Options are…anyone? Anyone? Bueller?

Ok, pay attention now, class.  We are about to begin your options education.

Actually, if you rely on this to learn all about options, you are doing yourself a great disservice.  By no means am I am interested in writing a text book, so most of what you’ll get here will be just the basics.  If you’re interested in learning more, here is some recommended reading you might want to consider:

• Sheldon Nantenberg:  Option Volatility & Pricing
• Guy Cohen:  The Bible of Options Strategies
• Nassim Nicholas Taleb:  Dynamic Hedging

So…let’s start with the basic question:  What is an Option?

An option is a contract.  It is a contract that allows you to buy or sell an underlying asset at or before a specified date.  It does not obligate you do so; it just gives you the right.  Should you decline to exercise this right before said date, the option expires.  However, should you choose to ‘fight for your right to party’, the seller is obligated by the contract to take the opposite side of the trade (an in case you’re the seller – aka. short calls or puts – this is called an assignment).

While I personally only deal with ‘stock’ options, you can have them on virtually any asset that you wish.  You can have options on futures, commodities, real estate…hell, you even have options on the VIX, which is kind of like having an option on a bunch of other options!

Speaking of VIX, one thing I do not plan on getting into is all this advanced valuation, volatility smile, Black-Scholes, Monte Carlo nonsense.  Just know that people much smarter than you developed a bunch of computer models which are now at the bidding of Market Makers whose only job is to fuck you on your trade.  So if you think there is rampant manipulation in stock trades, just wait until you try some options trading!

Oh, and again speaking of my perspective…I only trade ‘American’ options.  These are the ones that most are familiar with, I believe – they can be exercised at any time before their expiration dates.  ‘European’ options, on the other hand, can only be exercised on their expiry date.  These 2 styles are both ‘vanilla’.

Yes, that does mean that there are ‘exotic’ styles, too.  These involve seemingly random rules, such as you can only exercise if the Moon is in the 2nd pass and Jupiter aligns with Mars, or some such.  Frequently, they are also options on multiple instruments, such as stocks combined with currencies.  Look here for some other funky combos.

One exotic that has gained some traction in recent years is the ‘binary option‘.  As the name implies, you either win or lose, there is no middle ground.  You get a fixed amount if you win (doesn’t matter by “how much”); you get nothing if you lose.

So that’s it.  We’re done!  Thank you for attending, hope you have a nice day!

Oh ok, here’s a bit more handholding:

How To Read an Options Quote:

Best explained with a concrete example:  SPY Jun’09 90.0 call @ $5.50, where:

• SPY – James Bond!  Or the underlying instrument’s symbol.
• Jun’09 – the expiration date (usually the 3rd Friday of the stated month)
• 90.0 – the price at which the contract will change hands if exercised
• call – the type of option.  There are only two types:  calls & puts.
• @ – ‘at’.  Apparently this symbol is not quite as modern as you’d think…
• $5.50 – the ‘premium’/price paid per share.  Keep in mind, that 1 contract usually represents 100 shares of the underlying.  So this specific option would cost $550.

So that’s it for now.  Come back next time for some boring definitions, some of which may be clad in white togas and strappy sandals.

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