Trading Options: Using Technical Analysis to Design Winning Trades, + Website

CHAPTER 8

Introduction to Options

Derivatives are thought to be complicated and out of reach for most investors. They are considered the realm of financial engineers with degrees in astrophysics—true rocket scientists. They can indeed be very complicated, but the most basic ones are well within the reach of the general public. Exchange-traded funds (ETFs) are a great example, and so are options.

Options are derivative securities. All that means is that they derive their price from another security. In this chapter we focus on options basics. We define all of the important terms that characterize an option first. Then we discuss why options are useful and how they are different from stocks. Finally, we delve more deeply into two main building blocks of all options strategies, puts and calls. (Many of you who have a background in options may find this remedial; for others it may be a good refresher, or you may want to just skip to Chapter 9 on options combinations.) By the end of this chapter you should be able to understand and recognize the data in options tables. You should also know why options are useful for our trades and the basics of puts and calls.

■ Definitions

Options, aside from being a derivative, are also a contract. The contract has many standardized features. First is that it gives the holder, or buyer, the right, but not the obligation, to buy or sell a security at a predetermined price in the future. That price is called the strike price. A call conveys the right ...