Basics

What Are Options?

Options are financial instruments that give the buyer the right, but not the obligation, to buy or sell an underlying asset at a specified price on or before a specific date. Here are the critical components of an option:

• Underlying Asset: Stocks, indexes, commodities, or currencies. For our purposes, let's focus on stock options.

• Strike Price: The price at which the option can be exercised. For instance, if you have an option to buy a stock at $50, that's the strike price.

• Expiration Date: Every option has a lifespan, after which it expires worthless if not exercised or sold.

• Option Type:
• Call Option: Gives the holder the right to buy the underlying asset.

• Put Option: Gives the holder the right to sell the underlying asset.

The Basics of Options Trading

Buying Calls: If you believe the stock price will increase, you might buy a call option. Here, you're betting on the price going above the strike price before expiration.

Buying Puts: If you believe the stock price will decrease, you might buy a put option, betting on the price dropping below the strike price.

Selling (Writing) Options: You can also sell options. Selling options involve collecting the premium immediately but come with the obligation to fulfill the contract if the buyer exercises the option.

Trading Options Premiums

This is where my primary strategy comes into play. Instead of focusing on whether the option will be exercised (which involves the stock reaching the strike price), my strategy revolves around:

• Options Premium: This is the price paid for the option. It's influenced by:

• Time Value: The longer the time until expiration, generally the higher the premium, as there's more time for the stock to move.

• Intrinsic Value: If the option is in-the-money (the stock price is above the strike price for calls or below for puts), it has intrinsic value.

• Volatility: Higher expected volatility increases the premium because there's a greater chance the option will end in-the-money.

Alternative Trading Strategies

• Selling Options: You can sell options to collect premiums. Since options lose value over time (time decay) if you sell an option, you benefit from this decay, provided the stock doesn't move significantly against your position before expiration.

• Credit Spreads: You sell an option while buying another of the same class and expiration but at different strike prices. This limits risk and reward but involves collecting a net credit (premium).

• Straddle or Strangle: These involve buying both a put and a call on the same underlying at the same expiration and strike (straddle) or the same expiration but different strike prices (strangle). You profit if the stock price moves significantly in either direction.

4 Key Tips For New Traders

1. Leverage: Options provide leverage, allowing you to control a large amount of stock for a relatively small investment. However, this amplifies both gains and losses.
2. Risk Management: Always have an exit strategy. Options can expire worthless, leading to a total loss of the premium paid.
3. Education: Learn about different strategies, how premiums are calculated, and how market conditions affect options pricing.
4. Practice: Before investing real money, use virtual trading platforms to understand how options behave under different market conditions.

Conclusion

Trading options premiums is about understanding market movements, volatility, and the time element of options. By selling options or employing strategies like credit spreads, you can potentially profit from the time decay of options, provided the underlying asset doesn't move significantly against your position. 

My approach to options trading relies on trading options premiums ONLY. This requires a good grasp of market dynamics and a solid risk management approach.