Options Trading Basics
Master calls, puts, strike prices, expiration mechanics, implied volatility, covered call income, and defined-risk spread hedging.
TL;DR
- Trade standardized options contracts controlling
one-hundred-sharesof stock. - Harness
covered-callwriting to generate recurring options premium income. - Buy protective
put-optionsto establish defined downside portfolio insurance floors.
Call And Put Fundamentals
Contract SpecificationsEach standard equity option contract controls exactly 100 shares.
Set contract specifications to contracts times 100.Strike Price (K)Pre-agreed price at which the contract holder can buy or sell.
Check whether current price is greater than strike price.Option Premium PricingTotal premium equals intrinsic value plus extrinsic time value.
Set option premium pricing to intrinsic value plus time value.The Option Greeks Overview
Delta (Directional Sensitivity)Rate of change of option price per $1 move in underlying equity.
Set delta (directional sensitivity) to delta times stock price change.Theta (Time Decay)Daily dollar loss of extrinsic option value as expiration nears.
Set theta (time decay) to theta.Vega (Volatility Sensitivity)Option price change per 1% change in implied volatility.
Set vega (volatility sensitivity) to vega times iv change pct.Income Generating Strategies
Covered Call WritingSelling out-of-the-money calls against 100 owned shares for yield.
Selling out-of-the-money calls against 100 owned shares for yield.Cash-Secured PutSelling puts backed by cash to acquire stocks at discounted entry prices.
Selling puts backed by cash to acquire stocks at discounted entry prices.The Options WheelSystematic rotation between cash-secured puts and covered calls.
Systematic rotation between cash-secured puts and covered calls.Hedging And Defined Risk Spreads
Protective Put (Married Put)Holding stock while buying a put to establish an absolute price floor.
Set protective put (married put) to entry price minus put strike plus put premium.Vertical Credit SpreadsSelling one option while buying a further OTM option to cap loss.
Selling one option while buying a further OTM option to cap loss.Protective CollarBuying a protective put funded entirely by selling a covered call.
Set protective collar to put premium minus call premium.Tips
- Sell covered calls with a
30-to-45-dayexpiration window to capture accelerated theta time decay while keeping strike prices out-of-the-money. - Always execute multi-leg option strategies as
defined-riskspreads to prevent unexpected catastrophic overnight margin losses.
Warnings
- Never sell naked
uncovered-optionsbecause naked calls carry mathematically infinite capital loss risk during runaway short squeezes. - Remember that long out-of-the-money options suffer unrelenting
theta-decaywhich erodes contract value every single day until expiration.
In Practice
Calculate upfront cash income, downside breakeven price, and maximum return for a 30-day covered call.
An investor holding 100 shares of stock at $100 writes a 30-day covered call at a $105 strike for a $2.50 premium.
- 1. Collect immediate option premium cash: 100 shares * $2.50 = $250.00 cash credited.
- 2. Calculate downside breakeven price: $100.00 stock price - $2.50 premium = $97.50 breakeven.
- 3. Outcome A: Stock closes at $95. Option expires worthless; net loss = ($95 - $97.50) * 100 = -$250 (vs -$500 if unhedged).
- 4. Outcome B: Stock rises to $110. Shares called away at $105: Stock gain = ($105 - $100) * 100 = $500.
- 5. Calculate total profit for Outcome B: $500 stock appreciation + $250 premium = $750.00 (7.5% 30-day return).
Covered call produces $750 maximum profit (7.5%) while reducing net share cost basis.
Covered calls generate immediate cash yield in exchange for capping upside profit potential at strike price.
FAQ
A call option gives the buyer the right (but not obligation) to purchase 100 shares of stock at a set strike price before expiration. A put option gives the buyer the right to sell 100 shares at the strike price.
A covered call involves selling a call option against 100 shares of stock you already own. You collect the upfront cash premium, but agree to sell your shares if the stock rises above the strike price by expiration.
The Option Greeks measure risk sensitivities: Delta (price change per $1 move in stock), Gamma (rate of Delta change), Theta (daily time decay), Vega (sensitivity to implied volatility), and Rho (interest rate sensitivity).