The Ultimate Beginner Guide to Options Trading [Full course]
A full options trading course covering how option prices move based on volatility, time decay, and underlying price. Learn to read option chains, execute trades, and build strategies like spreads and iron condors. The key insight: selling out-of-the-money options captures a volatility premium because many investors buy protective puts.
Chapters
In this complete beginner trading guide to options video, I will show you exactly everything you need to know as a beginner to options trading. From the basics of how they work, how to actually buy and sell options, all the way to how to simplify all the complex maths behind it, like the Greeks. But we'll not just end up at learning basic theory. We'll also see some actual practical use cases and strategies, and how options can be an amazing tool in a day trading scenario, in a swing trading scenario, or for example, if you're just an investor trying to optimize. See, options can seem kind of complicated, and to be honest, they kind of are. But there's a reason why they're one of the most used trading instruments in the professional trading space. And it's because in options, you don't just bet on price going up or price going down like with any financial instrument. You can also, for example, bet on price staying there, or that it will not go above or below a certain level. You can bet on things like volatility or time passing. They're this amazingly three-dimensional financial instruments, plus they by default provide a 100x leverage, which as we will see can be a huge benefit but also potentially a huge risk if misused. And finally, ladies and gentlemen, we will learn one of the coolest types of strategy you've probably ever known about. Not a buy low, sell high vague type of concept strategy where you have to draw some geometric shapes on a chart. None of that. I'm talking about a structural edge validated by tons of academic research that if used correctly can allow you to systematically profit and extract money from the fear of big investors. The so-called variance risk premium harvesting. Of course, everything we'll see in this video is not financial advice. It's for entertainment and educational purposes only. Trading with Any type of tool or any type of strategy bears huge risks, and you could easily lose all your money. Now, to truly understand the power and the versatility of options, imagine options like this. Imagine option contracts like a fire insurance. You have the insurance company and the person buying the insurance. The person buying the insurance just pays a premium to, to cover his ass in case his house goes on fire. That payment is pure cash flow for the insurance company, and 9 times out of 10, no fire happens. But if it happens, well, the insurance company will have to pay for all of that damage, which is likely way more than the premium they've collected. Now, instead of a fire insurance on a house, you could see options as an insurance on a bear market. So maybe an investor with billions of dollars in the market, to protect himself from the risk of a bear market, will buy an option. And a market maker or someone else will sell it. And if nothing happens, which most of the time it doesn't, Well, the seller, or the so-called writer, gets pure cash. If something happens, though, he'll basically have to pay for the investor's loss. So yes, he will have this constant source of cash flow most of the time, but if he's exposed selling options during a bear market, he could literally wipe out years of profit. Now let's get one level deeper. Imagining you're the insurance company and imagine two different clients. One client has a wooden house in a dry, hot area where it never rains, where there's a lot of dry grass, and during the summer people go there to barbecue, smoke cigarettes, and fire juggling. That's client 1. Client 2 has a stone house in Antarctica or an igloo at the North Pole. Which one of these would you charge more for a fire insurance? Well, clearly this one, because it's way more likely to get a fire going on at some point. So this part of the insurance premium depends on how likely the fire is going to happen. We will call this the implied probability. Now imagine that one client wants 10 days insurance. The other one wants to insure for a full year. Which one will you charge more? Well, in 10 days there's less probability of a fire happening. In 1 year, you know, a lot of things can happen, so you'll likely charge more. So the second part of the insurance premium depends on how long you want to be insured. We will call this the time premium. And of course, if someone is insuring a luxury house and another guy is insuring a small studio, which one will you charge more? —of course, the luxury house. Let's call this the price premium. Now, instead of fire, let's translate it back to stocks. In stocks, for example, the probability of a fire happening translates in the probability of a crash happening, for example. We'll call this implied volatility, or vega. The time factor works exactly the same. In 1 year, more stuff can happen than in 1 month, than in 1 week, or in a single day. So as time passes, the premium is lower. We will call this the time decay or theta. Then a luxury house can be a stock trading at $1,000 per share. A cheap studio can be a stock trading at $10 per share. So of course there is a price component as well. We will call this delta. So these three components, volatility, time, and price, are the main components of what determines the price of an option. And they can vary through time. Congratulations, you you've just learned options trading. But really, do you understand how different this is? It's not just buying and selling to bet on price going up or down. It's much, much more. So there's so many strategies that you can implement, so many different ways to monetize your informational advantage. You can be much more creative in the ways you find an edge. Every opportunity has a risk. Risk and opportunity are just the two faces of the same coin. But if I made you curious about options, I can tell you it's a topic worth knowing about. And also not necessarily to understand how to trade this, but also because, for example, this huge insurance market, this option market, for example, on stocks, in terms of notional volume, moves way more money in daily volume than the entire stock market, equity futures markets, and ETFs. In America combined. Okay, so what happens in the option markets every single day affects the stock market with something called hedging flows. And that's another very interesting thing, but we will not discuss it in this video. We'll discuss it in the next one. So if you haven't yet, subscribe to the channel because we talk about a lot of really cool professional trading stuff and we interview some of the best traders in the world and a lot of other cool stuff. So now that you got a grasp of how it works, let's get the whiteboard going and start from the basics. Now let's start from the basic by starting with an example, right? Let's say you have