• Call Options- these give the owner the right to buy a stock at a specified price, within a specified amount of time. Investors who buy call options are hoping that the stock value increases before the option expiration date.
• Put Options- these give the owner the right to sell a stock at a specified price, within a specified amount of time. Investors who buy put options are hoping that the stock value decreases before the option expiration date.
• Strike Price- the price that the option can be bought or sold at.
• Options Investor Types: Buyers of Call Options, Sellers of Call Options, Buyers of Put Options, Sellers of Put Options
  

There is an important difference between the investors who buy and investors who sell options. Investors who buy puts and calls have the choice to exercise their option contracts. Investors who sell puts or calls have the obligation to exercise their options contracts. 

The price of a stock option must go above the strike price for investors to exercise and make a profit on call options and the price must go below the strike price for investors to make a profit on put options. When options fall into these ranges, they are called “in the money”. 

Options can be used for a wide range of trading scenarios, such as:

• Reducing your risk from stock ownership
• Generating an income from stock you already hold
• Speculative trading in an up or down market
• Multi leg option strategies to take advantage of specific market action
• Volatility based strategies to take advantage of market volatility even if you do not know which way the market will go.

While is it true that options take some time to understand and to master, most people agree that once they have spent the time to properly educate themselves about options, that they are much better off for doing so. 

Many stock traders I know, once learning about options have never traded a single stock again. They can make more money, and take less risk by using a properly structured option strategy.

So if anyone is still on the fence, its definitely worth taking the time to learn about options.

If you are looking for a fully hedged way to take advantage of time decay, a vertical spread can be an excellent tool. Knowing a little about them now, you will recall that a vertical spread has a limited profit potential but also a limited loss scenario for both the buyer and the seller. So, how do we use this covered trade to take advantage of time decay.

At-the-money options have more extrinsic value than their similar month in-the-money or out-of-the-money options. Since it is an option’s extrinsic value that decays away over time, you could set up a vertical spread by selling an at-the-money option and buying either the out-of-the-money option (creating a credit spread) or buying an in-the-money option (creating a debit spread). If the stock holds tight to the out-of-the-money option, the option’s extrinsic value will decay away at a faster rate than either the in-the-money option or the out-of-the-money option due to the fact that the at-the-money option has more total extrinsic value to decay in the same amount of time as the others.

Creating the vertical spread by selling an at-the-money option and buying an out-of-the-money or in-the-money option as a hedge looks like a good idea, but now there are a couple choices. Should you do the put spread or the call spread? Should you buy it or sell it? The decision of what to do from here should first be based on which way you think the stock will move. Although you are playing for time decay and you are assuming an overall lack of movement, you can’t expect the stock not to move at all. So even though you are playing time decay, you still want to form an opinion about in which direction the stock is most likely to move. By doing this, you’ve now give yourself another way of making the trade profitable. You are playing for a lack of movement but now you can still win if you pick the right direction. This scenario presents you with two ways to win and only one to lose.

Now that you have picked which at-the-money strike you are going to sell and you’ve picked your anticipated stock position you still have a decision to make. Do you do the call vertical spread or the put vertical spread? Remember both the vertical call spread and a vertical put spread allow you to participate in either stock direction. For the bulls, you can buy a vertical call spread or sell a vertical if you think that the stock will go up. For the bears, you can buy a vertical put spread or sell a vertical call spread. For each direction there are two choices to decide from. One is a purchase, one is a sale. The best way to decide which to do, other than your own style or comfort ability is a simple risk/reward analysis.

By selecting an at-the-money option to sell as part of a vertical spread, an investor can execute a time decay play with a hedged position.

Much in the same way that a vertical spread can be used as a time decay play, it can be used as a volatility play. We stated earlier that an at-the-money option has more extrinsic value than any other option in its expiration month. This is due to a number of contributing factors including time but it is in no small way due to volatility. Volatility is a huge component of an option’s extrinsic value. An option’s dollar sensitivity to movements in implied volatility is known as vega. Obviously, an at-the-money option will have a higher vega (volatility sensitivity) then will an in-the-money or out-of-the-money option in the same month.

