Mike Martin

Implied Volatility Guides (with Visual Examples)

Posted on January 27, 2022March 29, 2022 by Mike Martin

Last updated on March 29th, 2022 , 03:18 pm

7 guides to help you master topics related to implied volatility (option prices).

Implied Volatility Basics

Implied volatility represents a stock’s option prices, and is one of the most important options trading concepts to master.

What is the VIX Index?

The VIX Index is a commonly watched indicator, as it measures option prices on the S&P 500 Index.

The Expected Move

The “expected move” represents a probabilistic forecast for a stock’s price in the future.

Trading VIX Options

Want to trade VIX options? Be sure to understand common misconceptions.

Trading VIX Futures

VIX futures can be used to trade expectations related to changes in the VIX Index.

The VIX Term Structure

The VIX term structure represents the relationship between near-term and long-term VIX futures contracts.

IV Rank vs. IV Percentile

How do you know if a stock’s current implied volatility is high or low relative to its historical levels? IV rank and percentile can help.

Mastered implied volatility? Move on to the Greeks next!

Next Lesson

Additional Resources

Implied Volatility for Trading Options | tastytrade

Historical and Implied Volatility – The Options Industry Council

Options Trading Explained | Visuals for Beginners

Posted on January 26, 2022April 21, 2022 by Mike Martin

Last updated on April 21st, 2022 , 01:55 pm

Ever wondered what stock options are, and what the benefits of trading options are as opposed to simply trading stock?

Keep reading to learn options trading basics and why people trade them. You’ll learn each concept with visualizations to help you understand options logically.

TAKEAWAYS

Options are leveraged securities, which means profits and losses are magnified.
Options typically have less principle risk than stocks.
Options can be combined to profit from any market direction, including markets that go nowhere.
All options have a 1.) Strike Price 2.) Expiration Date and 3.) Contract Multiplier (typically 100×1)
Call options profit in bullish, or rising markets.
Put options profit in bearish, or falling markets.
Just like stocks, options can be both bought and sold.

What is Options Trading?

Options trading is the act of buying/selling a stock’s option contracts in an attempt to profit from the stock’s future price movements. Traders can use options to profit from:

1.) Stock price increases (bullish trades)

2.) Stock price decreases (bearish trades)

3.) When a stock’s price remains in a specific range over time (neutral trades).

Option Trading Benefits

The benefits of option’s trading are innumerable. Here are a few of the more important benefits.

With options, traders can leverage return potential, which means significant gains can be made with relatively small amounts of money.

For example, an options trader can risk $500 and make $500 (100% return on investment) if their stock price prediction is correct. When buying shares of stock, the stock price must increase 100% for you to double your investment.

However, there’s also the potential to lose more money compared to trading shares of stock. Leverage can work for or against you, but when used carefully it can increase returns on investment immensely.

Another huge benefit of trading options is that the strategies used can sometimes have significantly less loss potential compared to buying/shorting shares of stock. This does not apply to all option’s strategies, but certain strategies do indeed reduce risk when compared to stock trading.

As mentioned earlier, options can be used to profit from virtually any stock price movement (or lack of) in the future. They can even profit when the stock does not move at all!

Unique Option Characteristics

Before getting to the specific details related to options, we need to first cover the 3 unique characteristics of option contracts:

1.) Expiration Date

All options have expiration dates, which is the date the option’s final value is determined and can no longer be traded.

Stocks typically have options with expiration dates ranging from a few days to two years away.

Longer-term option’s are referred to as “long-term anticipation securities”s or simply LEAPs.

2.) Strike Price

An option’s strike price is the price at which shares will be bought/sold if an option is exercised. We’ll talk more about this in a moment.

3.) Contract Multiplier

The number of shares an option contract can be converted into. Typically, equity options like AAPL options have a contract multiplier of 100 (each option can be converted into 100 shares of stock). Index options are NOT settled via delivery of stock, but cash.

Options and Leverage (Trade Example)

Our first trade example will demonstrate how options can leverage returns compared to simply buying shares of stock.

Trade Example: Stock Trade vs. Option Trade

Stock Trade ➜ Buy 4 Shares for $150. Sell 30 Days Later for $160.
Profit ➜ +$40 (6.7% Return: $40 Profit / $600 Investment).

Option Trade ➜ Buy the 30-Day 150 Call for $5. Sell for $10 in 30 Days (Stock at $160).
Profit ➜ +$500 (100% Return: $500 Profit / $500 Investment).

As we can see, the option trade resulted in a much more significant return relative to the money invested. However, if the stock price remained at $150 over the 30-day period, the stock trader would not have lost any money, while the options trader would have lost the entire $500 investment.

If you’re wondering, buying a $5 option costs $500 because of the option contract multiplier of 100. The $5 option price is on a per-share basis, which means the actual cost of the option is 100x more than the option’s displayed price.

The Two Option Types

Now that you’ve seen the power of options, let’s get into the two option types.

The first option type is a call option:

Call Option: This type of option gives buyers the right to buy 100 shares of stock (per contract) at the option’s strike price before the option expires. Here are some examples of what this means:

Strike Price	Meaning
$100	Call buyer has the right to buy 100 shares of stock for $100/share before the option expires.
$120	Call buyer has the right to buy 100 shares of stock for $120/share before the option expires.

Since there’s more value in having the ability to buy shares of stock at lower prices, call options with lower strike prices cost more money:

Strike Price	Hypothetical Option Price
$100	$3.50
$120	$0.06

Additionally, call options at lower strike prices have a higher probability of being valuable at expiration, as call options only have value at expiration if the stock price is above the call’s strike price at the time of the expiration date.

Call Option Example

To make sure call options make complete sense to you, let’s look at a hypothetical trade example to demonstrate the profit/loss potential when buying a call option.

Call Trade Example

Stock Price ➜ $50

Trader’s Prediction ➜ Share price will increase to $60 in two months.

Option Trade ➜ Buy the 50 call that expires in 60 days for $5.00.

Stock Price in 60 Days	P/L of Call Option	P/L (+100 Shares)
$0	-$500 (Call Worthless)	-$5,000
$50	-$500 (Call Worthless)	$0 (Call Worth $5)
$55	$0 (Call Worth $5)	+$500
$60	+$500 (Call Worth $10)	+$1,000
$65	+$1,000 (Call Worth $15)	+$1,500

At $50 or less (at or below the call’s strike price), the option will be worthless at expiration because there’s no value in being able to buy shares of stock at $50 with the call option when the stock price is at or below $50.

At $55, the call option is worth $5 at expiration because the ability to buy shares of stock $5 below the current share price is worth $5/share.

At $60, the call option is worth $10 at expiration because the ability to buy shares of stock $10 below the current share price is worth $10/share.

At $65, the call option is worth $15 at expiration because the ability to buy shares of stock $15 below the current share price is worth $15/share.

Compared to buying shares of stock, buying call options can have significantly less loss potential when the stock price falls substantially. However, for the call option to break even or profit, the stock price must increase.

Selling Call Options

Just like shares of stock, call options can also be sold as an opening trade. For instance, let’s say a stock is trading for $100 and we sell the 110 call for $5.00:

When selling call options, as long as the stock price is below the call’s strike price at expiration the position will be profitable. However, if the stock price rises substantially, the loss potential on a short call position is theoretically unlimited.

Here’s how this particular short call position would perform based on various stock prices at expiration:

For instance, if the stock price rose to $200 by the call’s expiration date, the loss would be $8,500 per call that was sold.

With the stock at $200, the 110 call would be worth $90 because the ability to buy shares $90 below the current share price is worth $90/share. Since the call was sold for $5, the loss would be $85 on the option, which represents an $8,500 loss per contract due to the option contract multiplier of 100.

At $115, the call would be worth $5 and there would be no profits or losses.

At $110 or lower, the 110 call would expire worthless and the call seller would keep the $500 collected when initially selling the call.

Because of the risk outlined above, it’s not advised to sell call options without protection in the form of long stock or another call option purchased against the short call.