invested in a stock where the price was $100 and you invested right over here and through time price went up. Now your investment has had a good return and now the stock is worth $500. Well, now you are in an unrealized profit of $400, but now you're afraid that you're gonna lose your investment and the economy is kind of in the verge of collapsing and the stock market has just started the initial phase of what you think could be a bear market, for example, right? So you don't want to feel all of this drawdown that maybe could happen, right? But at the same time, if you sell your stock at $500 and cash in this $400 profit, well, first of all, you have to pay taxes on the profit because this unrealized profit, now it's realized and you have to pay taxes on it. And imagine you're a bank or a hedge fund or a billionaire, you don't want to pay taxes, you want to optimize, right? And also, if you're a billionaire and you have maybe millions or billions invested in this stock right now, if you sell all of it, all of a sudden you're going to have a huge transaction cost. You're going to pay a lot of spread. You're going to pay a lot of commissions. Yuck. So instead of selling at $500, you buy the option to sell at $100. Literally. So you buy a put option. You buy a put means you're buying the option to sell at this price. So you buy the right to sell, for example, at $500. And this is kind of like your insurance, right? So you pay a premium, let's say a $1,000 premium. That's your cost. But let's say you bought 100 shares of this. So the total value is like $10,000 when you bought, and now it's $50,000. Well, you're basically paying $1,000 to protect this $50,000. So let's say you pay this and price actually drops, for example, to $150. Well, your unrealized loss now is basically $35,000. So on paper, you have an unrealized loss from the top, from your maximum profit of $35K. So let's say this is price now. You have two options. You either exercise your right, so you actually sell those 100 stock at $500 each, so you basically don't have this loss and you sell them to then rebuy them again at $15,000. So option 1, you exercise this option. Option 2, you don't exercise the right to sell at $500. You can simply take this option you bought that is now worth $35,000. You sell it to someone, you cash in the difference, and you've basically hedged your loss without having to sell physically the stock. This is kind of cool, right? It's a cool protection mechanism. Now let's say, for example, you're shorting a stock. So you're selling short a stock at $500 and your short position is profiting. But instead of closing your short position, because you think, you know, maybe price might go up a little bit, your short position might get in drawdown, but ultimately you have a long-term vision that is gonna go short. Well, to hedge this potential drawdown, instead of buying back the stock and closing your short position, you can buy the option to buy. Which is a call. So you buy a call option that basically gives you the right, grants you the right to buy at, for example, $150. Let's say the stock price rises back to $400, and as every option is worth 100 times 100 underlying shares, your profit would be $25,000. So once the underlying price reaches $400, you can either exercise your right to buy at this price and close your short position, with the profit that was unrealized before, or you can sell this call to the market, cash in the $25,000 difference, and then continue with your short position. So when you buy a call, you're basically buying the right to buy the underlying asset. Let's say, for example, this is a call on Apple with a strike price of $500. So you're basically buying the right to buy Apple shares at $500 each, specifically 100 of them, all of this within a certain timeframe. So for example, it can be a 45 days option, specifically 45 days till expiration or 45 DTEs. So you're basically reserving the right to buy Apple at $500 for 45 days. This is when you buy a call. The other side is you can buy a put. Let's make the same example of Apple. At $500 strike, 45 DTEs, which is the right to sell. So you're buying the right, the option, literally. I want to reserve the option to sell or buy this stock within a certain date and time. And to do that, I will pay a premium. Then I might choose to exercise my right to buy or sell or not. Now, if buying the call and buying the put, just like an insurance, you're paying a premium just in case something happened. The other side of this trade will be a person selling a call or selling a put. As we say in the example, if you are the guy good at the insurance, this is your insurer. So he's basically committing to let you exercise your right to buy. So he'll have the duty to sell. So he's committing to sell it to you in case you want to buy it. And as buying the put is the right to sell, Whoever's gonna sell you that option is committed that he's gonna be your buyer. So he's committing to buy. You have the right, he has to. That's the difference. And you can be in either side of this trade, as we will see. But let's make an example and let's understand the so-called payoff chart. This is very important because this is basically showing you how much money you will eventually make or lose. And you know, typically the stock charts have the price on the Y-axis and time on the x-axis. And so you see price going up, right, through time. Let's revert this and let's have the price of the stock here. So let's say this is our stock at $500. Here maybe is, you know, $100. Here is $1,000. So we have price on this line and here you have the profit and loss of your options trade. Let's start with buying a call. So buying the right to buy. Let's say the middle line here is $0 or breakeven. And this is the line. So let's say this call costs you $1,000, right? Well, that's the premium you pay, right? So that's like your cost. So your profit and loss when you buy the call will be $1,000 as a loss. And as you bought it, and you bought it here at 500, if price goes up, your option will increase in value. If price goes down, your option will be just worthless. You would have paid your premium, and you just don't exercise that option. So regardless of how down the price goes, you didn't buy the stock, you just buy the option to buy it, and you paid that money. So even if price drops, your maximum loss will be fixed to the amount of premium you paid to buy that option. That's it. But if price goes up, as we said, your option increases in value. For example, let's say when the stock price reaches $5.50, you'll start earning a little bit of money until the option you paid $1,000 is now worth $1,000. So if price rises a little bit from the strike price you paid at, you reach the so-called breakeven point where you paid $1,000 to buy the option and the option is now worth $1,000. That's your breakeven point. And at that point, the more price rises, the more your option is worth. So the more money you will be making. And if, for example, it's $1,000, the price of Apple, your option will be worth $500 per share