Getting Started
What Is an Option?
An option is a contract that gives the buyer the right — but not the obligation — to buy or sell an underlying asset at a predetermined price on or before a set date. The buyer pays a premium for this right. The seller collects the premium and accepts the corresponding obligation.
Calls vs. Puts
A call gives the right to buy; a put gives the right to sell. Call buyers profit from rising prices; put buyers profit from falling prices. The relationship is symmetrical — for every call buyer there is a call seller (writer), and the same for puts.
Intrinsic vs. Extrinsic Value
The price of an option has two components. Intrinsic value is the amount an option is in-the-money — zero if out-of-the-money. Extrinsic value is everything else: time value plus implied volatility premium. All out-of-the-money options are 100% extrinsic value.
The Options Chain
The options chain lists every available strike price and expiration date for a given underlying. Understanding how to read an options chain — open interest, volume, bid/ask spread, implied volatility — is foundational to execution.
Core Concepts
Implied Volatility (IV)
IV is the market's forecast of future volatility, embedded in option prices. When IV is high, options are expensive. When IV is low, options are cheap. IV is mean-reverting — this is the basis for the volatility crush strategy around earnings.
Historical Volatility (HV)
HV measures what an asset actually did over a lookback period. Comparing HV to IV tells you whether options are relatively expensive or cheap versus actual past moves. A wide IV/HV spread can signal overstatement of risk by the market.
Put-Call Parity
Put-call parity is the relationship: C - P = S - K/(1+r). It ensures no arbitrage exists between calls, puts, and the underlying. Violations of put-call parity, when they appear, are quickly arbitraged away — but understanding the formula clarifies the entire pricing structure.
Expiration and Assignment Risk
Long options expire worthless if they finish out-of-the-money. In-the-money options at expiration may be automatically exercised. Short options face assignment — early assignment on American-style options is always possible and must be managed.
The Greeks
Delta — Direction Risk
Delta measures how much an option's price changes for a $1 move in the underlying. Calls have positive delta; puts have negative delta. A delta of 0.50 means the option behaves like 50 shares of stock. Delta also approximates the probability of expiring in-the-money.
Gamma — Rate of Change of Delta
Gamma measures how fast delta changes when the underlying moves. Long options have positive gamma; short options have negative gamma. Gamma is highest for at-the-money options near expiration — which is why near-term options can become unstable.
Theta — Time Decay
Theta measures how much value an option loses each day as time passes — the "time decay." Theta accelerates as expiration approaches, particularly for at-the-money options. This is the enemy of option buyers and the friend of option sellers.
Vega — Volatility Sensitivity
Vega measures how much an option's price changes for a 1% move in implied volatility. Long options always have positive vega; short options always have negative vega. In high-IV environments, vega risk becomes a primary concern for both buyers and sellers.
Core Strategies
Covered Call
Sell a call against 100 shares you own. You collect premium but cap your upside at the strike price. Effective in flat-to-slightly-bullish environments. The tradeoff: you give up upside participation in exchange for income.
Protective Put
Buy a put against shares you own. You pay a premium for downside protection below the strike. Like insurance — costly if nothing goes wrong, invaluable if something does. Often used ahead of known events.
Bull Call Spread
Buy a call and sell a higher call. Buys upside participation at lower cost but caps the gain at the short strike. Net debit. Works well when you expect a moderate move higher rather than a large one.
Iron Condor
Sell an OTM put spread and an OTM call spread simultaneously. Profits when the underlying stays within a range. The tradeoff: defined risk on both sides, limited profit if the underlying stays flat. Best in low-vol, range-bound environments.
Tools We Use
We use OptionsStrat to visualize and analyze options strategies — including break-even points, max profit/loss zones, and probability distribution across strike prices. It's particularly useful when building or reviewing complex multi-leg positions before entry.