Allow me to bestow some fruitful knowledge upon you savages. Firstly, buying out of the money weekly calls based on some narrative a wall street bets Robinhooder regurgitated is far from a wise investment strategy. If you’re on this path now, finish this blog, then rotate into the SPDR sectors for the time being.
Bullish (long) = buying calls / selling puts
Bearish (short) = buying puts / selling calls
Know your greeks & what intrinsic value means:
Intrinsic value is the difference between the strike price of the option and the current stock price. the intrinsic value of an option is tied to the stocks movement, which you’ll notice when looking at the in-the-money options and out-of-the money options; the closer the strike is to the current stock price, the more intrinsically valuable it will be. therefore, out-of-the money options have both lower premiums and intrinsic value.
Time value (extrinsic value): we’ve established that options with more time remaining will have higher cost associated with it as opposed to an option closer to expiration. this is based on a probability; the more time before expiration, the higher chance it has to increase in intrinsic value. smart investors simply won’t pay high prices for options that are set to expire soon, this is specifically why i liken weekly calls to gambling and why the fintwit peanut gallery has graced the weekly at-the-money options with a fitting moniker: lotto’s. (as they expire the same day, and usually expire worthless…uh, ya think?)
Time decay (theta, we’ll get to this) is the rate of decline in the value of an options premium due to the passage of time. time decay accelerates as expiration comes closer.
High premiums tend to benefit options traders, but once the seller has initiated the trade and gets paid their premium, they’ll want the option to expire worthless so they can cash in.
Sellers will benefit with time decay, therefore measuring the decline rate with theta (time decay). theta is usually expressed in negative numbers and represents the amount an options value will decrease per day.
Selling options is a positive theta trade, which means the position gains profit as time decay accelerates. as the option value declines, the seller is free to close it their position by buying back the option at an even cheaper premium.
If you’re going to start selling options, you have to get a comfortable understanding of “volatility”. this is the rate of price fluctuation in the stock and the overall expectation of volatility which is quantified in “implied volatility” (or vega, another greek to know well). this is essentially the doppler radar to price movement.
A simple reference: if a stocks implied volatility is high, the cost of the options will likely be high as well.
Vega (implied volatility) fluctuates up and down depending on the markets supply and demand for the option contracts. more buying will inevitably inflate the contract premium and get fomo buyers in the mix. vega is part of the extrinsic value and inflate or deflate premiums in a flash.
Remember when i said the greeks are a big deal? here’s another one to know well: delta. this little sucker determines precisely how much an option will increase if price moves in your contract’s favor. this is a solid measure of price change in an option’s value v.s. the rate of price changes in the stock.
A delta of 1.0 means the option will move dollar-for-dollar with the stock price, where as a delta of .25 will move 25 cents on the dollar with the stock price. therefore an option trader selling premium would say a delta of 1.0 means the contract will be 1 cent in the by the time it expires.
The further out of the money, the higher probability of success is when selling the option with the threat of being assigned if the option contact is exercised.
The greeks to know are as listed:
Since we’ve covered the first 3, heres gamma: the rate of change in an options delta per 1 point move in the stock price. gamma is a convexity measure of an option’s value and is the first derivative of delta, which is used when gauging an options price movement relative to the amount it’s out of the money. the deeper o.t.m., the smaller the gamma. the nearer to the money a contract is, the more gamma it will have. since delta is only reliable for a short period of time, options traders will use gamma to give them a more concise forecast of how the delta will change as the price changes.
Long positions have positive gamma | Short positions have negative gamma