and it's 100 shares, so it's $50,000 profit minus the $1,000 you pay. So your profit and loss here would be plus $49,000. So this is cool because your profit is potentially unlimited, but your maximum loss is always capped. The premium you pay is your maximum loss. So yes, it is a 100x leverage trade, but when you buy a call, the loss is always limited. So you don't have to place a stop loss a little bit below or a little bit below and worry like you do with futures or with a stock leverage position. You don't have to really worry about placing a stop loss. Price could go even to zero, right? And still you would lose maximum $1,000. That's cool. But it comes with its own set of problems. We'll see about that later. Now, let's say you are the other side of this trade and you sell this call at $500. This will be your breakeven line in your profit and loss of this sell call position. And as you are the seller of this option, that $1,000 that the guy paid to buy this option is your net profit. So first you cash in clean $1,000. And if price goes lower, well, no problem. You're not gonna lose any money, but you're not gonna earn any more. This is just a premium you cash in to grant someone else the opportunity to buy at $500. If it goes lower, they're likely not gonna buy. You still cashed in. Just like an insurance broker selling a fire insurance. But if price reaches $510 and it starts going lower, you're gonna have to start paying the damages. The call option you sold now has increased in value, so you're gonna start having to pay for that, down to the point where you're at breakeven, and you remember how the profit of buying the call went high? Well, you're gonna pay for that. So you're gonna lose potentially unlimited amount of money, okay? This is not that fun situation to be in. So your loss is potentially unlimited. And your profit is capped. So that's not so cool, but there's a cool thing about it we'll learn later. But for now, just understand this. Now let's say instead of a call, we buy a put. So we buy the right to sell at $500. Well, what I'm gonna pay is $1,000, as always. That will be my pre-accepted loss, the cost of my trade right over here. And if price rises and I've committed to sell, I'm just not gonna sell. You know, I just have paid this premium to have the option to sell. I don't need to exercise that right. So I paid my premium. That's my maximum loss. Price can even rise indefinitely. That's the maximum money I'm losing because I just paid for the option to sell. I didn't actually sell. Then price drops 10 points and my option to sell is now worth $1,000. So I basically repaid my premium and now I'm at zero.. And that is our breakeven point. But if price massively drops, my option to sell will start being worth way more up until zero, basically. So I have really high profit potential. And since from $500, it's now worth $100, that's a $400 times 100 shares. That's a $40,000 net gross profit minus the $1,000 I paid. That's a $39,000 profit. So I buy the option to sell here. If it rises, I won't sell. I just paid my premium. If it does fall, however, my option increases in value and I can either exercise my right to sell it at $500 and buy it back at $100, cashing in the $40K difference, or I can simply sell my option that is now worth $39,000, just cash in the difference and don't exercise my option. Now, let's see the other side of this trade like you were selling a put. So you sold the put and you cashed in $1,000. That's your net profit. If price goes any higher, fine, the buyer will not exercise his option and you just cashed in clean $1,000 and that's your profit. If price starts going lower, you're gonna start losing money and 10 points below, you're gonna be at breakeven now. But if price starts falling, you're gonna have to pay for the damages. And like before, you're gonna have to pay those $39,000 that the guy is making because this option is now worth a lot of money and you're on the other side of the trade. So you could potentially lose unlimited money. Not a fun position to be in, right? So to recap, when you buy a call, you buy the right to buy, and if price starts rising, your option is gonna increase in value and you're gonna make money. If you're on the other side of that trade and you sell that option, you cash in the money, you don't lose anything if price goes down, but if price starts rising, you're gonna start have to pay for that money and potentially lose indefinitely. If you buy a put, you're gonna pay for your $1,000, if price goes up, you just don't exercise that option. But if price starts falling, your option increases in value and you can potentially make a lot of money. If you're on the other side of that trade, that premium will be your net profit. If price rises, you just cashed in the premium, that's it. But if price starts falling, you're gonna start to have paying for the damages, you start going at breakeven and potentially lose indefinitely. And this is the payoff charts of buying options. Now, the cool thing about options is, for example, let's say this is the price of Apple and the current price is $500 per share. Well, I can buy, for example, a call option, right? Let's say you want to buy, buy call. I can buy the call option, which is the right to buy at $500, or I could buy the option to buy even lower, you know, maybe at $490. So price is here of the underlying asset, but the strike of my option is maybe $490, right? So I can buy it a little bit below and pay, for example, this $10 difference, which is times 100, so it's $1,000 more. And I can, instead of buying it where the price is now, buying it at even cheaper, paying the difference, of course, but buying it a little cheaper. This is the difference between buying an option at the money, which is at the current price, which is when the strike of the option corresponds to the current market price, Or I can buy it where it's basically already in profit or in the money, ITM. Or if I'm really convinced that price is gonna really go high from here, I can also buy it a little more expensive. Like, I want to buy the option to buy at $510. So I'm actually paying a little higher, $10 higher. So, you know, I'm gonna have to pay a little less. It's gonna be a little bit cheaper to buy this option, of course. Because I'm buying it at $5.10, which means out of the money, OTM. So the difference between the strike price I'm buying my options at and the current market price of the underlying asset is what we define as moneyness. So buying a call below price is clearly in the money because it's already in profit basically. Buying it at the current price is at the money. Buying it at the more expensive price is out of the money because I'm buying it kind of at a loss. Now let's say I'm buying a put, so I'm buying the right to sell. If I buy an option with a strike price of $500, that's an at-the-money put. If I'm trying to sell at a higher price, so selling at a better price, at a premium, then it means it's in the money because it's already in profit. If I am selling at a lower price, which is technically already in a