The Second Option Type: Puts

Put Options give buyers the right to sell 100 shares of stock (per contract) at the option’s strike price before the option expires. Here are some examples of what this means:

Strike Price	Meaning
$80	Put buyer has the right to sell 100 shares of stock for $80/share before the option expires.
$90	Put buyer has the right to sell 100 shares of stock for $90/share before the option expires.

Since there’s more value in having the ability to sell shares of stock at higher prices, put options with higher strike prices cost more money:

Strike Price	Hypothetical Option Price
$80	$0.49
$90	$3.50

Additionally, put options at higher strike prices have a higher probability of being valuable at expiration, as put options only have value at expiration if the stock price is below the put’s strike price at the time of the expiration date.

Like we did with calls, let’s go through a hypothetical put option trade example:

Trade Example: Put Option

Stock Price  ➜ $200
Trader’s Prediction  ➜ Share price will fall to $190 sometime over the next 30 days.
Option Trade  ➜ Buy the 30-Day 200 Put for $6.50

Stock Price in 30 Days	P/L of Put Option	P/L (-100 Shares)
$250	-$650 (Put Worthless)	-$5,000
$200	-$650 (Put Worthless)	$0
$195	-$150 (Put Worth $5)	+$500
$190	+$350 (Put Worth $10)	+$1,000
$175	$1,850 (Put Worth $25)	+$2,500

At $200 or higher (at or above the put’s strike price), the option will be worthless at expiration because there’s no value in being able to sell shares of stock at $200 with the put option when the stock price is at or above $200.

At $195, the put option is worth $5 at expiration because the ability to sell shares of stock $5 above the current share price is worth $5/share.

At $190, the put option is worth $10 at expiration because the ability to sell shares of stock $10 above the current share price is worth $10/share.

At $175, the put option is worth $25 at expiration because the ability to sell shares of stock $25 above the current share price is worth $25/share.

Compared to shorting shares of stock, buying put options can have significantly less loss potential when the stock price increases substantially. However, for the put option to break even or profit, the stock price must fall.

Selling Put Options

Just like calls, put options can also be sold. For instance, here’s how selling a put would work out if we sold a 170 put for $7 on a stock that was trading for $190:

As long as the stock price is above the put’s strike price at expiration, the position will realize a full profit and 100% of the option premium collected when selling the put will be kept. The reason for that is the put will be worthless because there’s no value in the ability to sell shares at a price below the current share price.

However, if the share price falls, selling put options can result in significant loss potential:

For example, if the stock price fell to $150 by expiration, the 170 put would be worth $20 because there’s a $20-per-share value in being able to sell shares $20 above the current stock price.

Since the put was sold for $7, an increase to $20 would represent a $1,300 loss per put contract that was sold. The worst-case scenario when selling puts is that the stock price falls to $0 (the company goes out of business) before the option expires.

Final Word

Trading options has its benefits over trading shares of stock, but, as you’ve learned, there are also some massive risks related to trading options. Hopefully, you’ve learned the basics of how options work and are prepared to keep learning.

Want to go in-depth on options trading? Read our complete guide here!

NOTE! In order to trade options, you must first be approved for options trading by your broker.

Next Lesson

Additional Resources

Options Trading Explained: A Beginner’s Guide – CNBC

Open Interest vs Volume in Options Explained

Posted on January 26, 2022May 9, 2022 by Mike Martin

Last updated on May 9th, 2022 , 11:24 am

One of the things every options trader should do before entering a position is gauge the amount of trading activity in the options they wish to trade. Failing to run a quick liquidity check can leave an options trader stranded in a position, forced to exit at an unfavorable price.

Two metrics that every options trader should look at before entering a position are volume and open interest.

Care to watch the video instead? Check it out below!

What is Option Volume?

An option’s volume is the total number of contracts that have been traded on that trading day. For example, if an option has a daily volume of 15,000, then 15,000 contracts of that option have traded on that particular trading day.

The following chart shows the estimated total number of option contracts that were traded for various products over 1 year:

As we can see here, almost a billion option derivatives were traded among the top four products in the options markets, which indicates SPY, VIX, QQQ, and IWM options are very actively traded. With that said, every product included in the above chart is very actively traded.

Next, we’ll talk about open interest.

What is Open Interest?

In the stock market, an option’s open interest represents the total number of contracts that are “open” between any two parties. In other words, open interest is the number of option contracts that have been opened, but not yet closed. Let’s run through a basic example to demonstrate how open interest works.

Open Interest Example

Consider the following trade orders that are routed by two different traders, but on the same option contract:

Here, Trader A is buying-to-open 5 contracts to open and Trader B is selling 5 contracts to open. Both of these simple trading strategies are new positions.

If both traders are filled on their orders, the option’s open interest will increase by 5 because two traders have opened positions in that contract.

What happens when one of the traders closes their position while another trader opens a position? Consider the following trades:

As we can see here, Trader B bought 5 contracts to close while Trader C sold 5 contracts to open. In this case, open interest remains at 5 because there are still 5 contracts open between Trader A and C. However, if Trader A sells 5 contracts to close and Trader C buys 5 contracts to close, open interest will decrease by 5:

So, open interest represents the number of option contracts that are open in the market between two parties, though you don’t need to be concerned about the specific parties.

In summary, open interest increases when two parties get filled on opening orders, and decreases when two parties get filled on closing orders. When one party has an opening order and the other has a closing order, opening interest will not change (assuming both orders have the same number of contracts).

The Importance of Option Liquidity

An option’s volume and open interest are very important to you as an options trader because you do not want to get caught trading illiquid options (low volume and low open interest). Illiquid options tend to have wide bid-ask spreads, which can single-handedly wipe out a trading account over time.

Additionally, it’s harder to get out of option positions at good prices when volume and open interest are low, which means losses may grow larger due to the inability to exit a position.

What are ideal levels of volume and open interest? At the bare minimum, the options you use for your positions should have volume in the hundreds and open interest in the thousands:

Minimum Daily Volume: 100s, preferably 1,000s.

Minimum Open Interest: 1,000s.

At this point, you understand the basics of volume and open interest, and why they’re important to you as an options trader. In the next section, we’ll go over which options on a stock tend to have the most of each.

Which Options are the Most Liquid?

So, you know what option volume and open interest are, but which options tend to have the highest of each? To answer this, we’re going to run through some data on two of the market’s most actively traded products: the S&P 500 ETF (SPY), and Apple Inc. (AAPL).

First, we’re going to compare the volume and open interest of SPY options at each strike price on a single trading day. Then, we’ll look at different expiration date cycles.

To analyze the volume and open interest based on the strike price, we chose a day from earlier this year and plotted the volume and open interest of calls and puts at each strike price. We used the expiration cycle with approximately 50 days to expiration. Let’s take a look:

Regarding volume, we can see that the most actively traded options are the ones with strike prices near the stock price (at-the-money options). Less and less trading volume tends to occur in the options that are further away from the stock price.

Regarding open interest, we can see that even strike prices (185, 190, 195, etc.) have the highest open interest (and higher volume), suggesting that market participants prefer to trade even strikes as opposed to uneven strikes (187.5, 192.5, etc.).

So, options with strike prices close to the current stock price tend to be the most actively traded. Additionally, options with even strike prices tend to have the highest open interest because market participants prefer even strikes over uneven strikes.

Next, we’ll compare the volume and open interest across multiple expiration cycles.

Option Liquidity vs. Time to Expiration

In this next section, we’ll use SPY and AAPL options to analyze the volume and open interest across multiple expiration cycles. In both examples, we chose a day earlier this year and analyzed the volume and open interest for multiple expiration cycles. Let’s start with SPY:

Here, we can see that the near-term expiration cycles clearly have the highest volume and open interest compared to the longer-term expiration cycles. In this case, the 46-day expiration cycle has the highest open interest but not the highest volume. This could be caused by traders closing near-term option positions, therefore lowering the open interest in the short-term cycles.

AAPL Volume and Open Interest

Let’s take a look at AAPL’s options to see if the same trend exists:

In the case of AAPL, the near-term expiration cycles have the highest amount of volume, but there is still a significant amount of open interest in the longer-term expiration cycles. Some possible explanations are that more traders have longer-term theories regarding AAPL, or that more traders are using longer-term cycles for stock replacement strategies.

