Options Investopedia Tips

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Buy

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the term "buy," can be replaced by the terms "long" or "hold."
buyers have all the rights; they've paid a premium for the rights.

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Sell

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The term "sell" can be replaced by the terms "short" or "write."
Sellers have all the obligations; they've received a premium for taking the obligation (risk).

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Options Matrix

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Options Contracts General Definition

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buyers have all the rights; they've paid a premium for the rights.
Sellers have all the obligations; they've received a premium for taking the obligation (risk).
think of an options contract like a car insurance contract: the buyer pays the premium and has the right to exercise; and can lose no more than the premium paid.
The seller has the obligation to perform when and if called upon by the buyer; the most the seller can gain is the premium received.

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Are the buyers of puts bullish or bearish?

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the buyers of puts are bearish. The market value of the underlying stock must drop below the strike price (go in the money) enough to recover the premium for the contract holder (buyer, long). The maximum gains and losses are expressed as dollars.
So to find that amount, we multiply the breakeven price by 100. If the breakeven point is 37, multiply by 100 to get the maximum possible gain for the buyer: $3,700. The maximum loss to the seller will also be $3,700.

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"Call Up and Put Down"

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It's true for the buy (or long) side ONLY.

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Time Value for Buyers and Sellers

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Because an option has a definite expiration date, the time value of the contract is often called a wasting asset. Remember: Buyers always want the contract to be exercisable. They may never exercise ((they will probably sell the contract (closing it) for a profit instead)), but they want to be able to exercise.
Sellers, want the contract to expire worthless because this is the only way that the seller (short) can keep the entire premium (the maximum gain to sellers)

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Four No-Fail Steps to Follow:
The FOS Four Option Steps

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Identify the 1.strategy
Identify the 2.position
Use the 3.matrix to verify desired movement
Follow the 4.dollars

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options premium formula

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Premium = Intrinsic Value + Time Value

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An investor is long 1 XYZ December 40 call at 3. Just prior to the close of the market on the final trading day before expiration, XYZ stock is trading at 47. The investor closes the contract. What is the gain or loss to the investor?
The four-step process:

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Identify the strategy - A call contract
Identify the position - long = buy = hold (has the right to exercise)
Use the matrix to verify desired movement - bullish, wants the market to rise
Follow the dollars - Make a list of dollars in out:
a situation in which a contract is "trading on its intrinsic value." The phrase, "just prior to the close of the market on the final trading day before expiration" means that there is no time value, and, therefore, the premium is made up entirely of intrinsic value.
Because the investor is long the contract, they have paid a premium. The problem states that the investor closes the position. If an options investor buys to close the position, the investor will sell the contract, offsetting the open long position. This investor will sell the contract for its intrinsic value because there is no time value remaining. Because the investor bought for three ($300) and sells for the intrinsic value of seven ($700), they will have a $400 profit.

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Intrinsic Value Chart

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cautionary note: The contract itself is in or out of the money, but this does not necessarily translate into a profit or loss for a particular investor. Buyers want the contracts to be in the money (have an intrinsic value). Sellers want contracts to be out of the money (no intrinsic value).

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Formulas for
Long Calls:

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Maximum Gain = Unlimited
Maximum Loss = Premium paid
Breakeven = Strike price + Premium
remember that whenever the buyer gains a dollar, the seller loses a dollar. Call buyers are bullish; call sellers are bearish. Look at the formulas: Simply swap the gains and losses and remember that both parties to the contract break even at the same point.

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Formula for Short Calls:

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Maximum Gain = Premium Received
Maximum Loss = Unlimited
Breakeven = Strike Price + Premium
remember that whenever the buyer gains a dollar, the seller loses a dollar. Call buyers are bullish; call sellers are bearish. Look at the formulas: Simply swap the gains and losses and remember that both parties to the contract break even at the same point.

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Formulas for
Long Puts:

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Maximum Gain = Strike Price - Premium x 100
Maximum Loss = Premium Paid
Breakeven = Strike Price - Premium

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Formulas for Short Puts:

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Maximum Gain = Premium received
Maximum Loss = Strike Price - Premium x 100
Breakeven = Strike Price - Premium

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Straddle Strategies and Breakeven Points

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straddle strategies always two breakeven points.
If an investor, for example, is buying a call and a put on the same stock with the same expiration and the same strike, the strategy is a straddle.
If the investor is selling a call and selling a put on the same stock with the same expiration and the same strike price, it is a short straddle.

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The essential straddle strategies (based on the Options Matrix)

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the arrows within the loop on the long straddle in the Options Matrix, you'll notice that the arrows are moving away from each other.
This is a reminder that the investor who has a long straddle expects volatility.
the arrows within the loop on the short straddle are coming together.
This is a reminder that the short straddle investor expects little or no movement.