loss, I'm basically buying it out of the money. So it's inverted, of course, with the call option. Now let's say I bought it at $500 at the money, then price starts rising and the underlying asset goes to $600. Now what used to be an at the money call for $500 has become in the money. If price from here went lower down to $400, what was previously at the money now is out of the money. I hope that's clear. This is the moneyness. Now, how do you actually buy and sell these options? Well, with any broker or platform like, for example, TastyTrades, Thinkorswim and Charles Schwab, or even Robinhood. There's a lot of option brokers and platforms. And how they'll typically look like is you choose, for example, the SPX options, so the options on the S&P 500 index. So you first choose the asset. It can be any stock or even futures. You know, you can buy an option on crude oil futures. So you select the underlying asset and then you select the expiration, the DTEs. You can have 0 DTEs, 1 DTE, 2 DTEs, 3, blah, blah, blah, blah, blah, blah, blah, all the way up to like 300 DTEs or 720 DTEs. There's like a lot of options you can buy or sell expiration-wise. 0 DTEs being the ones that expire today, 1 DTEs being the ones that expire tomorrow, and so on and so forth. And then you have to choose the strike. So at which strike I'm gonna buy or sell my option. And you can do all of this in the so-called option chain. Which you could see as the menu, as the book, the order book of options. And it will typically look something like this. For every DTE, let's say this is a 45 DTE option chain, you're gonna have all the strikes. So for example, $1,000, $1,005, they typically go 5 by 5, $1,010, $1,015, $1,020. That of course, it depends on the option and on the underlying asset. S&P goes every 5 points, then you have 995, 990, 985. So you can select where you want to buy either your puts on the side or your calls on the side. And of course, if you're going to buy call at cheaper prices, this is going to be in the money. This is going to be at the money. This is going to be out of the money, right? Because you're paying them more than the current price, which in this case is $1,000. If you want to buy puts, you can also buy them at the money. You can buy them, so basically buying the right to sell at a higher price, which is in the money because it's already in profit, or you can buy them, for example, out of the money at a lower price. So you sell at a lower price. It's a, it's a little bit inconvenient, right? So it's out of the money. And for every single one of these strikes, for every single expiration, you're gonna have a bid column and an ask column. What are bid and ask? Now, if you're at all familiar with normal directional asset trading, like futures trading, like CFD trading, or normal stock trading, whatever that is, typically below the current price of the stock, let's say $100, below you have the bids or buy offers. Above you have the ask or offer or the sell offers. And these are basically your sell limits and buy limits. So if you want to buy, for example, let's say this is, you know, Bitcoin, you can either offer to buy a Bitcoin at $99 and place a buy limit, for example, for one contract here. And you're basically saying, hey, I want to buy, but only at $99, only if someone comes and accepts my offer. That's why it's a buy offer. So you have to wait for price to get to you, the market to get to you and fill your buy limit order. It's like a passive order, right? Or instead of waiting and not having the guarantee that anyone's gonna come and fill you, if you wanna buy and be matched with a seller right away, you're gonna pay a slightly higher price. You're gonna pay 101 and accept one of these sell offers. So you're gonna accept that offer, buy your Bitcoin market. Instead. So buying market means accepting one of these sell offers. Buying limit or buying bid means placing a buy offer and waiting for a seller that has— that is in a hurry just like you to accept your offer. So if you buy market, you pay the so-called spread or bid-ask spread. So you pay slightly more and you buy aggressively, but you have the guarantee that you're going to get filled now, and that the exchange will match you with one of these sell offers. Same thing if you want to sell, you either accept a buy offer or you place your own sell offer here and decide, hey, I want to sell only at 102, I want to make my own terms, I'm only going to sell if price reaches this level. You don't have any guarantee that price will go there and that market will reach that price and be your counterpart so that another buyer will come and buy from you. You don't have that guarantee, but at least that's the price you make. And this works in every single normal contract. And it works also in options. The only difference is you have an ask and you have a bid for every single strike, both for puts and for calls. So for example, this 45 days DTEs at-the-money option could have a price written at like $10.00 as an ask price. So this is the best sell offer and the best bid at, let's say, $9.20 as your buy offer. So if you were to buy market, you would basically have to pay a spread of $0.80 per share, which times 100 would be $80. So, for example, if you want to buy an option, you can either have the same price as the bid and hope that someone will sell aggressively to you, or you can buy at mid-price. So basically placing an offer which is slightly higher than this one. So if this is $9.20, you're gonna place it at $9.60, or you can accept the sell offer and buy market and accept whatever price these passive sellers are pricing you. So you can either place a limit on the bid and have low chances of getting filled, you can buy at mid-price and maybe having a higher chance of getting filled, or you can buy market and accept to pay the entire spread. So you're gonna pay more to buy that put. The same things, of course, goes for the calls. You're going to have the sell offers, the asks, and the bids, the buy limits. Let's see an example of an option chain. This is, for example, thinkorswim by Charles Schwab. And if I click on Trade and I, for example, select SPX, I'll be able to see here the option chains that I can open and close and see all of the expirations. As you can see, here is the days until expiration, 0 DTEs, 1 DTEs, 4, 5, 6, 7, 8, 11, blah, blah, blah, all the way down till options expiring in 2027 or 2031. And on this side, I can see the implied volatility. How is the expected volatility of these options? And of course, as you can see, the more you go up, the more they tend to go up. Let's open, for example, the option chain of the 0 DTE options expiring today. Normally, I will probably see 4 strikes only, the money strikes. Let's show all of them. Well, now you can see that for the 4th of June expiration, I have all the possible strikes I can buy or sell at. I have all the puts here with the bid and the ask column. I have all the calls here with the bids and the ask. And if I go all the way down, I'll see that there's a split color now. These are the at-the-money calls