Should I buy long single options like puts and calls?
Never. They have never been statistically proven with any significant market study to be a successful trade on a long-term basis. Sure you might get lucky here and there but long term you will lose money because option pricing is always overstated by implied volatility. This means that options are long-term slightly overpriced compared to the expected move of a stock. Don’t let anybody tell you otherwise - the numbers don’t lie.
What is the difference between front and back month options?
Front month options are the closest monthly contract that you are able to trade. Back month options are any other options that are not front month options. For example, if today is January 1st then the front month contract would be the January expiration and February or March would be the back month expirations. Note that you will also see weekly contracts between all of the monthly expiration but when we generally refer to the front and back month options we are talking mostly about the monthly contracts.
What is delta and why is it important for my option positions?
Delta is one of the four major Greeks that we use to measure possible risk/return. Specifically delta compares the ratio of the change in price of the underlying stock to the change in price of the option contract. This is sometimes referred to as a “hedge ratio”. For example, if the delta of a call option is 0.70 that means that for every $1 move higher in the stock, the option should increase in value by a factor of 0.70 and visa versa for a $1 move down in the stock. As options traders, delta is also an important relative measure of probability of success (see our video tutorial on this inside the library). We can also use delta to hedge other positions in the portfolio. If we have a short position with a -0.80 delta we can look to add another position that has a 0.80 positive delta to neutralize the risk of the first position.
How do you figure out the probability of a strike price being ITM at expiration?
There are 2 basic ways to figure this out. First, you could use delta as an approximate assumption though it’s not as reliable as the second choice we’ll talk about. If a strike price has a delta of 0.30 then that means there is approx. a 30% chance that the strike will be ITM at expiration or a 70% chance it won’t. The second way to figure this out is to use an ITM probability calculator on your broker platform. We cover this in specific video tutorials here in the platform but you would basically just look at each strike price and the columns next to the strike prices would show the ITM probability as an exact number - i.e. 28.75% exactly vs a 0.30 delta.
Why can’t we just buy options - is there a real “edge” to selling options?
Yes. You are completely free to buy options and I would be glad to sell them to you all day long because overtime option sellers are far more profitable than option buyers as a result of the fact that implied volatility always states the expected underlying move and option pricing is always too rich long-term. For example, a stock might have current implied volatility of say 20% over the next year in which case the options market prices the options expecting a 20% move in the stock up or down. When that year actually plays out the stock might only move 15% up or down, which is less than expected, meaning the options overpriced the move in the stock by a 5% margin. This margin is our “edge” as an options seller.
What does the “100” mean next to an option contract?
The 100 next to an option contract is that contract’s multiplier factor. The 100 designates that each 1 option contract controls 100 shares of underlying stock. Contract multipliers just give us an easy definition of the underlying contract size. For most options that we will be trading, the contract multiplier is 100 meaning that every 1 option controls 100 shares of the underlying stock or ETF. This is where you find the power of leverage with options.