Alpha Trader Course
What you'll learn:
I. Introduction
- Understanding the importance of the options market
- Risk for sale
II. Basics
- What is an option?
- Two types of options – Calls and Puts
- Rights vs. obligations
- Options buyers have no other benefits associated with shares of stock
III. Terminology
1. Long and short
2. Understanding short sales
3. Roles of long and short positions
4. Reversing trades
5. Role of Options Clearing Corporation (OCC)
6. Derivative instruments
7. Underlying asset
8. Exercise price (strike price)
9. Expiration date
10. American vs. European styles
11. Exercise versus Assign
IV. Mechanics of Calls and Puts
1. Contracts are the unit of trade
2.Total exercise value
3. Options are standardized contracts
4. Classifications of Options
a. Types
b. Class
c. Series
5. Option premiums
6. Option premiums must reflect immediate benefits (intrinsic value)
V. Understanding Option Quotes
1. Bid and ask prices
2. Bid – ask spreads
3. Volume
4. Open interest
VI. More Terminology
1. Intrinsic value and time value (extrinsic value)
a. Option premium = intrinsic value + time value
b. Time value = premium – intrinsic value
2. Moneyness (In, at, and out-of-the-money)
d. Deep-in-the-money (deep out-of-the-money)
e. Moneyness and time value relationships
3. Parity
a. Conditions for parity
4. Time decay
a. Time decay only affects time value
5. Similarities and differences between stocks and options
VII. Option Pricing Principles
1. Principle #1: Lower Strike Calls (and Higher Strike Puts) are More Expensive
2. Principle #2: Longer term options are more expensive
b. Square root rule – option prices increase with the square root of time
3. Principle #3: All options are worth either zero or intrinsic value at expiration
b. How to capture missing intrinsic value at or near expiration
4. Pricing Principle #4: Prior to expiration, all calls must be worth at least the stock price minus the present value of the exercise price, or S – Pv (E).
a. Time value of money
b. Present value and future value
d. Minimum value for puts prior to expiration
5. Pricing Principle #5: The maximum price for a call option is the price of the stock.
a. The maximum price for a put option is the strike price
6. Pricing Principle #6: For any two call options (or any two puts) on the same stock with the same expiration, the difference in their prices cannot exceed the difference in their strikes.
7. The role of volatility on option prices
8. Risk, reward and option prices
9. Option price behavior derived from a simplistic stock price model
VII. Profit and Loss Diagrams
1. Constructing profit and loss diagrams by hand
2. Characteristics of profit and loss diagrams
3. Effects of reversing trades
4. Using profit and loss diagrams to determine the best strategy
5. Options are a zero-sum game
IX. Option Market Mechanics
1. Understanding and determining expiration cycles
2. Contract size (the multiplier)
a. Effects of whole and fractional stock splits
3. Effects of dividends on option prices
4. Understanding “open interest”
5. Risks of early exercise on call options for non-dividend paying stocks
6. Exercising a call to collect a dividend
a. Record date
b. Payable date
c. Ex-date
7. Put options can have early exercise advantage
8. Automatic exercise
9. Types of orders
a. Market order
b. Limit order
c. Multiple fills
d. Tick size
e. “Or-better” orders
f. All-or-none restrictions (AON)
d. Day orders and good-til-cancelled orders (GTC)
e. Stop and stop limit orders
f. Limit order display rule
g. Leaning against the book
10. What causes large bid-ask spreads?
X. Put-Call Parity and Synthetic Options
1. Understanding the put-call parity equation
2. Synthetic Options
3. Applications for synthetics
4. Valuing corporate securities as options
XI. An Introduction to Volatility
1. Simple option pricing model
2. Fair value
3. Using the Black-Scholes Option Pricing Model
4. The importance of understanding volatility
5. Direction versus speed
6. Separating price and value
7. Volatility moves sideways over time
8. Using volatility for better options trading
i. Understanding implied volatility
9. Volatility is relative
10. The effect of the Black-Scholes Model inputs on option prices
XII. Option Strategies
1. Covered call
2. Return calculations
a. Return if exercised
b. Static return
c. Breakeven return
3. Max gains and losses
4. Which strike to write
a. Writing in-the-money calls
b. Writing out-of-the-money calls
c. Writing at-the-money calls
5. Risk of covered calls
6. Hedging with covered calls
7. Early assignment
8. Buy-writes
9. Rolling up, down, out
XIII. Stock Replacement
1. Long options provide protection, leverage, and diversification
2. Delta considerations when using long calls as a substitute for long stock
3. Time dependence vs. path dependence
4. Two definitions of leverage
a. Control more shares with the same amount of money (risky use)
b. Control the same amount of shares with less money (conservative use)
5. Constant-dollar diversification
6. The roll-up strategy
7. Delta considerations when using long puts as a substitute for short stock
8. The roll-down strategy
XIV. Vertical Spreads
2. Vertical spread – definition and construction
3. Limited risk, limited reward profiles
4. Max gain, max loss, breakeven
5. Bull spreads - using calls or puts
6. Bear spreads - using calls or puts
7. Buying (selling) vertical call spread is same as selling (buying) put spread
8. Rationale for using vertical spreads
9. Early assignment considerations
10. Risk-reward considerations
11. Price behavior of vertical spreads
12. Time considerations