OM strives to always keep a hands-on approach that is not too heavy on theory. However taking shortcuts can prove to be dangerous and without even delving into complex modelling, a sound knowledge of options Greeks remains in any case an absolute prerequisite. So, this page is a preview on the preliminary course to address OM strategies, in the form of a short reminder on basics of options building blocks. Rest assured, there is no trading or knowledge prerequisite for this beginner course, so read on… don’t be frightened if the jargon looks overwhelming at first.
At the same time it also clarifies what Options Masters does or doesn’t cover in mentoring classes and coaching sessions. In particular we shall stay clear of common hedging techniques i.e. the strategies here presented do not comprise buying or selling the underlying instrument. There are indeed many ways to combine options and futures, buy synthetic options, that are overall either fairly academic or specific to hedging portfolios dynamically and we do need those in our strategies. That said, OM is meant to be an open-ended community, and nothing stops community members from delving into new areas of this massive field of knowledge.
A long call is a bullish to very bullish strategy with a limited downside risk. It is a long Delta surrogate to buy the underlying (in the US, one call generally represents 100 units of the underlying). The more OTM (“out of the money”) one starts, i.e. the cheaper, the more bullish one should be to end up ITM (“in the money”). At expiration, the breakeven point (BEP) is at the strike price + premium paid. Considering any option holds a time value, BEP can be lower during its lifetime.
This is the mirror image around a horizontal axis of the above i.e. diving when the underlying goes up. However one must keep in mind that a “naked call” here entails a risk of unlimited loss ! This is why this should be left to very experienced traders. Others should either opt for a spread or a covered call (see image). A covered call strategy resembles a short put (cf put-call parity): it involves writing a call option while at the same time owning an equivalent number of shares of the underlying (cf. note above about hedging). The Call strike does not have to match the underlying’s breakeven point.
If the Call expires worthless, the premium received is a little bonus. If it however expires ITM, the breakeven point is lowered by the premium received; deep ITM however still means trouble…
Note that we, at OM, do not invest in the underlying so covered calls are not part of our typical strategies. Please also check put-call parity on Google or here on Investopedia to better understand their mutual relationship.
A short Call (a.k.a. Naked Call) position is short Delta, short Vega and long Theta.
Likewise, a long Put is also a mirror image of a long call around a vertical axis. It thus also shows a limited downside risk. The more OTM one starts, i.e. the cheaper, the more bearish one should be to end up ITM. At expiration, the breakeven point (BEP) is at the strike price + premium paid. Considering any option holds a time value, BEP can be lower during its lifetime.
Same principle applies, i.e. a short put looks like a covered call as per the Put Call Parity formula.
Want to learn more?
Please take a look at this additional page and / or consult the Options Guide web page. It builds dedication and discipline to do one’s homework properly so it is quite positive and constructive. That said though, it can’t replace the immediate feedback from a live course, so please check our mentoring page and course description, or of course contact us any time for a personal assessment.