{"id":8830,"date":"2019-06-28T12:11:19","date_gmt":"2019-06-28T16:11:19","guid":{"rendered":"https:\/\/ibkrcampus.com\/?p=8830"},"modified":"2023-04-05T11:54:56","modified_gmt":"2023-04-05T15:54:56","slug":"options-insights-trading-your-first-option","status":"publish","type":"post","link":"https:\/\/www.interactivebrokers.com\/campus\/traders-insight\/securities\/options\/options-insights-trading-your-first-option\/","title":{"rendered":"Options Insights: Trading your First Option"},"content":{"rendered":"\n

Options trading is a skillset that typically takes a few weeks to a few months to learn. The numbers and strategies can be intimidating initially, but don\u2019t be discouraged. If the option chains, Greeks and terminology seem complicated at first, there are tools such as OptionsPlay<\/a> and ongoing education from the Montr\u00e9al Exchange<\/a> to help simplify options for beginners! <\/p>\n\n\n\n

To learn how to get started with trading options, please view our recent webinar<\/a><\/strong><\/p>\n\n\n\n

Basic Strategies<\/strong><\/h2>\n\n\n\n

There are 2 basic strategies that options traders should learn before they start trading: writing covered calls (income) and buying calls and puts (speculation).<\/p>\n\n\n\n

Writing covered calls:<\/h3>\n\n\n\n

Writing covered calls is an income-generating strategy used for stock or ETF holdings in an equity portfolio. This strategy requires holding at least 100 shares and writing an \u201cout-of-the-money\u201d (OTM) call option. An \u201cout-of-the-money\u201d call option is one with a strike price above the current stock price. The writer of a call option is obliged to sell his or her stock at the strike price of the call option upon expiration. The goal of this strategy is for the option to expire worthless with the stock below the strike price at expiration, thereby allowing the investor to keep the income from writing the call option. When this happens, the investor can continue writing covered calls to generate a stream of income from his\/her equity portfolio through a series of expirations! In the event that the stock price is higher than the strike price upon expiration, the stock is sold to the buyer of the call option at the strike price. Here are some tips and best practices to follow to avoid the common mistakes made by beginners:<\/p>\n\n\n\n

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  1. Do not write aggressive calls<\/strong> \u2013 This refers to writing call options that have a strike price that is too close to the current market price, as there is a higher probability of the stock reaching that strike price.<\/li>\n\n\n\n
  2. 2.<\/strong> Write options with short expirations<\/strong> \u2013 Writing options that expire within a month. Longer expirations are tempting, as they deliver more income to the option writer. However, longer dated options deliver income at a slower pace compared to writing short-dated options more frequently.<\/li>\n\n\n\n
  3. Avoid earnings announcements<\/strong> \u2013 Earnings announcements cause stocks to experience extreme volatility, and this can cause the price of the stock to reach the option\u2019s strike price in a short period of time.<\/li>\n<\/ol>\n\n\n\n

    To learn more about covered calls (Covered Call Blog Post: https:\/\/www.optionmatters.ca\/the-definitive-and-practical-guide-to-selling-covered-calls\/)<\/p>\n\n\n\n

    Buying calls\/puts:<\/h3>\n\n\n\n

    Buying calls and puts is an option strategy that is used for speculation purposes (based on a bullish or bearish view on a stock or ETF). If an investor has a bullish outlook on a stock or ETF, buying a call option can provide upside exposure. Conversely, for a bearish outlook, an investor could buy a put option to profit from a potential downside move. When buying calls or puts, it is best practice to use expirations that are at least 1-2 months from expiry and with \u201cat-the-money\u201d strikes (a strike price that is close to the current market price). Novice options investors tend to make certain mistakes, but following some of these tips will help you avoid them:<\/p>\n\n\n\n

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    1. Do not hold a long option position until expiration<\/strong> \u2013 Unlike stocks, options have an expiry date. This means that the value of the option will decrease over time. Theta, which measures the rate at which an option\u2019s price will erode over time, is discussed in further detail below.<\/li>\n\n\n\n
    2. Do not purchase options with a very short expiration <\/strong>\u2013 If you believe that a share price will rally 5% in 2 weeks, consider an option with an expiration of 4 or 5 weeks. This will give you a buffer in the event that the stock takes longer than expected to rise 5%.<\/li>\n\n\n\n
    3. Always have an exit plan<\/strong> \u2013 Set a target and stop-loss level on the stock price, and exit your option position when one of them is triggered. Holding onto an option position longer than necessary will result in time decay (theta), which will erode your gains or magnify your losses!<\/li>\n<\/ol>\n\n\n\n

      Understanding the Greeks<\/strong><\/h2>\n\n\n\n

      The Greeks are variables used to measure factors affecting the price of an option. At first glance, the Greeks can be intimidating to new option traders. Buying stocks is much easier to understand, due to the dollar-for-dollar exposure, but options are not as straightforward. While the Greeks are not as complicated as they may initially seem, it is important for traders to understand how they work on a conceptual level. The two most important Greeks are \u201cDelta\u201d and \u201cTheta\u201d:<\/p>\n\n\n\n