because the current last price— let's take out some of these— SPX, there you have it. The last price is $7,553. So it's right in the middle between the $7,555 strike and the $7,550 strike. So I cannot buy exactly $7,553. I can only buy $7,550 or $7,550. So slightly in or slightly out of the money. And as you can see, if I move over here onto the bid column, I can sell market and I can set my order and accept the price of $29.40. If I click sell, the order page will pop up. By default, it has 10 options. I'm gonna, for example, put 1. It's gonna give me a recap, the expiration, the strike, if it's a put or it's a call. Just wanna switch it to call, I can do it directly from here. If I wanna buy it, if I wanna sell it, if I click plus, it's gonna become a buy put. But let's say I wanna sell it. As you can see, as I've clicked here, I basically said I'll, I'll start by accepting the bid price, which is $29. Now it's $28.70. And as you can see, it's going kind of up and down, which is going to be a limit that I placed together with the bid. Or I can move it and have it at mid price instead, which is $28.70. And as you can see, it's floating because it's right in the middle between the bid price and the ask price. They're all limit, but I can also buy market and accept whatever the price is. For this. So I can click confirm and send. Quick recap: what's the price I want to have? It's going to give me the max profit, the max loss, the cost of trading. But of course, as of now, I cannot sell because the market— it's so— it's, it's not a, it's not a trade I can open now. Then I would basically click on send and I would be having my trade open. But what I can do is right-click and analyze trade, and this is basically the payoff chart of my put option.. And as you can see, as I'm selling it at the money, this yellow line is the current price of the underlying asset. The pink line is what my profit and loss would be if I sold this now and I wanted to rebuy it. What would be the value of this option? The blue line instead is the value at expiration. And through time, this pink line will become the light blue line. I have my— let's bring this line to the center. As you can see, I have exactly 50% chances of expiring here, 50% of expiring there. Probability range is the distribution, so the probability mode is in the money. Or what is the Now, to show you how this exactly works, I'm gonna go on optionstrat.com, which is a free website, also have some, you know, payment options. I'm not affiliated with them in any way, but it's one of the many, you know, option building softwares. I think there's a similar thing in TradingView. Let me check. Yeah, TradingView, if you go on products and then options, you actually have a strategy builder that works in a kind of similar way. Like, there's a lot of free ones you can find. My favorite one for now is this one. So let's build, for example, a long call. This is a long call on Apple. Let's put 5 days till expiration— sorry, 1 day to expiration. The current price is $310, and this is the chart of buying a call. Let's zoom out with the range a little bit. And as you can see, this is the chart, exactly the payoff chart we've seen. It's just an interactive one. You see here 50/50, right? This is 50% chance of expiring out of the money and 50% chances of expiring in the money. This is your profit and loss over here. You're gonna pay $200 to buy the option to buy, and as soon as price starts going high, you start first going to break even as soon as price has reached 312. So you're in the money by 2 points, and the more you go up, the more you profit potentially, right? And this is the profit and loss, as you can see, at expiration. But if you were to, for example, buy it now, right, you see that the curve will look slightly different. Let's zoom in, because if you were to buy it— so if I buy it and sell it, I'll just earn zero, right? I'll just pay the commissions or the spread. But then as time moves forward, if price remains the same, you see how the curve gradually, gradually goes to the final shape, and as we said, the more time passes, the lower the likelihood of a fire happening. So if I were to resell my option now, it would be worth less and less and less and less, and I will be at a net loss, right? Now let's bring it back and let's make an example where we've bought a call, but what changes now isn't time, but what changes is volatility. If implied volatility suddenly gets higher and higher and explodes,— even with price being the same, you see how I'm making profit? I'm $200 in profit, even though I'm exactly at the strike I bought. So implied volatility, as we said, has a positive impact on the value of my option. Time has a negative impact on the price of my option. Volatility has a positive impact on the value of my bought option, But as you can see, it has a positive impact only in this area. Like it grows only around— once we're way in the money, it doesn't change much, right? The changes in volatility only affect these areas of moneyness. Same thing with the time. Time mostly affects these areas here. Here and here, the curve stays pretty much the same, right? Let's make an example instead if we were selling this call. So instead of quantity 1, let's make quantity -1. And as you can see now, let's zoom in. Let's say I'm selling now. I'm technically net credit. So the credit that I'll get for this option, the money I'll get at the end is $160. But now I'm earning zero. Only as time passes, then gradually my profit and loss creates itself, right? So if I sold it, for example, here, and then I was rebuying it here, maybe to, to close this trade earlier, I wouldn't have all of the profit yet. I have to wait until the expiration to see all of my profit being credited to my account. As you can see, the chances of profit are 74%. When I was buying it, the chances of profit were 26%. Not much. But back to the sold one. If in the meantime though, I just sold a fire insurance and a fire starts happening, look at what happens to my profit and loss. I'm losing a lot of money now. And if I were to rebuy the same strike I bought it for, I would be at a net loss. But if time passes and price stays the same, ultimately I'll get exactly the profit that I have planned. Now let's make an example where we sell both a put and a call at the same strike, and that's your short straddle. And at the current level of implied volatility, you can see that I'm gonna earn exactly in the same area of the probability distribution. More or less. If instead I sell the call a little bit out of the money and the put a little bit out of the money, my chances of profit are now 90%, but I'm only going to earn $83 and I risk to lose thousands of dollars, but with a very low chance. This is your short strangle, right? Now let's get back to a long call and let's really understand our Greeks. And let's start with the easiest one, which is time, right? Through time, the value of my option gets lower and lower if I buy it, right? But if you zoom out, as we've discussed, when we drag this back and forth, the highest effect