Options Math for Traders: How To Pick the Best Option Strategies for Your Market Outlook, + Website

CHAPTER 1

The Basics

The word option has come to mean many things beyond a financial instrument. The meaning includes the concept of choices or alternatives. In our context that’s appropriate because at the heart of an option is the fact that owners of options have a clear choice. They have the right to do something, but no obligation to do anything, once they’ve paid for the option. It’s this freedom, this choice, and this luxury of waiting that result in the unusual risk/reward profile for an option. The most that option owners can lose is the cost of the option. The amount that option owners can make is literally infinite in the case of a call option. On the other hand, the seller of an option has no choices other than the choice to reenter the market and repurchase the option, paying whatever the market demands.

Add to this element of choice the impact of an option being a wasting asset, since it will expire at some point, and we are left with a wonderfully nuanced instrument. All of these factors and others, such as the date of expiration as well as the price we’d pay or receive for the underlying asset, go into the calculus of considerations that is option trading.

OPTION SPECIFICS

A call option, often just referred to as a call, gives its owner the right to buy something. A put option, often referred to simply as a put, gives its owner the right to sell something. It’s an oversimplification in the extreme but instructive to say that if you think the price of something is ...