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3 Greek Terms Beginning Options Traders Need to Know By The Street
What does the Greek alphabet have to do with Wall Street? A lot. Delta, theta and gamma are important for traders to understand and how they impact your portfolio.
Options trading has given you the bug and though you're not quite ready to put money to work just yet, you're feeling good. You've gotten comfortable with knowing what a call and put are and the next time you're at a dinner party, people will be coming up to you to ask what a strike price is.
You're still understanding some of these basic terms to help you reach success when you hear a friend mention terms like gamma, theta and delta. After you're done freaking out, you realize the "Greeks," as they're collectively known, are actually pretty helpful and can aid you in understanding how sensitive the price of an option is to certain factors.
They're designed to help you understand the risks and rewards of your options, so understanding what they mean is the first step in your journey toward successful option trading.
Here are the three most important Greek terms and the importance behind them that every retail trader should know.
No it's not the airline you went on last week to visit your Aunt Gladys in Boca Raton -- delta is the share equivalent of your options position. This means that if you own a call or a put, it's the number of shares you're long or short.
If an option has 50 delta, it's essentially the same thing as owning 500 shares, says Adam Warner, author of Options Volatility Trading.
Why is it so important to understand? It's due to helping hedge (or limiting your exposure), says RealMoneyPro contributor Timothy Collins. "Often, new traders will incorrectly assume one option contract will provide the same exposure as buying 100 shares of a certain stock," he says. "An understanding of delta is critical in selecting the appropriate number of contracts to hedge the desired exposure."
Gamma may have been made famous thanks to Bruce Banner and the Hulk, but it's actually really important when it comes to options trading.
It's essentially the rate of change of your delta, says Warner. "If gamma is 100 and the stock goes up $1, the delta would be 600, so now you own the equivalent of 600 shares."
Traders should be cautious, though, because gamma isn't a straight line. As a result, it's important to know that a position can become more bullish or bearish as the value of change occurs, Collins notes. "If a trader doesn't understand this, they may find themselves far more exposed in the market than they intended," he says.
Despite what you thought, theta isn't the name of the fraternity or sorority you were in in college -- it's about time and the impact it has on options.
Theta is the time decay, or the amount of value your option loses as time goes on. As the option -- be it a put or a call -- gets closer to the expiration date, the value gets lower over time. Why is that? Simple, says Warner. "The more time an option has, more possible outcomes and it can move more," he says. "An option with more time can move more then an option with less time."
Time decay may be the single most important concept to understand in options trading, Collins notes, because of how much it can impact potential profits. "Theta is often the crusher of profits in option trading for buyers," Collins says. "It is important to understand the impact the clock has on your position and potential profits."
Understanding delta, gamma and theta are crucial for options traders and it's important to realize the impact they'll have on your portfolio. They'll help increase your chances for profit, while helping you sound like a Wall Street hotshot all in the same.
3 Options Terms Every Retail Investor Should Know
Options trading isn't easy, so before you begin, you should learn what the basic terminology is.
Sure, you know how to buy and sell a stock or a mutual fund. You know what an ETF is, and terms like "ex-dividend," "DRIP" and "short-selling" don't make you sweat.
But now that you're comfortable buying and selling stocks, there's a whole new world out there -- options. Options allow you to participate in the stock's day-to-day price movements without actually owning/shorting the stock. And you get in on the action at a much lower cost. These fast-moving and fast-money trades combine volatility, leverage and speculation to allow traders or investors to create additional wealth.
However, if you're not careful, they can blow up in your face and cause you to lose a small fortune.
Don't worry, though: while not for the brand new investor, options trading can be quite lucrative, and it's important to understand these tools, even if you don't use them right away.
Before you decide whether you should buy the Apple (AAPL) September $125 calls or sell the Tesla (TSLA) November $250 puts, you need to know what these options terms mean first.
Here are three options terms every retail investor should know.
A call is a bet that the stock price will move higher. So if you're really bullish on Apple going into its October earnings, you might buy a call.
However, you don't have to buy the stock, if you don't want to, says Adam Warner, author of Options Volatility Trading and a former market maker on the now defunct American Stock Exchange.
"It [a call] gives you the right but not the obligation to buy a specific stock by a specific date at a specific price," says Warner, who's been trading options for 28 years. "It helps minimize risk because you can only lose what you pay for the call, but it gives you unlimited upside."
A put is the opposite of a call -- it gives you the right but not the obligation to sell a specific stock by a specific date at a specific price.
Warner says: "It's safer than shorting and it's also a good hedging tool. You're hedging a long position, so it helps to hedge against downside risk."
So if you're really bearish about the prospects of a company like Mylan (MYL) or Wells Fargo (WFC) , both of which have seen tremendous amounts of negative press in recent days and weeks, buying a put on either of these companies may make sense for you.
Strike Price/Expiration Dates
Now that you know what a call and a put are, what are those numbers and letters next to the various options? Those are the specific strike prices and expiration dates.
"The strike price references the specified price of the call or put contract," says RealMoneyPro contributor and former hedge fund manager Timothy Collins. "The expiration date references the time period of the call or put contract."
So if you think Apple shares will hit $115 before November, you might buy the $115 Apple call option to help capture some upside in the stock.
Options trading isn't easy and it isn't for the faint of heart, so approach with caution. But understanding the terms and what they mean can increase your chances of success rather than wandering blindly into the fray.
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Profiting from Trading Stock Options
What Are Stock Options?
Options are financial instruments that give the right, but not the obligation, to engage in a future transaction on some type of underlying security. Buying a call option provides the right to buy a specified amount of a security at a set strike price at some time on or before expiration, and vice versa buying a put option provides the right to sell. Upon the option holder's choice to exercise the option, the options writer who sold, or wrote the option must fulfill the terms of the contract.
Options Trading Software Valuation Models
Theoretically the value of an option can be determined by a variety of techniques, software, systems, including sophisticated option valuation software models. These software models can forecast and predict how the value of the option will change with changing market conditions. The risks associated with trading and owning options can now be better understood and managed with higher degrees of precision with these options software models.
Different Types of Stock Options
Exchange-traded options are an important type of options which have standardized contract features and trade on public exchanges, allowing trading among independent parties. Over-the-counter options are traded between private parties, most times well-capitalized institutions, which have negotiated separate trading and clearing arrangements with one another. Another important type of option, particularly in the U.S.A., are employee stock options, that are awarded by a company to their employees as additional incentive compensation.
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