of this is here, in this area around here. So if you were to plot a chart of how time affects the value of my option based on the price, here you'll have zero effect, zero effect, zero effect, zero, zero, and you'll start going higher, actually lower, because the effect is that it decreases the value of my option. You have the peak here, exactly here, because this is where it's more affecting, exactly at the money. So here you have this, and then slightly less, slightly less effect, slightly less effect, slightly less, slightly less, until time passing has no effect when we're extremely out of the money— sorry, when we're extremely in the money. In fact, if we click on more and we look at theta, that's exactly the shape of this. There's going to be very few effect of theta out of the money or in the money, the more we get closer to the center, the higher the effect of time. And of course, at now, the effect is -27 in this case. The more we go on, the faster the effect. The curve, you see, it gets tighter because the probability of expiring at those prices now are getting lower and lower. And the more I get to the expiration, the tighter and tighter this curve gets. Up until the point where we're expired and time has done its work. Now let's see if we sell a call. When we sell a call at now, we don't have any money, but slowly through time, the guy bought from us is worthless and worthless and worth less money, worth less, worth less, and time allows us to cash in all of the credit of our sold option. So the curve of the impact of time in our option would have a little effect here, little effect, little, little. It'll get higher and higher and higher and higher and higher. The peak would be around here, and then it would get lower and lower and lower until at this point time doesn't change much because you're way well out of the money or in the money. So the most of the effect happens at the center, but in a positive way. So if we see the chart of theta here You'll see that it has exactly that shape. Theta is gonna affect the value, the price of my option, mostly at the money and gradually less as you move out or in the money. Through time, it's gonna have a wider effect in a narrow area, and then it's gonna stop having an effect, having its peak, of course, here, and then the option is expired and that's it. That's the chart of the effect of time in the value of our option, the theta. Now, if we bought and as we said implied volatility increases, look at where it increases and look at how implied volatility determines the width of the probability distribution here in the background, this bell curve. The lower the volatility, still 50/50, but in a narrow area, the higher the implied probability that price will go way wider and the larger our standard deviation. It affects this in a very similar way to the theta. So if volatility increases at the money, I have the highest effect. The more you go out of the money or in the money, the lower the effect. So if you had to draw a chart here, the effect would be positive, but not much, not much. A little bit more, a little bit more, a little bit more. The highest effect of volatility would be here, less here, less here, less here. And it would have this shape where the effect is low, the effect is high, and then it's low again. So let's click on more and look if it's true. Let's click on Vega and voilà, it's exactly how it is, how it looks like. Changes in implied volatility will affect the price of your option, the value of your option in a positive way if you bought it mostly at the money, less and less out of the money and less and less in the money. And of course, through time, the effect of surges in implied volatility will be lower and lower because we're getting close to expiration. So the less the probability that volatility will spike really, really high and that you'll expire out of in the money until expiration, where implied volatility matters less and less and the option is expired. The games are done. If you were to sell a call instead and volatility suddenly rises, you're going to start losing more money. So volatility, vega, will have an effect, very high effect here, but negative. So it's going to have low effect here, low effect here, a little bit higher, a little bit higher. Peak, then lower, then lower, then lower, lower. So the chart of vega in a sell option would probably look something like this, because a seller of volatility is impacted negatively by volatility rising, of course, because you're selling a fire insurance and the fire is starting. So let's see the vega of a sell call option. But let's sell it properly at the money. Yeah, there you go. A lot of effect at the center, less effect at the sides. So vega answers, how does the value of my option change based on a 1-point change in implied volatility? Theta answers the question, how does the value of my option change through time? The final piece of the puzzle, you could say, is price, because as you can see, we are at $294 here, $294, $310, $320. Here, a change in price doesn't change the value of my option, like from $294 I'm still losing $265. If we go up 2 points, I'm still losing $265. If we go up other 2 points, I'm still losing $264. Here instead, a change in 2 points of price starts affecting the price of the value of my option. You see the profit and loss now, it's $240, $230, and here it starts rising faster. So now, for example, at $309, the value of my option is minus $100, and at $310, 1 point up, it's worth minus $50. So there was a $50 change in the price of my option when we went up 1 point. And the more you go up, the more this is constant. So here, for example, we're at $320, $745. If I go up 1 point, so $321, there you go, my price is $841. So exactly $100 more. So here, out of the money, a change of 1 point in price doesn't affect my option at all. So what we define as the Delta here would be 0. The value of the option will be affected by a change in price. If price rises by 1 point, I earn $100. So here the Delta, we say, is 100. Here the Delta is 0 because a change in 1 point in the stock price is not affecting the value of my option. Here at the middle where we saw it was $50, that's what we call Delta 50. So the chart of it would probably look 0 here, and then it will start going higher and higher up to the point where it plateaus really high. And if we open the chart of the Delta, this is exactly how it looks like. When we're at the money, the Delta is always 50. If the underlying price goes up 1 point, the value of my option increases by $50, here by $60, here by $70, here by $100. Here instead, I will have no effect. And if you think about it, it makes sense because as of here, you have 50/50 chances of price expiring this way or this way. The more price rises, the less the probability that it's gonna expire here, the more the change in value of my option will follow price, but only at now. As time passes instead, one point in price will always equal $100 of variation in my option price because of the 100x leverage, right? So of course at expiration, it doesn't matter