In Today’s Stock Options for Dummies discussion, we aim to explain basic terminology about online trading.
To that effect, we are going to use options as a vehicle to convey some basic concepts to an audience that is not too familiar with trading in general and options trading in particular.
Such is the goal of today’s discussion titled Stock Options for Dummies.
Table of Contents
Stock Options for Dummies: Why?
Too often, I hear people around me say they wish they knew about the stock market so that they could make money.
Even more so when I mention that I trade options.
Their perception of trading options is that it is even more dangerous than trading stocks.
That is true.
Therefore, one must Learn To trade Options just like any profession that provides a revenue.
The stock market has been around for 227 years thus proving that it is not going away any time soon.
Most people invest passively through their Employer 401(k) each year.
Their money go into investment account put together by just the few professionals who have mastered the skills to design investment portfolio.
Our aim here is to share information about the market to demystify this idea that only the few can be knowledgeable about it or even profit from it.
Stock Options for Dummies: Who Is It For ?
Here are the basics.
The New York Stock Exchange as of the research of this paper has 7883 stocks.
We generated below two views displaying the distribution of these stocks based on the first Letter of the stock and the number of letters in each stock.
The Letter “C” is the most common first letter for a stock in the US market.
There are 640 such stocks starting with Citibank (ticker: C)
It is closely followed by the Letter “S” and the Letter “A” with 626 and 590 stocks respectively.
Only 36 stocks start with the Letter “Y” making it the least popular first Letter in all the traded stock as of today.
Of course, this number will fluctuate over time as new stocks are issued (primarily through Initial Public Offerings: IPO) or simply by name changes as was the case recently for VRX that became BHC.
I remember a story in Peter Lynch’s One Step Up on Wall Street about the number of Letters in a stock name.
It was of the tune how he liked 5 Letters stocks.
Well, Do you know how many of those there are in the market today ?
The pie chart below give us the Answer to that question.
There are only 212 stocks (or 3%) with exactly five Letters.
The majority of stocks have 4 Letters (58% more precisely) followed by 3-Letter stock with 36% of total.
Stock Options for Dummies: The Semantics
In just a couple of paragraphs above, assuming you managed to be captivated until this point, you have learned quite a few things about the stock market.
Next, we are going to take you through some basic terminology of stock options in order to start familiarizing yourself with the semantics.
Should you consider taking up on this profession later on, the terminology will no longer represent a barrier to entry.
What is a stock option or an option?
I will spare you the Investopedia’s definition we provided in an earlier chapter.
All you need to know is that it is something (a financial instrument) that is related can be traded.
How ? its value is a function of the variation of the stock it is defined by.
Some stocks we just reviewed in our opening sections will have options or will be called optionable.
That’s means that you and I can trade options on them.
Just as a reference, of the 7883 stocks we enumerated above, only 4188 are optionable.
The Market Makers (the brokerage firms) decide what stocks they want to write options on.
What is Options writing ?
Well, a stock option is just a creation from thin air.
So writing an option means deciding to sell that product.
Once the Market Makers do that, then retail (people like you and me) can do the same or buy with the hope of selling them at a higher price.
Options Strategies or Types
We will keep to the basics here.
In case you would want to really dive into it.
The types of options to trade depends on whether you think the stock (known as the underlying) will be going up or down.
The basic strategy for an upward direction is a CALL.
For downward direction, PUTS are the simplest strategy.
I like how Trader Travis uses the animals Bull and Bear analogies to described Calls and Puts.
Sellers and Buyers
From the names Bull and Bear come the adjective Bullish and Bearish.
This refers to traders who believe a stock will be going up or down respectively.
So, a bullish trader who buys call options can say “I am Long calls”.
For the traders who buy Put options on a given stock, they will be referred to as being Long Puts.
The key thin to understand in this process is that whenever a trader buy options, another trader (yes Market Makers are traders as well) takes the opposite side of that trade.
So if you are making money on your options calls for instance, this means that the seller(s) of those calls are losing money.
The way is work for each side is like this.
The sellers get the money at the beginning of the trade.
That is theirs to keep if the trade evolves in their favor over the time of the trade.
Otherwise, they get to cut their losses anytime the trade is going against them by buying the same position they sold at the beginning of the trade.
This last action is called closing your position.
The time of trade is from the moment buyers and sellers enter the trade to the expiration of the stocks option.
Standard expirations are every Friday for most stocks. Some stock have only monthly expirations on the third Friday of the month.
ETFs like SPY now have expiration on Mondays, Wednesdays and Fridays.
Yes, this is very recent (2018) .
It brings good opportunities for traders to make money fast but also for Market Makers to profit from.
Stocks options are sold in a quantity known as number of contracts.
This quantity varies from one to as may as a trader wants or is able to find a seller of.
We gave you a brief overview of the US stock Market as it stands in the Fall of 2019.
The naming of basic options strategies took us through some very basic strategies.
Our hope is that this entry level introduction to stock options will help you with the furtherance of your knowledge on How To Learn To Trade Options.
I hope you found this discussion valuable for your trading methodology.
If you would like to increase your knowledge and further your understanding of these concepts, may I suggest this similar article.
If you would like see how we put this information in application to make money trading Options, click here.
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