VIX Contango: The Ultimate Beginner’s Guide

Posted on March 14, 2022March 28, 2022 by Chris Butler

Last updated on March 28th, 2022 , 02:05 pm

VIX Contango: The Ultimate Beginner's Guide

Stock market volatility products are confusing for beginner market participants because of their complexity.

Fear not!

In this particular guide, you will develop an understanding of:

Contango and backwardation in the Cboe volatility index (VIX) market
The major implications it has for the performance of popular volatility products such as VXX and UVXY.
VIX trading strategies for contango and backwardation market conditions

Prepare to take one step closer to becoming a master of the VIX/volatility landscape!

What is Contango?

“Contango” refers to a situation where futures contracts trade at a premium to the “spot” price (the current price) of a commodity/index.

For example, if the Cboe VIX index is at 15 and the VIX futures contract settling in 30 days is 17, we have contango in the VIX futures market.

Here’s a simple example visualization of contango:

Contango is typically present in the VIX market, making it more useful to understand than backwardation (the opposite of contango). We will briefly cover backwardation in a later section.

Why is Contango Important to Understand?

Contango in the VIX market drives the performance of volatility products and trading strategies, so understanding it will help you make more informed trades.

In the VIX market, the VIX index is the calculation of expected S&P 500 volatility based on 30-day S&P 500 index (SPX) option prices. But we can’t directly trade the VIX index because there are no VIX shares. To trade VIX index predictions, traders turn to VIX options and futures.

But before trading futures, it’s essential to understand how futures prices perform over time relative to the spot price.

Futures Prices Converge to the Spot Price

A critical concept to understand in futures markets is that futures prices converge towards the spot price over time:

On a futures contract’s expiration date, the contract’s price will equal the spot price.

A futures contract with no future equals the spot price.

For example, if the VIX index is at 15 and a 30-day VIX futures contract is at 17, the contract’s price will fall from 17 towards 15 with each passing day if the VIX index remains at 15:

The above image illustrates how a futures price converges to the spot price over time if the spot price remains constant.

In reality, the VIX index will fluctuate as market volatility changes, but volatility index futures will get “pulled” towards the index as their settlement dates approach.

Here’s a visual using real historical data to prove this:

As we can see, each contract’s price equals the VIX index value at expiry.

What can we do with this information?

The VIX Futures Curve

Volatility traders pay close attention to the “VIX futures curve” or “VIX term structure” because it can inform them of how volatility products will perform over time if volatility remains unchanged. It also tells us how much we need the VIX index to change for our volatility trades to work out.

The “VIX futures curve” is simply a chart of the prices of VIX futures contracts with varying expiration dates, from shorter-term to longer-term.

VIX Central is a free resource for visualizing the current VIX futures curve, as well as viewing historical curves.

VIX Contango Example

When the VIX futures are in contango, we get an upward-sloping curve, indicating that longer-term contracts are more expensive than shorter-term contracts:

VIX Backwardation Example

When the VIX futures are in backwardation, we get a downward-sloping curve, indicating that longer-term contracts are cheaper than near-term contracts.

The current futures curve is in backwardation as I write this in March 2022:

In the above curve, the March and April contracts are trading at the level of the VIX, but the longer-dated contracts are at lower and lower values the further out the settlement date.

During normal/low volatility market periods, the VIX futures are usually in contango. We’ll explore the intuitive understanding of why that is in a later section.

VIX Futures Contango vs. ETP Performance

The performance of VIX futures determines the performance of popular volatility exchange-traded products (ETPs).

For example, the daily performance of VXX is equal to the daily percentage changes of front-month and back-month VIX futures. Be sure to read our guide on VXX for an in-depth understanding of this product’s mechanics.

When VIX futures contango is present, short-term VIX futures contracts will bleed value with each passing day if the VIX index does not increase.

The result? Long volatility products like VXX and UVXY will experience drawdowns since their performance stems directly from daily changes in VIX futures. Short volatility products like SVXY and SVIX benefit from persistent contango.

Why Are VIX Futures Usually in Contango?

During normal market conditions, the Cboe VIX Index is typically below 20. When the VIX is below 20, it’s common for contango to be present in the VIX futures market.

An easy way to understand why is to think of a VIX futures contract as insurance. When stock market volatility increases, the VIX index and futures rise, making them popular hedging instruments for risk managers.

During a financial crisis, such as in 2008 or 2020, the VIX index and futures spiked as the stock market collapsed violently.

Here’s how the volatility index futures reacted to the VIX spike in 2008:

If the market is in a low volatility period, risk management desks might buy VIX futures to hedge their portfolios against an increase in market volatility. As seen above, long positions in volatility index futures will gain value during market crises. The profits from these long volatility positions will offset losses in long equity positions.

Since futures contracts have expiry dates, volatility traders must decide between hedging short-term and long-term.

Generally speaking, there’s a higher probability of negative events occurring over a longer period of time (such as five years) as opposed to a shorter period of time (such as one month).

The probability of the market falling 10% is higher over a 1-year period than a 1-week period.

As a result, buying long-term VIX futures provides traders with a long duration of protection, justifying a higher price compared to buying a short-term future that provides only a small window of protection.

And so during normal market conditions, longer-term volatility futures trade at higher prices than shorter-term volatility futures, resulting in contango in the VIX futures market.

How can traders take advantage of contango in the VIX?