because here you paid your premium, here you start being in profit based on the stock price., which is ultimately probably the most important thing that matters, right? So through time, delta either goes to 0 if you're out of the money or to 100 if you're in the money. And this is why you see this curve here, right? You see this as a curve at the beginning, and then gradually it becomes the final chart where it grows linearly with the price of the underlying asset, as you would expect. But as in the meantime, A lot of things can happen. This rise is gradual. So the Delta answers the question, how much does a 1-point increase in the underlying price, in the stock price, affect the price of my option and my profit and loss? And these are the 3 most important Greeks. And as we said, Vega, Rho, Theta, and Delta are first-order Greeks. Because they take the price of an option and the factor directly affecting it. So Delta is how the price of the underlying asset affects my option. Theta is how passage of time affects the price of my option. Vega is how a change in volatility affects the price of my option. Gamma instead is a second-order Greek, and Gamma basically asks the question, how does a 1-point change in price affect the Delta of my option? So it's basically trying to measure the variation of the Delta. That's why it's called a second order Greek, because it's a Greek of a Greek. So if I get back to the Delta, right, which is low here, gets high here, and then kind of plateaus. If you wanted to draw a chart of how fast Delta changes through price, here it doesn't change a lot. Here it starts changing a little more. Curve goes up very fast. It reaches the highest peak here, and here it kind of slows down. So lower and lower and lower and lower. So how price impacts the delta of my option will look probably something like this. And if we open the chart of gamma, this is exactly how it looks like. So gamma, delta, vega, and theta are basically these mathematical formulas that create what we call the convexity of an option, this curve that you see here. The price of an option when we're not at expiration yet doesn't grow linearly. It grows with this curve that through time flattens. And this is going to be very important, especially to understand the concept of gamma exposure and how the market makers of this market, of the option market, hedge their exposure. It's going to be awesome. We're going to probably learn in one of the next few videos. But these are all the elements and the factors that affect in real time the price of the option you're either buying or selling. Now let's see some of the strategies through our options software. As we said, this is just buying a call. I can click here and add maybe a buy put, creating what we define as the straddle. If I put the put out of the money and the call as well a little bit out of the money, I'm creating what is called a strangle. So I'm betting on price staying here by expiration. If I sell these instead, it's a short strangle. So I'm gonna earn money if price stays inside of this range, I'm gonna earn $82, but facing a potential loss, as you can see, which is infinite potentially. But let's say I add to cover my potential losses a call slightly even more out of the money, and then also adding a buy put slightly more out of the money, I get an iron condor. So I'm gonna earn $49 if price stays exactly where it is, and I'm gonna lose $200. So I'm gonna cap my maximum loss if price eventually goes outside. If instead the call and put I sold are exactly the same strike, I'm gonna get an iron butterfly. Now let's say I buy and sell a call, but I will sell my call slightly out of the money. You see what happens here? I'm gonna earn 46% of the times. My profit is capped at $137. My loss is capped at $113. So here I'm betting on price going up by a little bit and not going any lower than a little bit. This is an example of a spread, and this is a spread that is bullish because I'm betting on a long, and it's made out of calls. I can also have it if I click on switch to put and I switch this one to put as well, and I I sold put slightly out of the money, this is a bear put spread. So I'm bearish technically, and it's a spread of puts. If instead I sell the put slightly in the money, it's gonna be exactly like a bull call spread, but it's a bull put spread instead. And the chance of profit will be exactly the same. The profit though is gonna be slightly different, but it's pretty much like the same trade. So the basic ones are long call, long put, and as you can see in the income section, you have a covered call. And a covered call, as you can see here, not only has sold an Apple call slightly in the money, but also has long 100 shares. So if selling the call will basically grant me a profit of $4, but having an indefinite amount of money I lose if price is going up, when I buy the same amount of shares on the underlying asset as well, if price rises, I'll earn money up to the point where the losses from my call will be offset by the shares I'm buying. And this is what you call a covered call. Then of course you have the spreads, you have the butterflies and the condors, and you have the same ones but in the form of calendar. A calendar call spread, it's basically like a straddle. And as you can see, it kind of looks like the same, but it has this weird shape which is curvy now because I'm selling the call, for example, expiring tomorrow, and I'm buying the call expiring a couple of days later. So if price stays around the same area, my sold call will basically generate all of its profit. But in the meantime, the call I bought didn't yet experience the entire time decay. So I'm basically long theta, we say, on this call that I'm selling, and I'm long theta on a longer expiration. So I'm basically earning from the time difference. This is another very common strategy. Then of course you have all the directional ones we've talked about in the long side. And this, for example, is what we call a collar. And a collar, also widely used by JP Morgan fund, the JHEQX, the JP Morgan Hedged Equity Fund, that basically works like I'm long stocks, right? I'm currently exposed to a long stock, in this case Apple, but I also buy a put a little bit out of the money so that in case something happens, my stock loss is capped. And at the same time, to have another stream of income, let's say, I sell an out-of-the-money call so that I cash in the premium, but at the same time, I also cap my profit. So this is basically a strategy that is widely used to suppress the volatility of a stock portfolio. This is a very classic strategy called the collar. So as we can see, they have sell put over here and buying put over here. So the— if you delete this and you don't see it, it's exactly what it is. But in this case, they sell a put and they buy the call. So this is how it kind of looks like. And as you can see from the returns, the blue dot is the profits of that quarter of the JP Morgan equity— of the JP Morgan hedged equity fund, and the profits are slightly lower than the performance of the S&P, but