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Straddle Follow the Dollars

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In a straddle, investors are either buying two contracts or selling two contracts.
To find the breakeven, add the two premiums and then add the total of the premiums to the strike price for the breakeven on the call contract side.
Subtract the total from the strike price for the breakeven on the put contract side.
A straddle always has two breakevens.

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Straddle breakeven on the call contract side

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add the two premiums and then add the total of the premiums to the strike price for the breakeven on the call contract side.

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Straddle break even on the put side

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Subtract the total from the strike price for the breakeven on the put contract side.

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Example - Straddle
An investor buys 1 XYZ November 50 call @ 4 and is long 1 XYZ November 50 put @ 3. At what points will the investor break even? AND between what two prices will the investor have a loss?

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Hint: Once you've identified a straddle, write the two contracts out with the call contract above the put contract.

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On a Long Straddle At what points will the investor break even? AND between what two prices will the investor have a loss?

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The investor must hit the breakeven point to recover the premium.
Movement above or below the breakeven point will be profit.

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Long Straddle Maximum Loss

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Because the investor in a long straddle expects volatility, the maximum loss would occur if the stock price were to be exactly the same as the strike price (at the money) - neither contract would have any intrinsic value.

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Short Straddle Maximum Gain

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the investor with a short straddle would like the
market price to close at the money to keep all the premiums.

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Formulas For Long Straddles

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Long Straddles:
Maximum gain: Unlimited (the investor is long a call)
Maximum loss: Both premiums
Breakeven: Add the sum of both premiums to the call strike price and subtract the sum from the put strike price

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Formula For Short Straddles

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Maximum gain: Both premiums
Maximum loss: Unlimited (short a call)
Breakeven: Add the sum of both premiums to the call strike price and subtract the sum from the put strike price

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Combination Straddles

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the investor has bought (or sold) a call and a put on the same stock but the expiration dates are different and/or the strike prices are different, the strategy is a combination. If asked, the calculation of the breakevens is the same, and the same general straddle strategies - volatility or no movement - apply.

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Spreads def.

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A spread is defined as an investor being
long and short the same type of options contracts (calls or puts) with
differing expirations, strike prices or both.
If only the strike prices are different, it is a price or vertical spread.
If only the expirations are different, it is a calendar spread (also known as a "time" or "horizontal" spread).
If both the strike price and expirations are different, it is a diagonal spread.
the investor is a buyer or a seller

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For this Spread complete Step 2 of the 4 step process-
Identify the Position:
Write 1 ABC January 60 call @ 2
Long 1 ABC January 50 call @ 8

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In spread strategies, the investor is a buyer or a seller.
When you determine the position, look at the block in the matrix that illustrates that position and keep your attention on that block alone
address the idea of debit versus credit. If the investor has paid out more than they have received, it is a debit (DR) spread.
If the investor has received more in premiums than they have paid out, it is a credit (CR) spread.
Here, there is one additional qualifier to the complete description of the spread. We can now call it a debit call spread. The spread has been established at a net debit of $600.
The investor is, in net terms, a buyer of call contracts.
In the matrix: buyers of calls are bullish. This is a bull or debit call spread. The investor is anticipating a rising market in the stock.

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For the Spread complete step 4 of the 4 step Process: Follow the Money
Write 1 ABC January 60 call @ 2
Long 1 ABC January 50 call @ 8

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write the $Out/$In cross directly below the matrix so that the vertical bar is exactly below the vertical line dividing buy and sell. That way, the buying side of the matrix will be directly above the DR and the selling side of the matrix will be exactly above the CR side.

the higher strike price is written above the lower strike price. Once you've identified a spread, write the two contracts with the higher strike price above the lower strike price to visualize the movement of the underlying stock between the strike prices.
The maximum gain for the buyer; loss for the seller and the breakeven for both will always be between the strike prices.

(DR) (CR)
$800 $200
$600

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Formulas for
Debit (Bull) Call Spreads:

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Maximum Loss: Net Premium Paid
Maximum Gain: Difference in Strike Prices - Net Premium
Breakeven: Lower Strike Price + Net Premium

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Formulas for
Credit (Bear) Call Spreads:

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Maximum Loss: Difference in Strike Prices - Net Premium
Maximum Gain: Net Premium Received
Breakeven: Lower Strike Price + Net Premium

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Break Even for call spreads
Write 1 ABC January 60 call @ 2
Long 1 ABC January 50 call @ 8

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CAL - In a Call spread Add the net premium to the Lower strike price.
Maximum loss: $600 - the net premium. If ABC stock does not rise above 50, the contract will expire worthless and the bullish investor loses the entire premium.

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CAL

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In a Call spread Add the net premium to the Lower strike price.

