Blog

News

Details

Basic Options

04/27/2020

Options are financial instruments that give investors the opportunity to speculate on changing prices or protect positions.  The value of an option is based on an underlying asset.  Options contracts are between two parties, the buyer and the seller, who each have specific rights and obligations.  In short, an option contract allows you to speculate on a future outcome, be it bullish or bearish.  That’s a lot of financial lingo, so let’s start with an analogy.

Say you are considering buying a house in a neighborhood you like for $500,000.  You think the house might be a little overpriced until you hear that the city is thinking to build a botanical garden nearby, which would drive up the prices of all the houses in the neighborhood significantly.  If the garden is constructed, you estimate that the house’s value would go up to at least $700,000.  But you aren’t sure if it’s a rumor.  What do you, the prospective buyer, do?

You create a contract with the seller of the house.  You agree to pay the seller $25,000 up front.  In return, the seller agrees not to sell the house to anyone else for 6 months.  At the end of the 6-month period, you have the right, but not the obligation, to buy the house for the original price of $500,000.  

If the garden project gets cancelled, and the house’s value drops to $400,000, you will walk away having lost only $25,000 instead of the $100,000 you would have lost from buying the house at $500,000.

But say the city does build the garden, and the value of all the homes in the neighborhood increases to $1,000,000 – you can still buy the house for $500,000, a great deal!  Because you and the seller both signed the contract, the seller is obligated to sell you the house at the agreed upon price no matter what happens.  You could keep the house or turn around and sell it immediately for a hefty $475,000 profit (because remember, you paid the $25,000 premium, which is not refundable).

Now, if you talked to a real estate agent, we’re not sure that they would let you do this.  But you can in the stock market – here’s how.

Jen and Barry’s trades on the stock market with the symbol JNB.  Right now, JNB stock is trading at $100 per share.  You see on their website that they will release three new ice cream flavors next month, and you think to yourself that the stock price will probably go up.  But you don’t want to buy a ton of shares in case it doesn’t pan out.  What do you do?

You buy a Call Option!  For just $1 per share, you can purchase the right to buy JNB stock from a seller anytime in the next 3 months for $100.  Since options are usually sold in groups of 100, you pay $100 for 100 options.  The seller pockets the $100 you paid and keeps it no matter what happens.  This is a binding contract – if you want to buy the shares any time in the next three months for $100, the seller must sell them to you at that price.

Imagine you were right.  Jen and Barry’s launch the new flavors and their stock skyrockets all the way up to $110 two months later.  You decide to exercise the option – it’s “in the money,” as they say.  You go back to the seller and buy 100 shares of JNB for just $100.  You immediately sell them all on the stock market for $110 each, making a profit of $900 ($1000 from the sale minus the $100 you paid to the seller).

And if you’re wrong?  If JNB doesn’t do so well, and dips down to $85 per share?  Well, now you’re pretty glad you only spent $100 instead of potentially losing $1500 by buying 100 shares a few months ago.  And you don’t have to exercise the options – you wouldn’t want to buy JNB at $100 anymore anyway.  They’ll expire after three months.  The seller keeps the $100 premium.

Trading options on Webull may seem tricky at first, but we promise it isn’t hard.  If you forget about your options and the expiration date arrives, Webull will exercise the options for you if you’re “in-the-money” (remember, that means if the trade is beneficial to you) and let them expire if they are “out of the money” (if it didn’t work out in your favor).  We’re going to walk you through an options trade from start to finish. Please feel free to follow along with any ticker of your choosing.

1) Locate the ticker by searching them up in your “Explore” bar on top of the Markets tab.  

2) On the bottom of the page, you will see Options icon.  Tap on it.

3) This will take you to the Option Chain.  The default view may simply be a jumble of green and red numbers – for beginners, we recommend switching to the “List View,” which is easier to interpret.  To do so, tap the small hexagonal icon on the top right of the screen and select “List View.”

4) On the top you should see a collapsible bar that indicates the expiration and year of the options.  In this screenshot it says “24 Apr 20(w) 100.”  That means that the options expire on the 24th of April 2020, and that they are weekly options.  Traditional options expire on the third Friday of the month, but weekly options have gained popularity.  Webull offers both.  If you collapse this bar you’ll see that there are many selections for different expiration dates throughout the year.  We’ll stick with the April 24 selection right now.

5) Scroll down until you see the current Share Price.  The white numbers in the left column indicate strike prices you can select.  To see a different number of strike prices, tap the icon next to the funnel on the bottom right (the one on our screen says 10).  You can see six, ten, twenty, etc strike prices.  Remember, the strike price is the agreed upon price that you set now and honor later.

6) Let’s focus in on the $275 strike price directly above the Share Price.  (On our screen we have both Calls and Puts because we have selected “Both” on the bottom left.)  The following definitions will help you understand more about options:

a. Webull shows you the break-even price, or price at which you can choose to exercise or dispose of the contract without incurring a loss (for a call option, strike price plus premium paid; for a put option, strike price minus premium paid).  

b. We can also see the % Change, which is how much the contract’s value has changed intraday, so today only.  

c. The Implied Volatility is the market’s forecast of the movement in the price of the underlying stock based upon the options prices.  The higher the number, the more volatile the security.  

d. Theta represents a theoretical value by how much an option’s premium will decrease over time assuming implied volatility and price movement are constant.

e. Delta is the amount an option price is expected to move based on a $1 change in the underlying stock.  

f. Gamma is the rate that delta will change based on a $1 change in the stock price.

g. You will also see the Bid and Ask prices, and below them the Mid price. The Mid price is the average of the Bid and the Ask; Webull calculates option pricing with the Mid price.  

h. Finally, the Last price shows the price of the last option contract of this variety sold today.

7) Now, select the option you want!  We’re going to go for that $275 Call.  Hit the Trade button on the bottom left and you will be taken to another screen.  Here you should select the Limit Order and set the price.

8) Finally, set the number of contracts you wish to buy.  Remember, one contract is 100 shares.  Great job!

Option trading entails significant risk and is not appropriate for all investors.  You need to complete an options trading application and get approval on eligible accounts.  Option investors can rapidly lose the value of their investment in a short period of time and incur 100% loss prior to and by expiration date.  Please read Characteristics and Risks of Standardized Options  before investing in options.