Good Kids Trading is a community of ordinary people who all share an interest in trading options. Some good kids (we like to refer to members as 'good kids') rely on trading as their primary source of income, others see it as a pleasurable part-time job, and some are simply trying to navigate their way through the process. Personally, I belong to the category of people who consider it a side-hustle. I have “graduated” from the trying to figure things out category but let’s face it, there is always so much to learn about trading I think I’ll always be figuring something out.
If you are new to options let me help you with this series of articles. In this series I endeavor to explain the basics for someone new to options and options trading. I'll also share my experiences so you can learn quicker and avoid some of the mistakes that I made when I first started out. For those of you who already are familiar with the basics, check out this article on risk management for the options trader.
What is a stock option?
Soon after I got a handle on the basics of trading shares of stocks, I explored my broker and came across options trading. I was honestly put off by it at the start. Obligation to buy or sell versus right to buy or sell seemed so confusing. On top of that, I recalled that most of the financial guru’s I came across said that options were risky and should be avoided. Maybe they are right for most folks who don’t want to take the time to learn. For me, this advice was a disservice because I was willing to learn. I just didn’t know where to start. I've since found that trading options made more profits with less risk compared to trading shares.
Before we go any further, there are options for ETF’s, futures, and even crypto. For the sake of simplicity, I will be referring to options on stocks in this series, but the concepts apply to all option markets.
A stock option is a contractual agreement between the buyer and the seller over 100 shares of stock. Just as with any transaction, for every buyer there is a corresponding seller. When you trade options, you are either buying from or selling to someone else. The only negotiable portion of the contract is the price or amount of premium transferred from the buyer to the seller. All of the other terms are “take it or leave it” in nature. There are 5 main terms to options contracts:
Stock or Underlying – Each contract covers exactly 100 shares of the stock.
Expiration Date – This identifies the date that the contract is valid through.
Strike – This is the agreed upon price of the stock that the option will execute on, if it is executed.
Premium – This represents the cost of the option. The buyer of the option pays the premium to the seller of the option. Keep in mind the posted premium represents the cost for only one share. Multiply this price by 100 or move the decimal two places to the right to calculate the true premium exchanged per contract.
Calls or Puts – More on this below!
The premium is the only negotiable term in an option contract. If you don’t like the stock, time, or strike, find one that you do like and trade that!
Breakdown of a Typical Options Page.
These pictures are from tastytrade which is a very easy to use trading platform that was created for options traders by options traders. All major broker’s option pages will look similar though.
Indicates the stock symbol
All dates are expiration dates for the options contract.
By default the left side shows call options and the right sight has the put options
Since this is an article on the basics, we won't get in the weeds with the other features on this page.
What are Call Options?
Call options give the buyer the right to buy 100 shares of stock from the call option seller at the strike price on or before the expiration date. The buyer can choose to execute the option at any point in time up to the close of market on the expiration date. The seller must comply with the decision of the buyer and has no say in the matter.
What are Put Options?
Put options give the buyer the right to sell 100 shares of stock to the put option seller at the strike price on or before the expiration date. The buyer can choose to execute the option at any point in time up to the close of market on the expiration date. The seller must comply with the decision of the buyer and has no say in the matter.
Call Options vs Put Options
The main difference between call and put options is that call options allow the buyer to BUY 100 shares of stock and put options allow the buyer to SELL 100 shares of stock. This article will not go into specific strategies. Other articles in other series absolutely will. Instead, this article will solidify the foundation and understanding of the basics which all option strategies build upon.
Buying vs Selling Options
In both call and put options there is a buyer and a seller. The buyer and the seller are just two people connected over the internet, through a broker, who happen to have exact opposite opinions on what will happen in the future. This is no different than trading shares of stock. The buyer of shares thinks the price will go up while the seller thinks the price will go down.
With options, it isn’t quite as simple as “buy if you think the price will go higher and sell if you think the price will go lower.” Right now, it is more important to focus on what the buyer and seller agreed to!
Option buyers pay a price for time and uncertainty to purchase the right, or ability, to buy or sell 100 shares of stock depending on if it is a call or put option, respectively. From a profit potential standpoint, the buyer doesn’t know how much they stand to make. The buyer can only lose the amount of money they paid when they entered the trade. To put it another way, option buyers have a defined amount of risk and an undefined profit potential.
Option sellers are paid a premium from the option buyer. While the option buyer knows exactly how much they can lose when they enter a trade, the option seller knows exactly how much they can make. This is worth repeating. An option seller’s maximum profit potential is the premium they are paid at the beginning of the trade! Selling options by themselves comes with undefined risk. To offset this scary statement, the option seller benefits from time passing. Every day that passes brings the contract closer to expiration which means there is less time for the seller to be wrong. Similarly, when the price stays away, or even better, moves away from the strike price, this also benefits the option seller.
Which is better?
When I learned the differences between buying and selling options, I recall thinking that buying options was the clear winner. If things went wrong, I could only lose so much, and if things went the way I wanted, I could make a huge profit.
After a few years of learning and trading, I’ve found that I significantly prefer selling options. Options tend to be overpriced and selling overpriced options works better for me than buying overpriced options. In fact, selling options is the basis for many of GKT’s strategies.
There is a place for both buying and selling options in a trader’s portfolio which is why it is important to have a good grasp of both.
Putting it All Together
In this article we covered the basics of call and put options. We also discussed the key differences between buying and selling options. When we trade shares of stock, we have two ways to trade: buy shares or sell shares. With options trading, there are four ways to trade:
Buy Call Options – Check out GKT’s Beginner’s Guide to Buying Call Options
Sell Call Options – Check out GKT’s Beginner’s Guide to Selling Call Options
Buy Put Options – Check out GKT’s Beginner’s Guide to Buying Put Options
Sell Put Options – Check out GKT’s Beginner’s Guide to Selling Put Options
Behind each way to trade there are some nuances that must be understood and appreciated and an entire article is dedicated to each. For a little teaser, check out this chart that shows what you want the stock’s price to do for each possibility.
If you are intrigued by any of this, join our discord community! We make real trades daily and share both our successes and our failures. As a community we grow and learn from each other. Even if you are just starting out, there is a place for you at GKT!