As volatility increases, the at-the-money option will increase in price to a greater degree than will an in-the-money or out-of-the-money option in the same month. As volatility increases, the at-the-money option will increase in price to a greater degree then will an in-the-money or out-of-the-money option whose vega’s will be less. Conversely, the at-the-money option will lose value at a greater rate than an in-the-money or out-of-the-money option should implied volatility decrease. The question now is how to use the vertical spread to take advantage of anticipated movements in implied volatility. Remember, the vertical spread affords you the luxury of being hedged on either side of the trade – both as a buyer and a seller of the spread.

So, if you think that implied volatility is likely to increase, you can set up a vertical spread by buying an at-the-money option and selling either the in-the-money or out-of-the-money option against it. Conversely, if you feel implied volatility will decrease; you can set up a vertical spread by selling an at-the-money option and buy either an out-of-the-money or an in-the-money option against it.

As to how to set it up, you would follow the same guidelines as you would for setting up a vertical spread to take advantage of time decay. Decide which direction you feel the stock would most likely move. If you feel the stock would most likely rise, you will have to decide between buying a vertical call spread and selling a vertical put spread.

Either way, the spread will have to be constructed with the at-the-money option being long if you feel volatility will increase or short if you feel volatility will decrease. If you feel the stock would most likely fall, you will have to decide between buying a vertical put spread and selling a vertical call spread. Again, either way, the spread will have to be constructed with the short option being the at-the-money.

As you can see, the vertical spread does not have to be used only in directional scenarios. It is very versatile allowing the investor several choices among a diverse group of potential uses. It also affords limited risk, albeit limited profit potential, to both the buyer and the seller.

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A call option gives the buyer the right but not the obligation to buy a specific security at a specific price by a specific date. It’s a way of “locking in” the purchase price of the stock for a period of time.

A put option gives the buyer the right but not the obligation to sell a specific security at a specific price by a specific date. It’s a way of “locking in” the sales price of a stock for a period of time.

The specific date is known as the contract’s expiration date. On or prior to the expiration date the holder of the option contract has the right to “exercise” the option.

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Options have been around long enough to beg the question, “Why are they getting so much buzz now?” Mad Money’s Jim Cramer recently exclaimed that options are the hottest, fastest growing segment of the market. Barrons shed light on baby boomers moving to options as a way to gain additional income and aid their sagging retirement portfolios. A major online brokerage firm polled its clients about which investment topics they would like to learn about. Options was the number one answer drawing in a whopping 62% of the responses. After 30 years of existence, options are now getting the attention they deserve. (more…)

Day and swing traders typically look for stocks with short-term movements. They are not in the business of holding positions overnight let alone a week or two. Options are, therefore, not a popular component of their trading strategies. With new opportunities for profit now available, many firms are allowing their traders to trade options. They soon find that option strategies do not apply to the in and out nature of day trading. Since these traders often look for break-out and go bottom fishing for profitable opportunities, premium paying options can be gainful. (more…)

Although the buy-write and covered call strategies are and have always been considered one and the same, I have always seen them as subtly different in a very important aspect. I have always seen covered call writers as investors who write (sell) calls on an existing stock position intended to be held for a time. This stock position was pre-existing. The stock was chosen for whatever reason (capital appreciation, chart driven, fad, stock in own company) but not because the stock had good buy-write potential. (more…)

The proliferation of online brokerage firms combined with low commission costs has empowered the average retail investor to navigate the options market like never before. Despite their reputation for being risky and difficult to master, options can present a unique advantage to the individual trader. They provide increased cost efficiency and are not as risky as equities. Options can also offer higher percent returns than stocks and strategic alternatives. (more…)