hey everyone it's kirk here again at
optionalpha.com and in this video we're
going to go through the differences
between buying options and selling
options now as a quick review there are
only two types of options contracts out
there calls and puts and everything you
can do in this space revolves around
these two types of contracts now until
now in our track one here for beginners
we've only really talked about options
buying not really talked about selling
we've mentioned that there's an option
seller but it's kind of been like this
person who's on the other side of the
trade we haven't really talked about how
they can actually build a position in a
core position selling options versus
buying and how that can be the basis for
trading for income
so let's start with this kind of table
here because i think it goes through a
little bit of the rights and
responsibilities that we need to be
aware of as traders when it comes to
buying or selling calls and puts now
remember there's two sides to every
trade so you always have a buyer you
always have a seller and then we can
only ever trade calls and puts so
there's really four types of basic
options
that we can get into we can buy calls
and puts or we can sell calls and puts
in this case the option buyer for a call
option has the right to buy stock at a
certain price in the future now again if
you are an option buyer you are
generally outlaying money in premium so
when you pay for something you get back
a right
for making a choice in the future you're
paying for that choice so again as an
option buyer they have the right to buy
stock at a certain price in the future
option buyers might buy a call option on
a 50 strike
stock and say they want to buy that
stock for fifty dollars a share at any
time in the future between now and
expiration
on the other hand a put option buyer has
the right to sell stock at a certain
price in the future so again they're
still paying money to the option seller
so they still get a right just like the
call option buyer but now instead of
wanting to buy stock they want to have a
guaranteed sell price at where they're
going to sell that stock in the future
okay so they might want to sell stock at
fifty dollars
and hope that the stock is trading for
thirty dollars and they can buy it in
the open market for thirty and resell it
for fifty okay so again the key here
with option buyers is they pay money
they have to outlay the money the cash
the capital
and for doing that they receive a right
back from the option seller or a choice
back from the option seller
now on the other side of the table here
we have the option sellers now the
option sellers now have the obligation
because they gave up their right to the
option buyer now they have the
obligation to sell stock at a certain
price in the future but here's the key
only if it's expiration or they are
assigned okay so this is the key it's
not like this can happen
at any point and you give up well it can
happen at any point but you don't give
up your right to do something with the
actual options contract because you can
close out of the options contract
and sell your contract to somebody else
or buy back your obligation you can do a
lot of things so the obligation to sell
stock only happens at expiration or if
they're assigned early in the process
now we have more videos about the
assignment process
here in the first track and module here
at option alpha and really most of these
assignments happen the last week of
expiration even the last few days so i
don't want you to get totally like your
feathers ruffled that this is going to
happen immediately when you get into a
contract it does happen the last week
usually the last couple days but again
the key here is as an option seller you
have an obligation to sell stock if you
agree with an option buyer that they're
going to buy stock from you at 50 you're
going to sell it to them at 50 you have
to sell it to them at 50 if that
contract actually comes all the way
through expiration
on the put side it's the same thing you
have an obligation now as the option
seller of that put option you have the
obligation to buy stock from that option
buyer who's going to sell it to you at
whatever the predetermined price is so
if that option buyer that put option
buyer says that they're going to sell
you stock at fifty dollars then you have
the obligation to buy stock at fifty
dollars your hope as the option seller
is that the stock is worth more because
now you're going to buy option buy stock
at 50 and then resell it in the open
market for some higher price but again
the key here is that the seller is now
collecting money from the option buyer
so money goes from the option buyer to
the option seller and then the right
gets transferred from option seller to
option buyer so that's the cycle that's
the process and again it works on both
calls and puts
now we also built this little graphic
here which i think is really cool this
kind of like a four part
graphic that shows you kind of what your
expectation is for the actual underlying
stock whatever you're doing okay in this
case if you are let's just kind of go
through all these different examples if
you are a call option buyer in this case
then you are hoping that the stock price
rises that's your hope you're buying a
call option in anticipation that the
stock price is expected to rise in the
future
if you are a put option buyer then your
hope is that the stock price actually
falls so you want to see the stock price
fall below your strike price that you
entered into
as a call or put seller on either side
this is where we start to really
distinguish the difference in this
non-directional trading as a call or put
option seller remember that you are
taking in a premium and really
the onus or the
the
need for that option or that stock to
move for you to lose that premium is
really on the option buyer so by taking
in that premium you also get the
additional benefit because you gave up
your rights
for the stock to actually move sideways
and still make money so in both the case
of a call and put if the option were to
move sideways meaning to trade range
bound or just move sideways and not
really trade higher or
excuse me higher or lower then you would
actually still make some money now you
do want as i call seller you want the
stock price to fall remember option
buyers on the call side want the stock
price to rise
you want the stock price to fall
as a put seller you want the stock price
