I'm aware there's a lot of stereotyping about options and how it relates to investing and personal finance. You may recall mainstream media headlines about certain individual options trader who made millions from the early 2021 "meme stocks" and others who lost just as much, posting screenshots of 99% losses from botched options trades.
When you think trading options, you may think of it as a sort of "stock market gambling" practice with ridiculous amounts of risk involved. If this is your current mentality surrounding options, let me be the first to tell you that you are not alone. This was my exact thought process until I actually learned about what options are and how an extremely low-risk strategy can lead to generating passive income every month regardless of the total condition of the stock market (more on that strategy later).
A quick disclaimer before I proceed: This series is a very basic and simplified explanation of what options are and how you can best utilize them in your journey to financial independence. I'm only sharing what I've come to learn and there are many other strategies surrounding options that I have not personally experienced. As with any investment, there is risk involved. I'm not a financial advisor and cannot legally provide any type of financial advice. I'm simply sharing my personal knowledge on this subject. Please keep that in mind as you proceed. With that, let's start with the foundation.
An options contract is the agreement between two parties (the buyer and the seller) to buy or sell a security (stock) at a predetermined price (strike price) prior to or on a predetermined expiration date.
If you just read that and have absolutely no idea what the heck you just read, fear not. Here's a more in-depth explanation of those key words:
Contract - Each options contract represents 100 shares of a stock, whether you're buying or selling the 100 shares.
Buyer and seller - This just means if you are buying or selling an options contract. There are always two parties in an options transaction.
Stock - The specific stock of the company you've chosen to trade options with.
Strike price - The predetermined stock price where the option contract is agreed to be bought or sold.
Expiration date - This is the predetermined date in which the option either gets exercised or expires worthless (more on that below).
Each options contract has collateral. Collateral takes one of two forms. It is either 100 shares of a stock or the cash equivalent to cover the purchase of those 100 shares. Here's what I mean:
If the 100 shares are used as collateral for the contract, then it's referred to as a call option. If you don't own 100 shares but have the cash equivalent, it's referred to as a put option. For example, if a stock is $10 per share and a contract is worth 100 shares, the cash equivalent would be $1,000 ($10 stock price x 100 shares = $1,000).
Again, if you own 100 shares, the shares are used for collateral. If you don't own any shares (or have less than 100) but have a cash balance in your buying power of at least $1,000, you are able to use the cash as collateral and create an options contract.
In this options transaction, a premium is either paid (by the buyer) or received (collected by the seller) upon the trade being executed. Premium is the value of the option. Think of it this way: nothing involving an option is free. There would be no point because and the seller would have no incentive to create the contract. More about buyers and sellers premium will be discussed in the Wheel Strategy so stay tuned.
I hope that this brief explanation was helpful and will pave the way moving forward. Keep in mind that everything discussed here, especially those key terms above, will be relevant and frequently referenced for future topics regarding Options Trading.
The next post goes in-depth regarding the options trading strategy that I personally utilize to generate approximately $1,000 per month of income in the form of options premium: The Wheel Strategy.
Comments