{"id":176233,"date":"2022-02-25T18:01:00","date_gmt":"2022-02-25T23:01:00","guid":{"rendered":"https:\/\/ibkrcampus.com\/trading-lessons\/introduction-to-options-2\/"},"modified":"2023-12-28T14:29:05","modified_gmt":"2023-12-28T19:29:05","slug":"introduction-to-options-2","status":"publish","type":"trading-lessons","link":"https:\/\/www.interactivebrokers.com\/campus\/trading-lessons\/introduction-to-options-2\/","title":{"rendered":"Introduction to Options"},"content":{"rendered":"\n
Let\u2019s say you have $10,000 to invest and you want to buy shares of a few companies. You decide to buy just 10 shares of Apple Inc. (Symbol: AAPL) at a price of $160 each for an investment of $1,600. (You will likely pay 35 cents commission to your broker for doing this.)<\/p>\n\n\n\n
What is an Option? <\/strong><\/p>\n\n\n\n
However, rather than investing in shares of companies, many investors trade using the options market.<\/p>\n\n\n\n
There are two types of options. Call options <\/strong>allow investors to position for upward <\/em>movement in underlying share prices.<\/p>\n\n\n\n
A call option is a contract that allows an investor to control 100 shares in a company.<\/p>\n\n\n\n
An option contract has an expiration date <\/strong>and a strike price. <\/strong>The price a trader pays for an option is called a PREMIUM<\/strong>. The buyer of the call option has the right to purchase the stock at the strike price at any time before the expiration time.<\/p>\n\n\n\n
Let\u2019s assume that an option at the $170 strike and one month to expiration costs $3.50 per contract. Since the contract is for the right to buy 100 shares at $170, it will cost $350.<\/p>\n\n\n\n<\/figure>\n\n\n\n
If the stock rises to $200, you make $400 profit on the investment of $1,600. In case of the option 100*(200-170)-350= $2,650 – profit.<\/p>\n\n\n\n
While buying the option looks a lot better, you must keep in mind that after 30 days the option expires and if the stock remains under $170 your $350 investment is all gone. On the other hand, the stock may rise much higher in the long run, even if temporarily the price goes down.<\/p>\n\n\n\n
Vertical Spread<\/h4>\n\n\n\n
With shares in AAPL trading at $160, an investor paid a premium of $3.50 for a 30-day call option at the 170-strike hoping that the share price would rise.<\/p>\n\n\n\n
The investor is bullish, but thinks that the share price might not reach $170, and is unlikely to go above $180 before expiration.<\/p>\n\n\n\n
But the investor could SELL <\/strong>a call option at a higher strike.<\/p>\n\n\n\n
Let\u2019s say he sells a call option at the 180-strike and this time receives <\/em>a premium of $1.10. Since the option contract covers 100 shares, he receives $110. By \u2018spreading\u2019 across the 170\/180 strike prices he can reduce the cost of the trade and would face a lower maximum loss of $240 in the event shares failed to reach $170 by expiration ($350-$110=$240).<\/p>\n\n\n\n<\/figure>\n\n\n\n
Why sell a call?<\/h4>\n\n\n\n
The call option offers upside exposure in the event the share price rises. However, by selling the 180 call the investor reduces the maximum possible loss to $240 and still could have a total profit, up to $760 that is the maximum. All profits above $180 on the stock are foregone.<\/p>\n\n\n\n
The vertical spread would become profitable at the lower strike price plus <\/em>the net premium paid for the two options or 170+$2.40 = $172.40. Profits grow at the point penny for penny as the share price increases. At $175 the call option is worth $500 less the $240 paid for the options or $260 profit.<\/p>\n\n\n\n
The maximum profit from the trade would occur at the higher strike price (or above) and is defined as the distance between the strike prices minus <\/em>the initial cost of the trade 100*(180-170)-$240 = $760.<\/p>\n\n\n\n
Above a share price of $180 the spread is always worth $760 to the investor since both call options increase at the same pace. Profits on the long 170-strike call are equally offset by losses on the sold 180- strike call. Even if AAPL rises to $200 per share, the vertical spread limits the investor\u2019s gains but is a less risky way of taking advantage of an upside movement in the share price.<\/p>\n","protected":false},"excerpt":{"rendered":"
New to options? In this video we introduce you to call and put options and walk through the basic use of a call. You will learn how to compare buying a stock to buying a call option. And we also advance to a call spread to illustrate how to better manage risk.<\/p>\n","protected":false},"author":899,"featured_media":176237,"parent":0,"comment_status":"open","ping_status":"closed","template":"","meta":{"_acf_changed":false,"footnotes":""},"contributors-categories":[13576],"traders-academy":[13125,13128,13132],"class_list":{"0":"post-176233","1":"trading-lessons","2":"type-trading-lessons","3":"status-publish","4":"has-post-thumbnail","6":"contributors-categories-interactive-brokers","7":"traders-academy-beginner-trading","8":"traders-academy-level","9":"traders-academy-trading-lesson"},"pp_statuses_selecting_workflow":false,"pp_workflow_action":"current","pp_status_selection":"publish","acf":[],"yoast_head":"\n
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Above a share price of $180 the spread is always worth $760 to the investor since both call options increase at the same pace. Profits on the long 170-strike call are equally offset by losses on the sold 180- strike call. Even if AAPL rises to $200 per share, the vertical spread limits the investor\u2019s gains but is a less risky way of taking advantage of an upside movement in the share price.<\/p>\n","protected":false},"excerpt":{"rendered":"