to go up or generally stay sideways and
again we'll continue to go through many
many more examples but hopefully this is
a really good graphic that you can use
print this out put it by your desk
and use it as you start to learn and
develop a little bit more trading skill
with whether you want to be an option
buyer or seller calls or puts this is a
really cool graphic that we made for you
all right so now let's review the
differences between credits
debits and opening and closing when
trading options because now we're
starting to get a couple more choices or
options no pun intended on how you can
build different strategies and it's
important to know how money is
transferred and how the order types go
through okay all right so here's the
deal now it doesn't matter in this case
whether you are doing or using this for
calls or put options because they work
both the same way and it really depends
on if you're going to be long options or
short options meaning if you're going to
be buyers in this case buyers long and
sellers which is short okay now let's go
through some examples here and we'll use
another graphic this is a great little
resource that you can print out and put
by your desk as well but if you are
let's say long meaning buying and you
want to buy to open because that's
usually how you start the option buying
process you have to buy to open a new
position and that's really the key here
is buy to open sometimes you'll see
broker platforms we'll put in here
btc
which is buy i'm sorry bto and we'll do
btc in a second but bto which is buy to
open again if you're going to buy to
open something you're going to outlay
money and that is called a debit so this
means that you are paying money
to the option seller to open a new
position okay now when you go back and
you want to reverse that trade because
again you have a choice to reverse that
trade any time between now and
expiration you don't have to hold on to
that trade all the way through
expiration you can go back and
remove your position and kind of sell
out of the position if you want to now
you're still long the position initially
but now you're going to go in and you're
going to enter a cell to close order and
again your broker might show this as
stc an stc order which is sell to close
don't get confused by the terminology
and all the acronyms you understand
exactly what it means it's just logical
uh progression and thought process that
we want to follow
so we already have a long option we want
to go back in and exit the trade we want
to use a sell to close order and when we
do sell that option back to the market
we're going to hope that we collect a
credit for doing so i mean we're going
to collect the credit we just hope we
collect more than the debit so in this
case if we paid a debit of let's say
five dollars we just bought an option
for five dollars we hope that we collect
a credit when we sell it back up seven
now we've realized a two dollar profit
on our trade beginning to end we bought
to open then we sold to close we paid
five dollars then we received seven at
the end we ended up with a net profit of
two dollars at the end of the day okay
just using basic numbers
now on the other side if you're going to
be an option seller first meaning you're
going to enter a short position whether
you're shorting calls or shorting puts
you're going to enter that first order
as sell to open so there's a little bit
different this is where some people get
a little confused but again just follow
me on this an sto order okay some
brokers might show that some other
brokers might not but you're going to
sell to open a new position now this is
going to be the other position that
someone else bought on the top side so
an option buyer would buy open and they
would be opening a position with an
option seller who is at the same time
opening a new position so two people are
opening a brand new position on either
side of the market in this case you're
gonna take in a credit now remember the
debit that the option buyer paid was
five dollars so you're going to take in
that five dollar credit in this case
with that option buyer now later on if
you decide to close out of your position
again you're hoping that you can make
at least five dollars on the trade maybe
something a little bit less but that's
the maximum amount you can make you
can't make more than the credit that you
received on the trade so you're going to
hope that you go back in again you still
have a short position
and you're going to buy to close out of
your contract so again this is on some
broker platforms going to be a btc buy
to close so you're going to buy to close
and you're going to pay a debit now
you're going to hope that you collect
let's say a 5 debit from that option
buyer
and somewhere else down the line you buy
back your contract and close out of the
position and let's say it only costs you
three dollars to buy out of the position
now you are left with a net profit of
two dollars okay so now you can see that
option sellers or those who are going
short no matter if you have calls or
puts
want the future value of those options
to be less because if the future value
of those options is less than the credit
that they initially received that
creates an opportunity to profit okay
with option buyers you want to buy
options at five sell them at seven
with options selling you want to buy
something say at five and sell them at
three or buy or i'm sorry settlements
five and buy them at three sell them at
seven environment five whatever the case
is okay so hopefully that makes a lot of
sense but again it's all about these
credits and debits debits you pay out
that's money out of your pocket credit
that's money that you receive you get
credit to your account okay so again if
we have option buyers just to use a
little bit more and kind of drill this
in if you need it if not you can skip
through this part of the video but if
you are an option buyer and this is your
contract this is your option contract
that you have if you're going to buy an
option you're going to
give up some of that cash
in exchange for getting that contract so
now you have the contract as an options
buyer but you had to give up some of
your cash to the option seller so you
paid a debit to get into this trade the
option seller received a credit okay if
they want to reverse the trade now if
you're an option buyer and you want to
close out of the position
you have got to go out into the open
market take your contract and sell it to