In most stocks, the option volume and open interest will be greatest in the near-term option cycles (less than 100 days to expiration). Additionally, the options with strike prices near the stock price (at-the-money) tend to have the most overall trading activity.

Understanding these key points can help you stay in liquid products, which will benefit you by keeping your “hidden” trading costs low, as well as ensuring you’ll be able to exit a position more easily if it moves against you.

Next Lesson

Additional Resources

Open Interest vs. Volume: Investopedia

The Bid-Ask Spread Explained: Options Trading 101

Posted on January 26, 2022May 2, 2022 by Mike Martin

Last updated on May 2nd, 2022 , 11:48 am

Bid-Ask Spread Definition: In the stock market, the “bid-ask spread” is the difference between the bid price and ask price for a security.

In this guide, you’re going to learn about the bid-ask spread, which is a crucial liquidity metric that should be examined before trading any stock or option (derivative). If you’d like, you can skip to a particular section by clicking on the section title.

Care to watch the video instead? Check it out below!

"Bid and "Ask" Explained

Before trading any product in the market, it’s crucial to gauge the hidden cost (in addition to transaction cost) of entering and exiting a position in that product. The bid-ask spread can be used to assess the cost of trading a particular stock or option.

Before discussing the bid-ask spread, we need to talk about what the “bid” and “ask” prices are. The following visual explains what the bid and ask prices represent.

When trading a share of stock or an option, you can get filled on your order immediately if you sell at the bidding price or buy at the asking price. Therefore, the bid-ask spread tells you how much money you would lose if you purchased something at the asking price and sold it at the bidding price (sometimes referred to as “slippage”).

In this case, you’d have to buy at $3.50 or sell at $3.00 to get filled immediately. When purchasing at the ask and selling at the bid (or vice versa), the corresponding loss will be $0.50, which translates to $50 for 100 shares of stock or 1 option contract.

Ideally, you want to lose as little as possible when entering and exiting a position, which means trading products with a narrow bid-ask spread is preferred.

Bid and Ask Spread: Market Makers

The function of a market maker is to provide market liquidity. These financial professionals accomplish this by standing ready to both buy the bid price and sell the asking price for the security they specialize in.

They profit from the “spread”, or the difference between the bid and ask price. However, they are obligated to fill you at the best price.

Market makers provide liquidity on particular securities on various stock exchanges, such as the NYSE and the Nasdaq.

Market makers want retail order flow so paid, they are willing to pay brokers for the right to fill their customers orders in a system called payment for order flow.

Bid and Ask Spread Example

As an example, let’s look at some hypothetical bid-ask spreads for various trading products:

If a trader wanted to purchase a share of stock instantly, they would have to pay the asking price of $100.03. To immediately get out of the position, they would have to sell at the bid price of $100.02. As you can see, the loss on this transaction is $0.01 per share (not including commissions). With 100 shares, the loss would be $1 ($0.01 x 100). A $0.01 bid-ask spread is the best-case scenario and is an indication that a product is actively traded.

Now, regarding the call option, the asking price is $1.20 higher than the bid price, which means a trader would lose $120 from just buying the call at the asking price of $6.30 and selling the option at the bidding price of $5.10. Trading products with a bid-ask spread this wide is clearly not advised.

Lastly, the put option has a bid-ask spread of only $0.05, which is considered to be a narrow spread. In the case of buying at the asking price and selling at the bidding price, a trader would only lose $5 per contract.

Spread in Stocks vs. Options

When trading shares of stock, the bid-ask spread will often be a few pennies wide. However, a majority of stocks have illiquid options with wide bid-ask spreads. So, be more aware of the bid-ask spread when transacting in the option markets, and try to only trade options with bid-ask spreads less than $0.10, as it will save your trading account from “hidden” costs that can accrue to massive amounts over time.

At this point, you know and understand the implications of the bid-ask spread. Next, we’ll quickly discuss which options tend to have the widest bid-ask spreads so you can avoid trouble when trading options.

Which Options Have the Widest Bid-Ask Spreads?

Options with strike prices further away from the stock price typically have wider bid-ask spreads.

To visualize this, we plotted a snapshot of the closing bid-ask spreads for calls and puts on SPY (S&P 500 ETF), which is an ETF that has one of the most actively traded option markets. We used options from early 2022 that had approximately 60 days to expiration:

As we can see here, in-the-money calls and puts have the widest bid-ask spreads (approximately $0.50 for the deep-in-the-money options). The options with the narrowest bid-ask spreads are the at-the-money options (strike prices near $205), and the out-of-the-money options. However, it’s worth noting that the out-of-the-money options have narrower bid-ask spreads because the option prices are cheaper (a $0.05 option couldn’t have a $0.50 bid-ask spread).

Bid-Ask Spreads of Long-Term Options (LEAPS)

Now, let’s look at the bid-ask spread of the same strike prices in the expiration that’s nearest to 365 days to expiration:

Right off the bat, we can see that the at-the-money 365-day options have a bid-ask spread near $0.20. These long-term options are known as “LEAPs”. The same options with 60 days to expiration had bid-ask spreads near $0.05. Regarding the in-the-money options, the bid-ask spread is slightly narrower in the 365-day options, which could be explained by higher trading volume in the long-term in-the-money options. Either way, it’s clear that the minimum bid-ask spread is four times wider in the 365-day options than in the 60-day options.

Spreads vs. Market Volatility

As mentioned previously, bid-ask spreads widen when market volatility picks up. To illustrate this, we plotted the average at-the-money bid-ask spread of SPY options on each day between August 3rd, 2015, and September 18th, 2015. We used the September 2015 expiration cycle:

As we can see, there’s a clear relationship between market volatility (as indicated by the VIX Index) and the bid-ask spreads of options on SPY. While only SPY is used as an example in the visual above, the same concept applies to other stocks in the market as well.

In this example, it’s important to note that the bid-ask spread increased from $0.025 to $0.15 as market volatility increased, but these were the closing bid-ask spreads. When the market opened on August 24th, the bid-ask spreads of SPY options were between $2.00 and $5.00 because the market had opened down 5%. However, the spreads narrowed throughout the day.

So, if you find yourself in a situation where the market is going to open significantly lower than the previous day, expect the bid-ask spreads to be wide in the first couple hours of the trading session.

What Is The Effective Spread?

Generally speaking, the bid and ask prices you see listed for a particular security are not the true market. This is often a wider spread than the true spread. You can often fill trades (particularly option trades) better than the listed market price.

This is because of price improvement.

The below formula (from Wikipedia) shows the equation to compute the “effective spread”.

Option Order Types

There are four primary types of option orders:

Limit orders ensure both buy price and sell price, but not execution. These order types are not filled until your “limit price” is reached. To get filled fast, limit orders set at the midpoint are recommended.

Market orders ensure that you will be filled immediately. You will sometimes buy at the lowest ask price and sell at the highest bid price in a market order. These order types are dangerous in options trading, especially in less liquid options.

Stop-loss orders trigger a market order when your stop price is breached.

Stop-limit orders trigger a limit order when your stop price is breached.

Bid-Ask Spread FAQs

Is a high bid/ask spread good?

Ideally, you want a very tight bid-ask spread. With a wide bid-ask spread, you will forfeit the difference between these two prices when entering and exiting positions.

If an option is bid at 1.20 and offered at 2, you will lose that 0.80 in value when you enter and then later exit the trade. Tight bid-ask spreads make for more efficient markets.

Do spreads count as day trades?

Spreads do indeed count as day trading. The more legs you have in your spread, the more transactions you will have. Day trading spreads in accounts under 25k are not recommended as this is the threshold to become a pattern day trader.

Next Lesson

Additional Resources

The Basics of the Bid-Ask Spread – Investopedia

Intrinsic & Extrinsic Value Explained (Options Trading)

Posted on January 26, 2022February 10, 2022 by Mike Martin

Last updated on February 10th, 2022 , 06:55 pm

Every options contract has a price, and this price consists of two components:

Here’s a quick visualization of an option’s price components:

TAKEAWAYS

Intrinsic value is the value of being able to buy or sell shares at the option’s strike price as opposed to the current stock price.
At expiration, an option will have only intrinsic value (or no value).
Extrinsic value represents all premium that is not intrinsic value.
Extrinsic value is comprised of “time value” and “implied volatility”.
Options deeper in-the-money have more intrinsic value and less extrinsic value
Out-of-the-money options are all extrinsic value.