also the tail losses are protected by this hedge, and it doesn't go any lower than 5%. So yes, you're giving up some profit in the long term, but you're also protecting from the so-called tail risk, which if we hide everything, the tail risk is the risk of price reaching the tails of the distribution. We call these low probability areas as the tails of the distribution. So price going really low doesn't happen very often, as we said. A huge crash, a huge bear market doesn't happen very often. But if it happens, I want to be hedged. So I'm basically gonna create a structure that hedges my losses in case something extremely bad happens. And if you look at the returns, the JP Morgan Equity Fund, this hedged fund, has a kind of a lower yearly return, annualized, but also a very much lower volatility, which a lot of investors appreciate. So it has a slightly higher, not so much, but a slightly higher Sharpe ratio. I doubt that the S&P has a 0.75 though, because historically speaking, yeah, if you include like 2008 or even 1929, the Sharpe ratio of the S&P 500 is way lower. And this also makes you understand something, right? There are a lot of funds that because they're afraid of this tail risk will systematically buy out-of-the-money puts. And exactly this This is the reason why selling options has a structural edge, because there's going to be a lot of investors that will constantly buy out-of-the-money puts, even though nothing happens ultimately, but just because they want to sleep well at night. They don't want to be exposed to the tail risk, even if it's just 1% of the time that it happens, it's going to crush all your profit as a stock investor. So this tendency to constantly buy out-of-the-money puts and kind of wanting to sleep well at night makes especially puts constantly a little bit overpriced. And the volatility premium that an option seller gets paid because of this potential potential high volatility scenario that might happen creates this bit of a skew and this constant difference between implied volatility, which is the volatility implied in option prices, and the realized volatility, which is the volatility that ultimately actually happens. And there's a lot of studies around this, there's a lot of academic research around this, and it's one of my favorite strategies when it comes to options. And if this video reaches 5,000 likes, we're gonna make a dedicated video about it. But long story short, if you constantly sell puts and you sell them constantly way out of the money— let's try it in the SPX, the S&P 500 index options, let's say 30 days to expiration type of option, and you constantly sell them a little bit out of the money, for example, where the delta is 10. So let's see, maybe here, let's see here, 0.10. Yeah, okay, your chances of profit are now 93%. And if you sell this constantly, you're going to cash in the premium, cash in the premium, cash in the premium, and most of the time you're going to be profitable. But this is very risky because that's just the profit at expiration. At now, you're not earning any money. And if price goes even just a little bit lower, you're starting to lose a lot of money. And if volatility starts rising, you could be losing $24,000, where at expiration you'll technically be in profit. But are you going to be able to sit there and wait for the time decay to offset the implied volatility effect is the real question. So how do you manage this? How do you stop potentially a loss in a short option strategy is the real deal. And again, if this video which is 5,000 likes, we're going to see and backtest exactly a strategy like this one. And now that we have understood all the basics of options, let's try to simulate some marketing environments or some scenarios where option could be an option. And let's say, for example, that our main idea is that the current conflict will at some point end, causing the prices of the oil futures to go down. So we have some sort of bearish scenario or a non-bullish one. Let's say we apply the volume profile to see where are the best areas to buy and sell. And let's say we draw our Value Area Low, our Value Area High of the range. Well, for example, I could wait that price reaches this supply zone. And instead of putting a short position where I have to place a stop loss that is likely to be triggered at some point, I forget about placing a stop loss in the first place and I just buy a put on crude oil. This way I don't have to worry about placing an actual stop loss. And for example, I can just buy a put 45 days from now at the money and wait for price to reach reach my target. Another thing that I could do if I don't expect a lot of volatility is I could sell a call here and a put here, and the profit and loss would probably look something like this. I'll make money as long as price stays inside the range. I'll start losing money indefinitely if it goes outside. But in this case, for directional trades where you have a clear direction, the best idea— where by fundamental reasons, by technical factors, you assume, or you high degree of probability that price will fall at some point and maybe prices will tend to rebalance, for example, this upper excursion and get back more to a fair price for US oil, then in a situation like this where you have a clear direction, buying a put in this case is potentially the best idea. If I had, for example, the opposite view, things will get even worse in Iran and it's likely that price will keep going higher from here, instead what I would do is I would buy a call, maybe a 30 days, a 45 days call, whatever that is, so that I can profit from the direction without having to worry about the downside risk. Now let's make another example. Let's say I'm looking at the USD/JPY and I want to bet on the fact that at some point the Bank of Japan will defend, as it's done in the past, this level of 160 by injecting liquidity into the forex market and basically cause another one of these sudden spikes in bearishness. And that since in June they're gonna hike rates, I don't expect they're gonna go much higher than 162. Well, if I had to trade it with a normal forex brokerage account, I have to, for example, sell here and place a stop loss somewhere above here and have a very defined risk to reward ratio. I cannot place a very tight stop, of course, because it's likely that it's going to take it. And even if I put it above here, there's still some likelihood that we will spike up before we spike down. But with an option, I don't have to worry about the stop loss again. But I cannot buy an option on USDJPY. I can buy an option maybe on the futures of the yen, which is 6J, and I can see that this is the level where it will probably stay defended. So I can, for example, buy a call over here or throughout all of this this time, I could have just persistently sold puts below here because it's very unlikely that the Bank of Japan will let its currency fall too much in value. But that still bears a little bit of tail risk that I can offset somehow. But I will profit a little bit, a tiny bit, if price doesn't go any lower.
