Trading Long Only Put and Call Options

Option trading as a complement to an investment portfolio

Why Consider Options Trading?

As an investor, you often face challenging decisions about managing your portfolio's risk and reward. Options trading can provide flexible solutions to common investing scenarios:

Scenario 1: Protecting Gains Imagine you hold stocks that have risen significantly in value. You're concerned about a potential market downturn but don't want to sell and trigger capital gains taxes. Buying put options can help protect your gains while maintaining your position, requiring significantly less capital than selling and repositioning your portfolio.

Scenario 2: Capitalizing on Opportunities Perhaps you've identified stocks in your portfolio that have declined substantially. You believe in their long-term potential but are hesitant to invest more capital to average down. Call options offer a way to potentially profit from a rebound while limiting your downside risk.

However, it's crucial to understand that options come with unique characteristics and risks:

• They have expiration dates, unlike stocks which you can hold indefinitely

• Options can expire worthless, particularly if they're out-of-the-money

• The key to successful options trading is establishing and maintaining strict risk management rules

This beginner's guide will help you understand the fundamentals of options trading. Whether you're new to options or looking to expand your knowledge, we'll cover the essential concepts, strategies, and risk management principles that can help you make informed trading decisions.

Options Trading Tutorial: A Beginner's Guide

1. What Are Options?

Options are financial derivatives that give the holder the right, but not the obligation, to buy or sell an underlying asset (such as stocks, indices, or commodities) at a predetermined price before or on a specified expiration date.

In this tutorial we will only be talking about long Puts and Calls.

There are two main types of options:

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

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

Options are traded on exchanges, and their value is influenced by various factors such as the underlying asset’s price, time until expiration, and market volatility.

2. Key Terminology in Options Trading

• Strike Price (Exercise Price): The price at which the underlying asset can be bought or sold.

• Expiration Date: The last date on which the option can be exercised.

• Premium: The price paid for the option contract.

• In the Money (ITM): When an option has intrinsic value (e.g., a call option is ITM when the stock price is above the strike price).

• Out of the Money (OTM): When the option has no intrinsic value (e.g., a call option is OTM when the stock price is below the strike price).

• At the Money (ATM): When the stock price is equal to the strike price of the option.

3. How Do Options Work?

Call Option Example:

• You buy a call option on stock XYZ with a strike price of $50, expiring in one month, and pay a premium of $5 per share.

• If XYZ stock rises to $60 before expiration, you can buy the stock at $50 (the strike price), making a profit of $10 per share minus the $5 premium, for a net gain of $5 per share.

• If the stock stays below $50, your option expires worthless, and you lose the $5 per share premium.

Put Option Example:

• You buy a put option on stock XYZ with a strike price of $50, expiring in one month, and pay a premium of $4 per share.

• If XYZ stock falls to $40 before expiration, you can sell the stock at $50 (the strike price), making a profit of $10 per share minus the $4 premium, for a net gain of $6 per share.

• If the stock stays above $50, your option expires worthless, and you lose the $4 per share premium.

4. The Basic Strategies in Options Trading

Here are a few simple strategies that beginner options traders can consider:

• a) Long Call

  • When to use: When you expect the price of an asset to go up.

  • How it works: You buy a call option. If the price of the underlying asset rises, the value of your call option increases. You can sell the option for a profit or exercise it.

• b) Long Put

  • When to use: When you expect the price of an asset to decline.

  • How it works: You buy a put option. If the price of the underlying asset falls, the value of your put option increases. You can sell the option for a profit or exercise it.

5. Factors That Affect Options Pricing (The Greeks)

Several factors influence the price of options, known as "The Greeks":

• Delta: Measures the rate of change in the option's price based on changes in the underlying asset's price. For example, if a call option has a delta of 0.5, the option's price would increase by $0.50 for every $1 increase in the underlying asset.

• Gamma: Measures the rate of change in delta for a $1 change in the price of the underlying asset. Gamma helps estimate how delta will change with fluctuations in the asset's price.

• Theta: Represents the time decay of an option's price. As options approach expiration, the time value decreases, and the option becomes less valuable. Theta tells you how much value an option will lose per day due to time decay.

• Vega: Measures the sensitivity of the option's price to changes in the volatility of the underlying asset. If volatility increases, options generally become more expensive.

• Rho: Measures the sensitivity of the option's price to interest rate changes.

6. Risk Management in Options Trading

Options can be risky, especially because they expire after a certain period. Here are some ways to manage risk:

• Only use money you can afford to lose: Since options can expire worthless, it’s essential to treat them as speculative and be prepared for losses.

• Use stop-loss orders: For both options and the underlying asset, use stop-loss orders to limit potential losses.

• Diversify: Don’t rely solely on options; ensure your portfolio is diversified with a mix of asset classes.

7. Common Mistakes in Options Trading

• Over-leveraging: Trading too many options contracts can lead to large losses.

• Ignoring the Greeks: Understanding how volatility, time decay, and price movements affect options is crucial to managing your strategy.

• Not having an exit strategy: Whether you plan to exercise your option or sell it before expiration, having an exit strategy can help you make better decisions.

• Chasing "cheap" options: Options that are too far OTM might be inexpensive, but they also have a low probability of becoming profitable.

8. Platforms for Trading Options

To start trading options, you’ll need a brokerage account with a platform that offers options trading. Some popular brokers for options trading include:

• Robinhood

• E*TRADE

• Charles Schwab

• Fidelity

• Interactive Brokers

Make sure to check the fees, margin requirements, and educational resources each platform offers.

Conclusion: From Understanding to Action

Options trading offers powerful tools for both protecting your portfolio and capitalizing on market opportunities. While the concepts may seem complex at first, successful options trading comes down to three key elements:

• Understanding the fundamentals

• Following a systematic approach

• Practicing disciplined risk management

However, one of the biggest challenges investors face isn't understanding options—it's knowing WHEN to make specific trades. This is where data-driven signals can make all the difference.

Our Trader's Edge system combines DynaLogic's proven zone technology with RSI readings to identify high-probability options trading opportunities. Since launch, this systematic approach has generated a 54.3% return compared to the S&P 500's 3.7%, with a 64% win rate on trades.

By combining the options knowledge from this guide with Trader's Edge's signals, you can:

• Take emotion out of your trading decisions

• Identify optimal entry and exit points

• Manage risk effectively through our proven system

• Capitalize on both upward and downward market movements

Ready to put this knowledge into action? Subscribe to Trader's Edge today and start receiving our daily options trade alerts, complete with detailed analysis and risk management guidelines.

Remember: Options trading involves risk, and past performance doesn't guarantee future results. Always trade within your risk tolerance and never invest more than you can afford to lose.

(Note: DynaLogic provides to subscribers relevant and real time market movement information on a host of equity securities. Signals (sell or buy) are based solely on mathematical changes in the price of a security. No other methodology is used.

DynaLogic is not a registered investment advisor, and it makes no representation or recommendation concerning the purchase or sale of any security investment product; DynaLogic provides no advice or recommendation whether a subscriber should or should not act on any signal a subscriber receives, and it has no knowledge whether a subscriber, in fact, acts on a signal or any signal; DynaLogic maintains no portfolio account or other investment information on any subscriber.)