What are Intrinsic and Extrinsic Value?

An option’s intrinsic value can be conceptualized as the value of being able to buy or sell shares at the option’s strike price as opposed to the current price of the shares. For example, if a stock is trading for $75, a call option with a strike price of $50 has $25 of intrinsic value. This is because the ability to purchase shares $25 below the market price should be worth at least $25.

On the other hand, with the stock at $75, a call option with a strike price of $75 has $0 of intrinsic value because exercising the call has no “real” value, as the investor can buy shares for $75 without using an option.

Intrinsic and Extrinsic Value at Expiration

At expiration, an option’s price will only consist of intrinsic value. Therefore, an alternative definition of intrinsic value is what the option will be worth at expiration (if the stock price were at its current price).

An option’s extrinsic value is the portion of an option’s price that exceeds its intrinsic value. From the previous example, if the call option with a strike price of $75 is trading for $5, its extrinsic value is $5. This is because the option has no intrinsic value, which means any value it has is extrinsic.

Why would an option with no intrinsic value be worth anything? Well, there’s a chance that the option ends up being valuable by the time it expires. An option’s extrinsic value is essentially the price associated with the potential for an option to become more valuable before it expires.

At expiration, options with only extrinsic value will be worthless. So, an option’s intrinsic value will always remain, but the extrinsic value will decrease as expiration approaches, as the option’s real value becomes more certain. For the reasons mentioned here, extrinsic value is often referred to as an option’s “time value.”

Now that you’ve learned the very basics of an option’s price components, let’s walk through and visualize how they relate to call and put options.

Intrinsic Value of Call Options

The intrinsic value of a call option is equal to the value of buying shares at the call’s strike price as opposed to the market price. For example, on a $150 stock, a call option with a strike price of $140 has $10 of intrinsic value because buying shares $10 below the market price should be worth at least $10 per share.

If the stock price is below the call’s strike price, then the option has no intrinsic value because a call trader has no benefit of buying shares at the strike price, as they can buy shares directly for a lower price. Consequently, any value the option has is extrinsic.

If the stock is trading above the call’s strike price, the call’s intrinsic value can be calculated with the following formula:

If the stock price is below the call strike, the intrinsic value is zero. An option will never have a negative intrinsic value, so the formula above only applies if the stock price is above the call’s strike price.

Call Option Example

Alright, let’s look at some visual examples of a call’s price components through time. First, we’ll look at an option that has intrinsic value (in-the-money) for most of the time. Then, we’ll finish by looking at a call option that consists of all extrinsic value through expiration.

In the following visual, we’ll look at the price of a stock (top), and a call option (bottom) with a strike price of $105. Be sure to compare the changes in the option’s intrinsic and extrinsic value as the stock price changes.

As you can see, when the stock price is above the strike price of 105, the call has intrinsic value. As the stock price increases further above the strike price, the call’s value shifts from extrinsic value to intrinsic value. Lastly, the call’s extrinsic value withers away as expiration approaches, leaving only intrinsic value in the call’s price at expiration.

Next, we’ll look at a similar example, except this time with an out-of-the-money call.

Intrinsic vs. Extrinsic: Out-of-the-Money Call Option

In this example, we’ll compare a stock’s price to a call option with a strike price of $195. Like before, examine the relationship between changes in the stock price and the call’s intrinsic and extrinsic value.

As demonstrated here, the stock price traded below the call’s strike price of $195 for almost the entire period. Consequently, the call’s price was purely extrinsic. As expiration approaches, the extrinsic value decreased to $0, leaving the call worthless at expiration.

In summary, call options have intrinsic value when the stock price is above the strike price. As the stock increases further above the strike price, the call’s price shifts from extrinsic value to intrinsic value. Lastly, any extrinsic value will experience time decay, or “theta“, as expiration approaches.

Intrinsic Value of Put Options

The intrinsic value of a put option is equal to the value of selling shares at the put’s strike price as opposed to the market price. For example, on a $50 stock, a put option with a strike price of $55 has $5 of intrinsic value because the ability to sell shares $5 above the current market price should be worth at least $5.

If the stock price is above the put’s strike price, the option has no intrinsic value. This is because the put owner has no benefit of selling shares of stock at the strike price, as they can sell shares for a higher price in the open market. Consequently, any value the option has consists of extrinsic value.

If the stock price is below the put’s strike price, the put’s intrinsic value can be calculated with the following formula:

If the stock price is above the put’s strike price, then the option’s intrinsic value is zero. An option will never have negative intrinsic value, so the formula above only applies when the stock price is below the put’s strike price.

Alright, let’s look at some visual examples of a put’s intrinsic and extrinsic value in action. First, we’ll look at an option that has intrinsic value (in-the-money) for most of the time. Then, we’ll finish by looking at a put option that consists of all extrinsic value through expiration.

Intrinsic vs. Extrinsic Value: In-the-Money Put

In the following visual, we’ll look at the price of a stock (top), and a put option (bottom) with a strike price of $190. Be sure to compare the changes in the put option’s intrinsic and extrinsic value as the stock price changes.

As demonstrated here, when the stock price is below the put’s strike price of $190, the put has intrinsic value. As the stock price decreases further below the strike price, the put’s value shifts from extrinsic value to intrinsic value. Lastly, the put’s extrinsic value decays away as expiration approaches, leaving only intrinsic value in the put’s price.

Next, we’ll look at a similar example, except this time with an out-of-the-money put.

Intrinsic vs. Extrinsic Value: Out-of-the-Money Put

In this example, we’ll compare a stock’s price to a put option with a strike price of $80. Like before, examine the relationship between changes in the stock price and the put’s intrinsic and extrinsic value.

Unfortunately, the put in this example never had any intrinsic value, as the stock price was always above the put’s strike price of $80. Consequently, the put’s price consisted of all extrinsic value. As expiration approached, the extrinsic value decreased to $0, leaving the put worthless at expiration.

In summary, put options have intrinsic value when the stock price is below the strike price. As the stock decreases further below the strike price, the put’s price shifts from extrinsic value to intrinsic value. Lastly, any extrinsic value will decay away as expiration approaches.

So, you’ve learned the basics of intrinsic and extrinsic value, and have also seen some specific demonstrations with calls and puts. At this point, you may be wondering what determines how much extrinsic value an option has. Well, you’re in luck, because that is the topic of the next section!

What Determines an Option's Extrinsic Value?

An option’s extrinsic value depends on a few factors:

1) Whether the option is in-the-money, at-the-money, or out-of-the-money.

2) How much time the option has until it expires.

3) The implied volatility of the options

First, options that are further in-the-money have more intrinsic value and less extrinsic value, and was visually demonstrated in the previous sections. As an option becomes further in-the-money, its value will shift towards intrinsic value.

At-the-money options will have the most extrinsic value of any option, while out-of-the-money and in-the-money options have less extrinsic value the further the strike price is from the stock price.

Second, options with more time to expiration are more expensive, and therefore have more extrinsic value than options at the same strike price with less time to expiration.

Option Value and DTE

In the following visual, we’ll compare four call options on the S&P 500 ETF (SPY) with varying days to expiration (DTE). With the SPY at $216, we’ll look at the 216 call in each respective expiration cycle. Let’s take a look!

As you can see, longer-term options at the same strike price are more expensive, and therefore have more extrinsic value. This is because there is more time left until the option expires, and therefore more time for the option to increase in value due to stock price changes.

Lastly, options on higher implied volatility stocks have more extrinsic value. To validate this, let’s look at the 100 calls with 30 days to expiration on three stocks that are trading for $100. Note how the higher option prices indicate higher implied volatility.

Why is this? Option prices determine implied volatility. When the future movements of a stock’s price are expected to be volatile, market participants are willing to pay more for protection, or to speculate on those movements (in other words, supply/demand leads to higher option prices, and therefore implied volatility).

All else being equal, if you look at two similarly-priced stocks, the stock with more expensive options will have higher implied volatility.

