell an asset at a specific price within a set time period.
Key Characteristics:
- Contract represents 100 shares of the underlying stock
- Limited time until expiration
- Strike price determines buy/sell price
- Premium is the cost of the option
Calls vs Puts
Call Options
- Right to buy stock at strike price
- Profit from stock price increases
- Limited risk when buying (premium paid)
- Unlimited risk when selling
Put Options
- Right to sell stock at strike price
- Profit from stock price decreases
- Limited risk when buying (premium paid)
- Limited risk when selling (strike price)
Strike Prices & Expiration
Strike Prices
- The strike price is the predetermined price at which you agree to buy or sell the stock
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For call options:
- Strike above current price = Out of the money (OTM)
- Strike below current price = In the money (ITM)
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For put options:
- Strike below current price = Out of the money (OTM)
- Strike above current price = In the money (ITM)
- At-the-money (ATM): When strike price equals current stock price
Expiration
- The date when your option contract expires and becomes worthless if not exercised
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Common option expiration types:
- Weekly options: Expire every Friday, usually 1 week out.
- Monthly options: Expire every 30 days (DTE)
- LEAPS (Long-Term Equity Anticipation Securities): Expire more than 1 year out. Ideal for long-term investment strategies and hedging.
- Options expire at market close on expiration day
Options Greeks
The Greeks are numbers that show how an option’s price reacts to different factors like stock price, time, and volatility. Delta is usually the most important for traders, but the others matter too.
Delta (Δ) - Direction & Probability
Delta measures how much the option price changes when the stock moves $1, and it also gives a rough probability of finishing in the money:
- A delta of 0.50 ≈ 50% chance of expiring in the money
- For selling calls: 0.20–0.30 delta ≈ 70–80% chance stock stays below strike
- For selling puts: 0.20–0.30 delta ≈ 70–80% chance stock stays above strike
Example:
Stock = $100. You sell a $95 put with delta -0.30. That means the option loses about $0.30 for every $1 the stock rises. It also means there’s roughly a 70% chance the stock stays above $95 by expiration.
Theta (Θ) - Time Decay
Theta shows how much value an option loses each day, all else equal:
- Negative for buyers (they lose value daily)
- Positive for sellers (they gain value daily)
- Decay speeds up as expiration gets closer
Example:
If theta = -0.05, the option loses $0.05 per share daily. For one contract (100 shares), that’s $5 per day lost for the buyer and gained for the seller.
Gamma (Γ) - Delta’s Sensitivity
Gamma shows how much Delta will change if the stock moves $1:
- Low gamma = stable delta
- High gamma = delta changes quickly
- Highest when stock price is near the strike
Example:
If Delta = 0.30 and Gamma = 0.05, then if the stock goes up $1, Delta increases to 0.35. Another $1 move would push it to 0.40.
Vega (V) - Volatility Impact
Vega shows how much the option price changes if implied volatility (IV) moves by 1%:
- Higher IV = higher option prices
- More time left = bigger Vega effect
- At-the-money options have the highest Vega
Example:
If Vega = 0.10, and implied volatility rises 1%, the option price increases $0.10 per share. For one contract, that’s +$10.
How Options Greeks Work Together
Example: Tesla $200 Put
You sell a Tesla $200 put when the stock is $220. Let’s see what happens as the stock moves.
When stock is far away ($220):
- Delta: Low. About 70% chance you win.
- Theta: Small daily income, around $3.
- Gamma: Very low. Things don’t change much yet.
- Vega: Small effect if volatility changes.
When stock gets closer ($205):
- Delta: Now about 55% chance you win. Risk rising.
- Theta: You make more per day (~$5). Time speeds up.
- Gamma: Higher. Your probability of winning the trade can change fast now.
- Vega: Bigger effect. A jump in volatility hurts more.
If fear hits (volatility jumps):
- Delta: Chance of winning doesn’t move much.
- Theta: Daily income slows down.
- Gamma: Can rise if price is near $200.
- Vega: Options get more expensive. Big moves against you.
Easy Memory Guide
- Delta: your probability of winning the trade.
- Theta: Money you make each day from time passing.
- Gamma: How quickly your probability of winning the trade can change.
- Vega: How much fear/volatility changes option prices.
Far from strike = calm and steady.
Near strike = fast changes, higher risk.
Volatility spike = everything gets more expensive.