somebody else okay that option seller or
new buyer in this case might then pay
you your money back okay so now you're
getting a credit back
and this seller if they're a new buyer
they don't already have an existing
position they're going to pay you some
money a debit and you're going to
receive your credit back okay so it's
all this interaction between buyers and
sellers surrounded by this options
contract that we have
all right so finally let's quickly talk
about trading cash versus on or with
margin because this is a big topic and i
want to make sure that we cover this
and talk through a little bit as much as
we can here
on this video tutorial now here's the
the main difference between them i want
to make sure you get the main difference
because there's so many little innuendos
between different brokers and i don't
want to pick one broker and say that
that's the way that they calculate
margin or how they do it because it is
literally
different between this broker and that
broker and your account and somebody
else's account even within the same
broker there's basic guidelines that
most brokers follow but you'll want to
check with them and know exactly how
they calculate things and you'll start
to see this as we go through some live
trading examples here at option alpha as
part of these tracks now the first thing
that you can do is you can trade on cash
now as the name suggests you have to
have the cash to back the trade this is
usually required on net long options and
cash is usually required in ira and
retirement accounts ira and retirement
accounts have a little bit more of a
stricter policy on the type of risk that
you can take meaning you can't trade
naked options or undefined risk trades
in a retirement account because mainly
you can't trade on margin in those
accounts
so with cash if you're going to go out
and you're going to buy an option
contract and the option contract is a
hundred dollars then you have to pay the
hundred dollars to get into that option
contract same thing in an ira account if
that option contract is a hundred
dollars you gotta have the cash to back
it up as far as a hundred dollar trade
if you go out and you say and you enter
a let's say credit spread or type of a
spread which we'll talk about here later
on and let's say the risk in that trade
is five hundred dollars okay and i'm
just using round numbers then you have
to have five hundred dollars to back up
the maximum potential risk in that trade
again if the maximum risk in a
particular trade whether it's a regular
long option or a credit spread or
something else if the maximum risk is
500
you've got to have the cash in your
account to cover that risk okay and same
thing goes with an ira if the maximum
risk is 500 you better have 500 in your
account to cover that trade or you won't
be able to place the order you won't
actually be even at a point where the
broker allows the order to go into the
open market to be placed
now this is different than trading on
margin margin is when you borrow or you
have less money put up than the maximum
amount of risk in the trade this is why
we talk a lot about here at option alpha
about keeping your position size small
keeping your overall allocation small
because margin can expand and we have
done podcasts and video tutorials on
that which you can definitely check out
but
margin is basically borrowing money or
trading with a little bit of help from
the broker okay in this case it usually
happens more often on net short
positions so if we are a call seller or
a put seller we might have to
enter that contract and we might have to
put up what's called margin so we put up
some portion of the maximum amount of
risk on the trade
to cover this now this usually does not
occur in any ira retirement account so
just for warning you have to usually
have cash backing it or the cash value
of the maximum risk in ira accounts but
let's go through a quick example here
so let's say that we are an option
seller and we collect a one hundred
dollar premium buying an option or
selling an option from an option buyer
okay that option buyer might pay cash
for that we collect that hundred dollars
of cash but now that we're an option
seller let's say the maximum risk on the
trade is one thousand dollars meaning at
the worst possible point we could lose a
thousand dollars on the trade well if we
are trading in a margin account or we
have a higher trading level approval
we can then go out and the broker can
help us and say you know what we're not
going to require that you have a
thousand dollars in your account
initially to enter this position
we might only require that you have
let's say 700 in your account okay so
now we're trading on margin mean the
broker is not going to require us to
carry the full risk in the trade
initially but don't get confused here
because if the trade starts to go
against you you still can lose the
maximum amount for that particular trade
and i'll show you later on in video
tutorials how we figure out what that
amount is but you can still lose that
maximum amount so don't assume that what
the broker carries an initial margin
requirement is going to cover all of
your risk in the trade okay now this is
again
mostly with net short option positions
not that long option option positions
but this is helpful because as you trade
on margin now you could potentially make
a hundred dollars on seven hundred
dollars of your account being margined
or a much better return than say making
a hundred dollars on a thousand dollars
of your account being margin okay so
it's a little bit more of that added
leverage potential
that your broker is going to look at now
another thing that most brokers look at
is what's called portfolio margin as you
get into higher trading levels and
higher account approval levels they'll
start to offset different positions so
if you have let's say a position in oil
and you have a position in say
let's say gold they might look at those
positions and say you know what your
position in oil you know offsets some of
the risk that you have in gold so for
both positions we're going to keep
dramatically less money in margin or
we're not going to hold as much money
because they're not really you know
they're uncorrelated and they don't
really have an impact on each other so
there's a lot of different things that
that happen with margin accounts and
again i want to kind of go through some
of the basics here so you guys
understand how cash versus margin
accounts work