Next Lesson

Additional Resources

Option Value – How Are Options Priced? | tastytrade

When Do Options Expire? | Options Expiration Explained

Posted on January 26, 2022May 3, 2022 by Mike Martin

Last updated on May 3rd, 2022 , 10:27 am

Options Expiration Date: All options (equity, index, and ETF) have an expiration date. After this date and time, the derivative can no longer be traded.

Unlike shares of stock, options cannot be held forever. An option’s expiration date represents the final day that the option can be traded before settling to its final value. Standard options that are in-the-money (ITM) at expiration will expire to long or short shares of stock, or cash if the options are cash-settled. Options that are out-of-the-money (OTM) at expiry will expire worthless.

Care to watch the video instead? Check it out below!

TAKEAWAYS

All option contracts will eventually expire.
After this date, options with strike prices that are in-the-money are assigned/exercised for stock
Worthless options at expiration are rendered null; no action is required.
Most traders prefer to trade short-term options with under 100 days until expiration.
Liquidity should be considered before trading an option. This includes the spread, volume, and open interest.

Option Expiration

The following table summarizes what standard equity call options and put options settle to at expiration:

Option Type	Long / Short	ITM / OTM?	Option Settlement
Call	Long Short	ITM ITM	+100 Shares of Stock -100 Shares of Stock
Put	Long Short	ITM ITM	-100 Shares of Stock +100 Shares of Stock
Call or Put	Long or Short	OTM	$0 (Worthless)

After each option’s expiration date, the stock option can no longer be traded. From a trader’s perspective, expiring options will seamlessly disappear from the account, replaced by the corresponding stock position if the option expires in-the-money.

Now that you know the various outcomes for equity options at expiration, let’s discuss the specific days that options expire.

When Do Options Expire?

Standard options expiration occurs on the third Friday of each month. As a result, the last day to trade options in the standard monthly cycles is the third Friday of each month, which will be between the 15th and 21st day of the month. If the third Friday of the month falls on a market holiday, then the final day to trade the standard monthly options will be Thursday of that same week.

Any expiration date that isn’t on the third Friday of the month is considered to be non-standard, which includes weekly and quarterly expiration cycles. Weekly expiration cycles typically expire every Friday, except during the weeks of quarterly expirations.

The following table summarizes the various expiration types you’ll encounter when trading equity options:

Expiration Type	Last Day to Trade	Standard or Non-Standard
Monthly	Third Friday of Each Month	Standard
Weekly	Every Friday, Except Quarterly Expiration Weeks	Non-Standard
Quarterly	Last Trading Day of March, June, September, and December	Non-Standard

What's the Longest-Term Options Expiration Date?

As an options trader, you’ll always be able to choose from expiration cycles of varying durations. The shortest-term expiration cycle will, of course, be 0 days (expiring that same day), while the longest-term expiration cycle (LEAPs) will typically be approximately two years away.

As an example, here were all of the available expiration cycles for Apple Inc. (AAPL) options as of December 9th, 2016:

As you can see, there are 16 listed expiration cycles. You may notice that the weekly cycles are more present in the near-term, while the longer-term cycles are primarily monthlies. Longer-term expirations will typically consist of standard monthlies because weeklies aren’t listed until a few weeks before their expiration dates.

Alright, so you know what an option’s expiration date is, but how do you choose which one to trade in? In the next section, we’ll discuss how you can go about choosing an options expiration cycle to trade.

How to Choose an Option Expiration Cycle

With so many available expiration cycles, how do you decide which one to use? When choosing an expiration cycle to trade, there are two factors to consider:

1) The options strategy you plan on trading

2) The amount of trading activity in the expiration cycle you’re considering (gauged by volume and open interest)

Let’s run through each of these considerations one-by-one.

Consider Your Strategy

Most of the time, options expiration cycles with less than 100 days to expiration will be used because most options traders have short-term predictions for the stock price or implied volatility.

Additionally, traders who primarily sell options may prefer staying in near-term expiration cycles because short premium strategies profit from time decay, which is virtually non-existent in longer-term options.

Conversely, traders who primarily buy options may also prefer shorter-term expiration cycles because short-term option premiums are less expensive and more responsive to changes in the stock price.

Then who trades long-term options? Well, a common way to utilize longer-term expiration cycles is by purchasing deep-in-the-money calls or puts to replicate long or short stock positions. By purchasing long-term, deep-in-the-money calls or puts, traders can minimize losses from the decay of an option’s extrinsic value while gaining exposure to shares of stock with a lower margin requirement (more leverage).

Consider Liquidity / Trading Activity

The second consideration, and perhaps the most important one, is the amount of trading activity in the expiration cycle. Trading activity can be gauged by option volume and open interest for a particular stock. You’ll learn about volume and open interest in-depth in one of the following guides, but for now all you need to know is that more volume and open interest is a good thing.

As mentioned previously, most traders prefer to trade short-term expiration cycles, which means the most option volume and open interest will be in the near-term cycles. Additionally, standard monthly expiration cycles will typically have far more volume and open interest than weekly cycles.

To validate this, we compared the open interest and volume in each of AAPL’s expiration cycles from the table in the previous section. Here were the results:

As we can see, the highest open interest values are in the standard monthly cycles. Additionally, the first two standard options expirations have significantly more open interest than any of the longer-term cycles (with the exception of the 406-day expiration).

What about the amount of option volume? Let’s take a look:

In this case, the weekly cycle with 0 days to expiration (expiring that same day) had the most option volume, which makes sense because many traders adjust or close their positions on the day of expiration. Considering only standard options expirations, we can see that the first two monthly cycles have by far the most volume.

American vs European Option at Expiration

European options are cash-settled while American options are settled via the underlying stock.

All index options are European style. Trading these options greatly reduces risk because European-style options do not allow for early exercise.

Final Word

So, what does it all mean? Well, trading the two nearest standard monthly expirations benefits options traders in terms of entering and exiting positions fluidly. However, if your strategy is built for longer-term or weekly expiration cycles, then of course you’ll have to use those.

📅 CBOE 2022 Option Expiration Calendar

Option Expiration FAQs

What time do options expire on expiration date?

The vast majority of options stop trading at the closing bell on expiration day. There are some exceptions to this rule for ETF and index options. All equity options (stock options) seize trading at the bell.

Do options expire at open or close?

Most all options expire at the market close. Some index options, however, expire at the market open. These are called “AM” options.

Do options expire automatically?

Options expire automatically at the close for the option expiration date listed in the contract. In-the-money options will be assigned and exercised while out-of-the-money options will simply be removed from the account.

Next Lesson

Additional Resources

Options Expiration Calendar 2022 – MarketWatch

What Are Options? The Basics of Call & Put Options

Posted on January 26, 2022May 9, 2022 by Mike Martin

Last updated on May 9th, 2022 , 05:18 am

What are options? To give you the textbook definition, options are financial contracts that give the holder (buyer) the ability to buy or sell 100 shares of stock at the option’s “strike price” at or before expiration. The seller (writer) has the obligation to deliver those shares if they are assigned to an option holder’s exercise.

Before you learn about the two option types, let’s go over basic characteristics of options.

Strike Prices & Expiration Dates

Two characteristics that all options have are strike prices and expiration dates. We’ve written entirely separate guides on both, but for now it’s necessary to provide a brief definition of each.

1.) A strike price is the price that shares will be exchanged at if the option buyer exercises, or if the option is in-the-money and held through expiration. For example, if a trader owns a call option with a strike price of $50, the trader will effectively buy 100 shares of stock at $50 per share if they exercise the option (a valuable right to have when the shares are trading higher than $50).

On the other hand, the seller of the call option is obligated to deliver these shares if assigned, effectively selling 100 shares of stock for $50 per share (an unfavorable scenario when the shares are trading for significantly more than $50).

2.) In addition to a strike price, all options have an expiration date, which is the date each option stops trading and ceases to exist. This is one of the major differences between stocks and options. Stocks can be held forever, but at some point, options expire. Prior to expiration, traders with positions must decide whether they want to close their option position, or let it expire.

