Edit: this is for people who don’t understand how options work or the concept. It’s a simple version, with many other factors to consider. But this is the general concept of how it works. There are a lot of good experts on here that can help better with strategy and technical analysis. Do not take any examples as ways to strategize. It’s just made up examples.
Background: I’ve been trading options for over a decade and I have no financial or business background. I learned before it was popular online and I am self taught. So I’ll be explaining it the way I was able to understand it. There are better ways, but this is what helped me. I turned $1700 into $500,000 back in 2014.
Options are basically lay aways for shares. So let’s use a house as an example.
If you bought a house for $1M and I come and offer you $1.2M (the strike price). The catch is I have a certain amount of time to decide if I want the house. You cannot back out but I’m not obligated to buy it. So what’s in it for you? I offer you a $10,000 deposit that you get to keep no matter what happens. Now what?
I hold a CONTRACT between us that costed $10,000 and I give myself 6 month expiration date to decide if I want it. So now I am hoping the housing market goes up above $1.2M so let’s go over a few scenarios.
Benefit? I profit on a $1M house as if I own it even though I only paid $10,000.
MARKET RISES 1. The housing market goes up and it’s now worth $1.4M within 3 months giving me 3 more months on the contract. So the contract is worth at least $200,000 because if I forced you to sell it (exercise). So I can go around and sell the contract to someone else and say “look I can force them to sell for $200,000 today, so give me $200,000 + $20,000 for the 3 months because it could continue to rise. So they pay $200,000 to receive $200,000 in equity and $20,000 premium because the contract still has more time. Meaning if the housing market goes up to 1.5M The new owner of the contract can now exercise the contract (option) and profit $80,000 or 4X their investment.
MARKET DIPS 2. The housing market dips and the house is now worth $800,000. I would owe you $1.2M so I just wait the 6 months and hope it rises or I sell my contract $10,000 at a loss maybe like $3,000 to someone else hoping it jumps back up. Worse case if the time comes to an end i lose $10,000.
MARKET RISES BUT NOT MUCH. 1. You do not have to hit the price you bet to earn money. So if the market hits $1.1M within 1 month since there is 5 months left. I can sell the contract to someone else for more now thst it’s more likely to happen. So I can get $20,000 even though it didn’t go over $1.2M. I’m selling the contract to someone else and letting them hope it goes up.
Now translating to stocks.
1 option or contract is 100 shares per contract.
So if you buy 6 contracts for apple to hit $300 you have 600 shares on hold for you. Every dollar above $300 you earn $600. Because you only owe the owner $300 so everything above is yours.
So your call is you betting it goes up, and if you do a put, you are betting it goes down. Either way you will only ever lose the initial deposit or purchase price of the contract.
Stock example I bet Nvidia will hit $360 by feb22 so I needed to pay the owner $15 per share as a down payment. So it was $1500 for the 1 option. Now the closer it gets to the price I said it would hit the price of the contract goes up because it’s now more likely to happen.
So for example if I said your house will hit $2M by 3 months you wouldn’t believe it would happen so you would accept a lower deposit say $1000 now imagine something happens and 1 week later your house jumps to $1.4M. Since it’s more likely to happen I could sell the contract to someone else for $2500 because it’s not as crazy and I’ve made 150% in 2 weeks.
You don’t hold a contract till the date, you flip the contract to someone else when you make money on the deposit.
How are they priced? The crazier your bet the cheaper it is. Tesla at $2000 within 2 months is probably impossible so it would be cheap. Tesla at $2000 by 2024 is more likely so it would cost more.
I turned $1700 into $500,000 from options at 19 back in 2014. But I’ve also lost $100,000 in a day when fedex dipped when gas was low because they buy gas in 6 month intervals. So their earnings were low and the stock dipped. With not that much time left I lost it all. So if it’s your first time, give your self some time in the expiration date . So be careful.
Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence or consult your financial professional before making any investment decision.