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Calculate Maximum Gain, Loss and Break Even for a Bull Debit Call Spread
Write 1 ABC January 60 call @ 2
Long 1 ABC January 50 call @ 8

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Maximum loss: $600 - the net premium. If ABC stock does not rise above 50, the contract will expire worthless and the bullish investor loses the entire premium.
Maximum Gain: Use the formula:
Difference in Strike Prices - Net Premium
(60-50) - 6 = 10 - 6 =4 x 100 = $400
Breakeven: Since this is a call spread, we will add the net premium to the lower strike price. 6 + 50 = 56. The stock must rise to at least 56 for this investor to recover the premium paid.
Notice that when the stock has risen by six points to the breakeven point, the investor may only gain four points of profit ($400). Notice that 6 + 4 = 10 - the number of points between the strike prices.
Tip: Above 60, the investor has no gain or loss. Remember when an investor sells or writes an option, they are obligated. This investor has the right to purchase at 50 and the obligation to deliver at 60.

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Write 1 ABC January 60 call @ 2
Long 1 ABC January 50 call @ 8
To profit from this position, the spread in premiums must:
Narrow
Widen
Stay the same
Invert

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Use the acronym DEW, which stands for Debit/Exercise/Widen. Once you've identified the strategy as a spread and identified the position as a debit, the investor expects the difference between the premiums to widen. Remember: buyers want to be able to exercise.
If the investor has created a credit spread, use the acronym CVN, which stands for Credit/Valueless/Narrow. Sellers, those in a credit position, want the contracts to expire valueless (no intrinsic value, worthless) and the spread in premiums to narrow.

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DEW

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Debit/Exercise/Widen.
Once you've identified the strategy as a spread and identified the position as a debit, the investor expects the difference between the premiums to widen. Remember: buyers want to be able to exercise.

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CVN

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If the investor has created a credit spread
Credit/Valueless/Narrow. Sellers, those in a credit position, want the contracts to expire valueless (no intrinsic value, worthless) and the spread in premiums to narrow.

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Formulas for
Debit (Bear) Put Spread:

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Maximum gain: Difference in Strike Prices - Net Premium
Maximum loss: Net Premium
Breakeven: Higher Strike Price - Net Premium

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Formulas for
Credit (Bull) Put Spread:

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Maximum gain: Net Premium
Maximum loss: Difference in Strike Prices - Net Premium
Breakeven: Higher Strike Price - Net Premium

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PSH

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For breakevens In a Put spread Subtract the net premium from the Higher strike price.

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Volitility Definition

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volatility refers to the amount of uncertainty or risk about the size of changes in a security's value. A higher volatility means that a security's value can potentially be spread out over a larger range of values. This means that the price of the security can change dramatically over a short time period in either direction. A lower volatility means that a security's value does not fluctuate dramatically, but changes in value at a steady pace over a period of time.
One measure of the relative volatility of a particular stock to the market is its beta. A beta approximates the overall volatility of a security's returns against the returns of a relevant benchmark (usually the S&P 500 is used). For example, a stock with a beta value of 1.1 has historically moved 110% for every 100% move in the benchmark, based on price level. Conversely, a stock with a beta of .9 has historically moved 90% for every 100% move in the underlying index.

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Covered Call Definition

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An options strategy whereby an investor holds a long position in an asset and writes (sells) call options on that same asset in an attempt to generate increased income from the asset. This is often employed when an investor has a short-term neutral view on the asset and for this reason hold the asset long and simultaneously have a short position via the option to generate income from the option premium.
This is also known as a "buy-write".
For example, let's say that you own shares of the TSJ Sports Conglomerate and like its long-term prospects as well as its share price but feel in the shorter term the stock will likely trade relatively flat, perhaps within a few dollars of its current price of, say, $25. If you sell a call option on TSJ for $26, you earn the premium from the option sale but cap your upside. One of three scenarios is going to play out:
a) TSJ shares trade flat (below the $26 strike price) - the option will expire worthless and you keep the premium from the option. In this case, by using the buy-write strategy you have successfully outperformed the stock.
b) TSJ shares fall - the option expires worthless, you keep the premium, and again you outperform the stock.
c) TSJ shares rise above $26 - the option is exercised, and your upside is capped at $26, plus the option premium. In this case, if the stock price goes higher than $26, plus the premium, your buy-write strategy has underperformed the TSJ shares.

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Hedge Definition

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Making an investment to reduce the risk of adverse price movements in an asset. Normally, a hedge consists of taking an offsetting position in a related security, such as a futures contract.
An example of a hedge would be if you owned a stock, then sold a futures contract stating that you will sell your stock at a set price, therefore avoiding market fluctuations.
Investors use this strategy when they are unsure of what the market will do. A perfect hedge reduces your risk to nothing (except for the cost of the hedge).