If a trader lets an option expire in-the-money, they will take on a stock position (unless the options are on a product with no tradable shares, such as the VIX or SPX). On the other hand, options that expire out-of-the-money simply disappear from the account, leaving the trader with any residual profits or losses from the worthless option.

Standard Option Contract Multiplier

The last basic option characteristic you need to know is called a contract multiplier. The real value of an option in dollar terms is the option’s price multiplied by the contract multiplier. A standard equity option contract has a contract multiplier of 100 because each option controls 100 shares of stock.

When you view an option’s price, the actual value of that option is the price multiplied by 100 (for standard equity options). For example, if you want to buy an option that’s quoted at $13.20, you’ll need $1,320 in your account to buy that option (not including commissions).

You’ve just learned the very basics of options. To bring it all together, every option has a strike price and an expiration date. Additionally, standard equity options have a contract multiplier of 100, which means the option’s value in dollar terms is the price multiplied by 100. Armed with this knowledge, it’s time to learn the basics of calls and puts!

First, we’ll cover call options. Then, we’ll finish with put options.

Call Option Basics

In this section, you’ll learn about call options. In order to accomplish this, let’s discuss calls from both the buyer and seller’s perspective.

Why would someone buy a call? Well, a call buyer benefits when the stock price increases to a price well above their option’s strike price. If the stock price does increase above the call’s strike price, the call option’s price increases, as the ability to buy shares at a much lower price becomes more valuable. Therefore, a trader who buys a call anticipates the stock price will increase.

Conversely, a call seller benefits when the stock price trades below the option’s strike price. If the stock does trade below the strike price, the call’s price will trade towards $0 as expiration approaches. As a result, the call seller will keep the premium (an option’s price is sometimes referred to as premium) they collected for selling the call. If the stock price increases above the strike price, the call seller is in trouble because as the stock price increases, the call becomes more and more valuable. When the option is worth more than the seller collected for it, they will have losses. Therefore, a trader who sells a call option anticipates the stock price will remain below the strike price.

Call Option Trade Example

Now that we’ve gone through both perspectives related to call options, let’s look at a visual example of how a call’s price changes when the stock price changes. In the following chart, we’ll analyze a call option with a strike price of $190. Be sure to compare the stock price to the call’s strike price, and see how that translates to a change in the call’s price.

What Are Options? Call Option Visualization

As illustrated here, when the stock price increases more and more above the call’s strike price of $190, the call option becomes more valuable. Now, if a trader had purchased the call option at the beginning of the period, they would have profits of about $1,500 (because the call is worth $15 more than the trader’s purchase price, and every $1 of an option’s price represents $100 in actual dollar terms).

On the other hand, the call seller would be sitting on $1,500 losses, as the contract is worth $15 more than they sold it for. In this example, the call option’s value increases because the ability to buy shares of stock at $190 gets more valuable as the stock price increases further above $190.

If this call option was held through expiration, a trader who owned the call option would be left with 100 shares of stock, with an effective purchase price of $195 per share ($190 strike price + $5 premium paid for the option). On the other hand, a trader who sold this call option would have -100 shares of stock (a short stock position of 100 shares), with an effective sale price of $195 per share ($190 strike price + $5 premium collected for the option).

Alright, now that you have the basics of call options down, let’s talk about put options!

Read! 29 Core Options Trading Strategies

Put Option Basics

Like we did for calls, let’s discuss put options from both the buyer and seller’s perspective.

Why would someone buy a put? A put buyer benefits when the stock price decreases to a price well below their option’s strike price. If the stock price does drop below the put’s strike price, the put option’s price increases, as the ability to sell shares at a higher price becomes more valuable. Therefore, a trader who buys a put anticipates the stock price will decrease.

Conversely, a put seller benefits when the stock price trades above the option’s strike price. If the stock price does remain above the put’s strike price, the put’s price will trade towards $0 as expiration approaches, and the put seller will keep the premium they sold the option for. If the stock price drops below the put strike, it’s bad news for the put seller. This is because as the stock price decreases, the put becomes more valuable.

The put seller will have losses for as long as the put is worth more than they premium they collected when entering the trade. Therefore, a trader who sells a put anticipates the stock price will remain above the strike price.

Let’s look at a visual to demonstrate these concepts!

Put Option Trade Example

In the following example, we’ll analyze a put option with a strike price of $95. Be sure to compare the stock price to the strike price of the put, and see how that translates to changes in the put’s value.

As demonstrated here, the put price increases when the stock price drops further and further below the strike price of $95. Why? Because the ability to sell shares at a higher price becomes more valuable as the share price decreases.

More specifically, the stock price dropping from $95 to $90 results in $300 in profits for the put buyer because the option’s value is $3 more than the trader paid for the option. Conversely, the put seller in this scenario would have $300 in losses, as the option is $3 more than they sold it for. However, at expiration, the put seller makes a $300 profit because the option expires out-of-the-money. On the other hand, the put buyer loses the full $300 they paid for the option.

At expiration, neither trader would have a stock position, as the option expired out-of-the-money. However, if a put option expires in-the-money, any trader who holds the option through expiration will end up with a stock position. For a trader who is short the put, the resulting position will be +100 shares per contract. Conversely, a trader who owns the put will have a position of -100 shares (a short stock position) per contract. The share entry price for both traders is the put’s strike price, less the amount the option was bought or sold for.

Additional Resources

What Are Options? – Forbes

Option Greeks | 5 Visual Guides to Measuring Risk

Posted on January 26, 2022February 9, 2022 by Mike Martin

Last updated on February 9th, 2022 , 10:02 am

In the below guides, projectfinance will teach you everything there is to know about the Greeks in options trading!

Option Greeks 101

If you want to trade options, you must know the Greeks. The good news? They can be simplified. Delta · Gamma · Theta · Vega.

Start Learning!

Option Risk #1: Delta

Delta estimates an option’s price change when the stock price rises or falls by $1. In other words, delta is used to gauge an option’s directional exposure.

Learn Delta!

Option Risk #2: Gamma

An option’s directional exposure changes when the stock price shifts. Gamma estimates how much an option’s delta will change when the stock price rises or falls by $1.

Learn Gamma!

Option Risk #3: Theta

The passage of time is the enemy of option buyers, and the best friend of option sellers. Theta estimates how much an option’s price will fall with each day that passes.

Learn Theta!

Option Risk #4: Vega

Implied volatility rises and falls with investor sentiment. Vega estimates an option’s price sensitivity relative to changes in implied volatility.

Learn Vega!

Additional Resources

Greeks (finance) – Wikipedia

9 Common Options Trading Mistakes – Don’t Do This!

Posted on January 24, 2022February 10, 2022 by Mike Martin

Last updated on February 10th, 2022 , 07:24 pm

There are many options trading mistakes that new traders make, and that’s entirely ok! Part of the process when learning anything in life is through mistakes.

With that said, it’s always good to be aware of common “land mines,” so you can make an attempt to avoid them, and ultimately protect your hard-earned money.

In this post, we’ll cover our picks for the top nine options trading mistakes that most new traders will make at some point.

1. No Exit Plan

It’s crucial to know exactly when you will close a trade, profitable or unprofitable.

Perhaps the most important thing to know is when you’ll close losing trades that carry a lot of risk, such as being short naked options. When trading limited-risk spreads, it’s ok to be accepting of the maximum loss potential of that position, so long as you’ve sized the position accordingly.

2. Trading Too Many Positions

Some may not agree that this is a mistake, but the fact of the matter is that it’s more difficult to keep track of your portfolio when you trade more and more positions.

Additionally, it’s likely that your positions are highly correlated, which means you’re really trading similar positions in different stocks. It’s ok to have multiple positions in different stocks, just be aware that they may react the same way when markets get volatile.

Lastly, during extremely volatile trading sessions, getting filled on your trades is next to impossible. If you have on 20 positions, good luck making timely adjustments in those positions at decent prices.

The only caveat to this particular point is that if you’re a brand new trader, you’ll benefit from more positions because you’ll gain more experience in regards to strategies and trade outcomes.

3. Trading Illiquid Products

Getting trapped in an option position that will be impossible to close can be costly. If you enter a position in options that are illiquid (very little to no volume or open interest), then it’s likely you’ll be exiting that position at a very unfavorable price

At the very minimum, trade options with open interest in the 1,000s and volume in the 100s (though volume will be lower early in the trading session).

4. Trying to Fix Entirely Broken Trades

Trying to fix broken trades is another common options trading mistake. At some point, the trade is no longer worth your commissions, and you’d be better off taking the loss and allocating your capital elsewhere.

There will always be another trading opportunity, so don’t waste your time trying to repair something that has a very low probability of getting fixed.

5. Taking Profits Too Soon

While taking profits on a trade is not a bad thing, creating a strategy that revolves around taking tiny profits may seem logical at first, as your probability of success will be incredibly high (90% or higher in some cases).

However, you must keep in mind that such approaches require you to have a very high success rate, as the inevitable losses will likely consume a good portion of your profits from winning trades.

Furthermore, commissions will eat into your returns when you take small profits, so try and let your profits run a little longer. A recent iron condor study we conducted showed that the 25% profit target combinations resulted in the lowest profit expectancy over time (sometimes negative when adjusting for estimated commissions), despite having success rates over 90%.

Of course, the strategy you implement should also be considered. For example, long calendar spreads are one example of trades that are typically closed at profit targets of 10-20%, as they don’t often reach profit levels of 50-100% on the debit paid. Another strategy in which profits are typically taken sooner is the short straddle, as the probability of reaching 50-100% of the profit potential is typically low.

6. Trading Too Big

This list of trading mistakes wouldn’t be complete without mentioning trade size.

Trading involves losses, and you can’t allow one losing trade to take you out. As a general guideline, you shouldn’t risk more than 2.5% of your portfolio in a short-term option position. Of course, this may vary based on risk tolerance, and it will be harder to comply with in smaller trading accounts, but don’t put 50% of your portfolio into a single option position!

If you’re trading longer-term options as a way to get leveraged exposure (such as buying 1-2 year call options on an equity), you may be able to get away with increasing your allocation.

7. Not Analyzing Implied Volatility

Implied volatility can be used to assess how “expensive” or “cheap” option prices currently are.

You should always analyze implied volatility before entering a trade to ensure that you won’t be battling changes in IV if your stock price outlook turns out to be correct.

One example of this would be buying call options after a severe market downturn. Typically, when stocks fall considerably, option prices get bid up and implied volatility rises. If you buy a call option in anticipation of a market increase, you might not make money if the market doesn’t increase enough to offset the inevitable decrease in implied volatility.

8. Not Checking for Market Catalysts

It’s always a good idea to make sure you’re aware of any upcoming events that could cause your stock to shift substantially in either direction.

More specifically, if a stock’s implied volatility has been rising and seems lofty, it’s usually for a good reason.

In regards to individual equities, earnings announcements will often cause a stock’s option prices to decay more slowly, leading to an increase in implied volatility as the earnings date approaches.

After the market catalyst passes and the uncertainty dissipates, option prices will change accordingly, but the stock/market may change significantly in one direction.

Be aware of such events before entering trades.

9. Trading Complex Products Without Researching Them First

There are some complicated products out there, particularly in the leveraged ETF and volatility space. Don’t worry! It takes some time to grasp how some of these products work. Just be sure that you read about them before trading them, as it will help avoid unexpected outcomes.

As an example, don’t sell that put spread in VXX until you understand what drives its movements!

That wraps up our picks for common options trading mistakes (in our opinion)!

Next Lesson

Supplemental Reading

Five Mistakes to Avoid When Trading Options – Options Playbook

Bull Call Spread Explained – The Ultimate Guide w/ Visuals

Posted on January 17, 2022March 24, 2022 by Mike Martin

Last updated on March 24th, 2022 , 07:13 am

A bull call spread is an options strategy that consists of buying a call option while also selling a call option at a higher strike price.

Both options must be in the same expiration cycle. Buying call spreads is similar to buying calls outright, but less risky due to the premium collected from the sale of a call option at a higher strike. As the name suggests, a bull call spread is a bullish strategy, as it profits when the underlying stock price rises.

We’re going to cover all of this in great detail, so be sure to keep reading if you want to master this strategy!

Let’s go over the strategy’s general characteristics:

TAKEAWAYS

The bull call spread consists of: 1. buying a call at strike price A 2. Selling a call at strike price B.
Max profit in a bull call spread is the difference between strike A and strike B minus the net premium paid.
In bull call spreads, max loss is the total premium paid.
The Breakeven for bull call spreads is strike A plus net debit paid.
The bull call spread is a cheaper way to go long when compared to straight call buying.

Bull Call Spread Strategy Characteristics

➦Max Profit Potential: (Call Spread Width – Net Debit Paid) x 100

➦Max Loss Potential: Net Debit Paid x 100

➦Expiration Breakeven: Long Call Strike + Net Debit Paid

➦Position After Expiration:

If the long and short call are both in-the-money at expiration, the assignments offset, resulting in no stock position. If only the long call is in-the-money at expiration, the resulting position is +100 shares of stock per call contract.

➦Assignment Risk:

When the short call of a bull call spread is in-the-money, a bull call spread trader is at risk of being assigned -100 shares of stock per short call contract. The probability of being assigned on short calls is higher when the short call has little extrinsic value. Alternatively, short call assignments are common before a stock’s ex-dividend date, primarily when the dividend is greater than the short call’s extrinsic value.

To gain a better understanding of these concepts, let’s walk through a basic example.

Bull Call Spread Profit/Loss Potential at Expiration

In the following example, we’ll construct a bull call spread from the following option chain:

In this case, let’s assume the stock price is trading for $150 at the time of entering the spread. To construct a bull call spread, we’ll have to buy a call option and sell the same number of calls at a higher strike price. In this example, we’ll buy one of the 145 calls and sell one of the 155 calls.

Initial Stock Price: $150

Long Call Strike: $145

Short Call Strike: $155

Premium Paid for the 145 Call: $8.80

Premium Collected for the 155 Call: $3.99

In this example, buying the 145 call for $8.80 and selling the 155 call for $3.99 results in a net debit of $4.81 (since $8.80 is paid, and $3.99 is collected). Additionally, the “spread width” is the difference between the long and short call strike, which is $10 in this case. Based on a net debit of $4.81 on a $10-wide bull call spread, here are the position’s characteristics:

Max Profit Potential: ($10-wide call strikes – $4.81 net debit paid) x 100 = $519

Max Loss Potential: $4.81 net debit paid x 100 = $481

Expiration Breakeven: $145 long call strike price + $4.81 debit paid = $149.81

Probability of Profit

This bull call spread example has a probability of profit slightly greater than 50% because the breakeven price ($149.81) is less than the current stock price ($150), which means the stock price can fall slightly and the position can still profit.

Position After Expiration

If the stock price is above 155 at expiration, both calls expire in-the-money. At expiration, an in-the-money long call expires to +100 shares, and an in-the-money short call expires to -100 shares, which results in no stock position for the call spread buyer.

If the stock price is between 145 and 155 at expiration, only the long call expires in-the-money, resulting in a position of +100 shares for the call spread buyer.

The following visual demonstrates the potential profits and losses for this bull call spread at expiration:

If the stock price is at or below the long call’s strike price of $145 at expiration, both the 145 and 155 call options will expire worthless, resulting in the maximum loss of $481.

If the stock price is in-between the strike prices at expiration, such as $149.81, the long 145 call will have value while the 155 call will expire worthless. At $149.81, the 145 call will be worth $4.81 ($149.81 Stock Price – $145 Strike Price) and the 155 call will be worth $0, resulting in no profit or loss on the trade.

If the stock price is above the short call’s strike price of $155, the entire 145/155 call spread will be worth $10 (the width between the strike prices), which means the profit on each call spread will be +$519.

Bull Call Spread Trade Examples

The first example we’ll investigate is a situation where a trader purchases an at-the-money call spread. An at-the-money bull call spread consists of buying an in-the-money call and selling an out-of-the-money call. When constructed properly, the breakeven price is slightly below the current stock price. Here’s the setup:

Initial Stock Price: $109.82

Strikes and Expiration: Long 100 call expiring in 45 days. Short 115 call expiring in 45 days

Net Debit Paid: $11.18 paid for the 100 call – $1.94 received for the 115 call = $9.24

Breakeven Stock Price: 100 long call strike price + $9.24 net debit paid = $109.24

Maximum Profit Potential: ($15-wide call strikes – $9.24 debit paid) x 100 = $576

Maximum Loss Potential: $9.24 net debit paid x 100 = $924

Let’s see what happens!

Bull Call #1 Results

In this example, the bull call spread position had both profits and losses at some point. With 14 days left until expiration, the call spread was worth slightly less than its maximum value of $15.

However, at expiration, the stock price was only slightly above the long call spread’s breakeven price. As a result, the long call spread trader didn’t make or lose any money by holding the trade to expiration.

However, the trade would have been profitable if the trader sold the spread when it was worth more than the entry price of $9.24. To close a bull call spread before expiration, the trader can simultaneously sell the long call and buy the short call at their current prices. As an example, if the trader closed the spread when it was worth $12, they would have realized $276 in profits: ($12 closing price – $9.24 purchase price) x 100 = +$276.

Since the long call is in-the-money at expiration, the trader would end up with +100 shares of stock (per contract) if they did not sell the long call before expiration. Upon selling the long call portion of a bull call spread, it’s wise to buy back the short call. Otherwise, the trader will expose themselves to unlimited loss potential.

Next, we’ll look at an example of a long call spread trade where the stock price moves against the position.

Unprofitable Call Spread Example

In this example, we’ll look at a situation where a trader buys an out-of-the-money long call spread. An out-of-the-money long call spread is constructed by purchasing an out-of-the-money call while also selling an out-of-the-money call at a higher strike price.

It’s important to note that purchasing out-of-the-money call spreads is a low probability trade because the breakeven price is above the stock price at entry. Additionally, the profit potential is greater than the loss potential.

Here’s the setup:

Initial Stock Price: $569.92

Strikes and Expiration: Long 575 call expiring in 35 days Short 635 call expiring in 35 days

Net Debit Paid: $32.45 paid for the 575 call – $11.00 received for the 635 call = $21.45

Breakeven Stock Price: $575 long call strike price + $21.45 debit paid = $596.45

Maximum Profit Potential: ($60-wide call strikes – $21.45 debit paid) x 100 = $3,855

Maximum Loss Potential: $21.45 debit paid x 100 = $2,145

As you can see, the long call spread’s breakeven price is more than $25 higher than the stock price when entering the trade, which means the stock price must increase more than $25 for the position to breakeven at expiration.

Let’s take a look at what happens:

Bull Call #2 Results

This example demonstrates that a significant stock price increase results in healthy profits for a bull call spread trader. Unfortunately, the stock price ends up dropping just as quickly. With the stock $45 points below the long 575 call at expiration, the long call spread expires worthless. The resulting loss for the call spread buyer is $2,145 ($21.45 debit paid x 100).

As mentioned before, a spread can always be closed before expiration if a trader wishes to lock in profits or losses. For example, if the trader in this example wanted to cut their losses when the spread traded down to $15, they would lock in $645 in losses: ($15 sale price – $21.45 purchase price) x 100 = -$645.

Alright, you’ve seen long call spread examples that break even and realize the maximum loss. In the final example, we’ll investigate a long call spread trade that winds up with its maximum profit potential.

Profitable Call Spread Example

In the final example, we’ll examine a long call spread example that ends up with its maximum profit potential.

Here are the specifics of the final example:

Initial Stock Price: $57.47

Strikes and Expiration: Long 49 call expiring in 82 days. Short 70 call expiring in 82 days.

Net Debit Paid: $11.10 paid for the 49 call – $1.85 received for the 70 call = $9.25

Breakeven Stock Price: $49 long call strike + $9.25 debit paid = $58.25

Maximum Profit Potential: ($21-wide call strikes – $9.25 debit paid) x 100 = $1,175

Maximum Loss Potential: $9.25 net debit paid x 100 = $925

Let’s see what happens!

Bull Call #3 Results

In the first 30 days of the trade, the stock price stagnates around the breakeven price of the long call spread. However, with around 45 days to expiration, the stock jumps 30% to $80 after an earnings announcement.

With the stock price $10 above the short call strike, the long call spread is worth around $20. With $21-wide strikes, the spread’s maximum value is $21. So, even though the position has around 45 days to expiration, the long call spread is worth near its maximum potential value.

When the call spread is worth $20, it’s likely that the long call spread trader closes the position for a profit because there’s only $1 left to make and $20 to lose.

If the trader did sell the spread for $20, the realized profit would be $1,075: ($20 sale price – $9.25 purchase price) x 100 = +$1,075.

Finally, if the spread was held through expiration, no stock position would be taken on because the exercise/assignment of the long and short call options cancel each other out. However, it’s possible that the spread trader is assigned on the short call when it’s deep-in-the-money before expiration.

Final Word

Congratulations! You now know how the bull call spread works as an options trading strategy. In summation, here is what we learned:

In a bull call spread, risk is limited to the net debit paid.
Bull call spreads can allow for less risk than just buying straight calls.
In the bull call spread, both upside and downside are capped.

* Want to make a little extra income from your bull call spread? Read our article on the bull call ladder strategy here! But be careful, this strategy introduces traders to great loss potential!

Additional Resources

What Is A Bull Call Spread? – Fidelity Investments

Bull Call Spread Definition – Investopedia

Bull Call Spread Debit … – The Options Industry Council (OIC)

Implied Volatility Basics

What is the VIX Index?

The Expected Move

Trading VIX Options

Trading VIX Futures

The VIX Term Structure

IV Rank ﻿vs﻿. IV ﻿Percentile

Next Lesson

Options Trading for Beginners: The ULTIMATE Guide

Implied Volatility Explained (The ULTIMATE Guide)

The Vertical Spread Options Strategies: Beginner Basics

Additional Resources

What is Options Trading?

Option Trading Benefits

Unique Option Characteristics

Options and Leverage (Trade Example)

Trade Example: Stock Trade vs. Option Trade

The Two Option Types

Call Option Example

Call Trade Example

Selling Call Options

The Second Option Type: Puts

Trade Example: Put Option

Selling Put Options

Final Word

Next Lesson

Stocks vs Options

Implied Volatility Explained (The ULTIMATE Guide)

The Vertical Spread Options Strategies: Beginner Basics

Additional Resources

What is Option Volume?

What is Open Interest?

Open Interest Example

The Importance of Option Liquidity

Which Options are the Most Liquid?

Option Liquidity vs. Time to Expiration

AAPL Volume and Open Interest

Next Lesson

Options Trading for Beginners

Long Call Options Explained

Long Put Options Explained

Additional Resources

"Bid and "Ask" Explained

Bid and Ask Spread: Market Makers

Bid and Ask Spread Example

Spread in Stocks vs. Options

Which Options Have the Widest Bid-Ask Spreads?

Bid-Ask Spreads of Long-Term Options (LEAPS)

Spreads vs. Market Volatility

What Is The Effective Spread?

Option Order Types

Bid-Ask Spread FAQs

Next Lesson

Leverage in Options Trading Explained

Intrinsic and Extrinsic Value in Options Trading Explained

11 Tips for Options Traders

Additional Resources

What are Intrinsic and Extrinsic Value?

Intrinsic and Extrinsic Value at Expiration

Intrinsic Value of Call Options

Call Option Example

Intrinsic vs. Extrinsic: Out-of-the-Money Call Option

Intrinsic Value of Put Options

Intrinsic vs. Extrinsic Value: In-the-Money Put

Intrinsic vs. Extrinsic Value: Out-of-the-Money Put

What Determines an Option's Extrinsic Value?

Option Value and DTE

Next Lesson

Implied Volatility Explained (The ULTIMATE Guide)

Option Greeks Explained: Delta, Gamma, Theta & Vega

Gamma Squeeze and Meme Stocks Explained

Additional Resources

Option Expiration

When Do Options Expire?

What's the Longest-Term Options Expiration Date?

How to Choose an Option Expiration Cycle

Consider Your Strategy

Consider Liquidity / Trading Activity

American vs European Option at Expiration

Final Word

IV Rank vs. IV Percentile