VIX Contango Trading Strategies

When contango is present, VIX futures and long volatility products like VXX and UVXY all predictably lose value if the VIX does not increase.

The VIX index is directly tied to the realized S&P 500 volatility.

If S&P 500 volatility increases, traders will bid up SPX option prices (which are used to calculated the VIX) as the expected movements of the S&P 500 index increase.

If S&P 500 volatility falls, the expected movements of the S&P 500 index contract. SPX option prices will fall (VIX falls).

What does this have to do with contango?

If VIX contango is present and traders believe S&P 500 volatility will remain unchanged or decrease, profits can be made from short volatility trading strategies, including:

Shorting VIX futures
Shorting VXX/UVXY shares
Buying puts on VIX/VXX/UVXY
Shorting calls on VIX/VXX/UVXY

These strategies can profit from persistently low market volatility, as the VIX futures will remain in contango and steadily lose value as they converge towards the lower VIX spot price (visualized earlier in this post).

However, traders should be cautious with short volatility trading strategies because when market volatility increases, it can do so violently.

For example, in the financial market crisis of 2020, the VIX index went from below 14 to over 80 within two months as the S&P 500 fell over 30%. Traders who were short volatility got destroyed during that time period, while traders who were long volatility experienced massive profits.

If you want to profit from contango in the VIX futures, trading strategies such as buying put options on VXX or UVXY provide traders with limited loss potential in the event of a spike in market volatility.

What Happens When VIX is in Backwardation?

The majority of this guide covers contango because it is present in the VIX market a high percentage of the time.

VIX backwardation occurs when the VIX index is above VIX futures contracts, and longer-term futures are at a discount to shorter-term futures.

Backwardation in VIX futures occurs when market volatility is elevated.

Since VIX futures always converge towards the spot VIX over time, VIX futures will appreciate over time if the spot VIX remains above these futures contracts.

For example, if it is February 1st and the VIX is at 50, and the March VIX future is at 40, the March VIX future will appreciate 10 points by its expiration date if the VIX index remains at 50.

That means long volatility ETPs like VXX and UVXY will also appreciate over that period since they track the daily percentage changes of short-term VIX futures.

But market volatility is always changing, and periods of extreme market volatility typically do not last long. Consequently, the VIX market can go from backwardation to contango quickly if the market recovers and volatility falls.

VIX Backwardation Trading Strategies

When backwardation is present, VIX futures and long volatility products like VXX and UVXY all gain value over time if the VIX does not fall drastically.

If VIX backwardation is present and traders believe S&P 500 volatility will remain unchanged or increase further, profits can be made from long volatility trading strategies, including:

Buying VIX futures
Buying VXX/UVXY shares
Buying calls on VIX/VXX/UVXY
Shorting puts on VIX/VXX/UVXY

These strategies can profit from persistently high market volatility, as the VIX futures will remain in backwardation and steadily appreciate as they converge towards the higher VIX spot price.

However, traders should be cautious with long volatility trading strategies when market volatility is already elevated, especially if it is extremely high (VIX over 50).

Extreme market volatility typically does not last long, which is precisely why long-dated VIX futures will trade at steep discounts to spot VIX during periods of significant market volatility.

Conclusion

Understanding contango and backwardation is key when trading VIX options, futures, and popular volatility products like VXX, UVXY, or SVXY.

The most critical concept to understand is that volatility products are tied to VIX futures, which converge to the VIX index over time.

During normal market conditions, contango is typically present in the VIX futures curve, leading to steady bleed in the values of volatility index futures as they drift towards the lower VIX index.

The result is losses in long volatility positions (long futures, long VIX calls/short VIX puts, long VXX/UVXY).

For traders to profit from long volatility positions when contango is present, market volatility needs to increase quickly, pulling the VIX index and futures higher.

Otherwise, traders can take advantage of the “contango bleed” and profit from short volatility positions as long as market volatility does not surge. Of course, shorting volatility is no easy trade.

At a minimum, I hope this post helped you grasp the complexities of the volatility market, helping you avoid common pitfalls and disastrous trading results that stem from a lack of awareness related to VIX trading.

Next Lesson

UVXY: What Is It and Is It Worth The Risk?

Posted on March 11, 2022May 4, 2022 by Mike Martin

Last updated on May 4th, 2022 , 05:21 am

The ProShares Ultra VIX Short Term Futures ETF (UVXY) is a great product for traders looking to both speculate and hedge on short-term volatility. Unlike most volatility products, UVXY provides 1.5x leveraged exposure to the daily performance of the S&P 500 VIX Short-Term Futures Index.

Worth noting here is the word “daily.” Over time, because of contango loss (more to come on this) and time decay, UVXY persistently sheds value. It is because of this UVXY is not designed for long-term traders. In both neutral and bullish markets, UVXY will collapse in value.

Should you trade Proshares Ultra VIX ETF? For most traders, UVXY is not worth the risk. Let’s break down this ETF to see why.

TAKEAWAYS

UVXY tracks the short-term VIX Futures index on a 1.5x leveraged basis.
UVXY uses “Swaps” to achieve its 1.5 leverage.
UVXY decays in value over time because of “contango.”
Contango occurs when an expiring futures contract trades at a premium to the spot price.
UVXY charges a very high expense ratio of 0.95%.

What is UVXY and What Does It Track?

As stated in the fund’s prospectus, ProShares UVXY ETF aims to provide investors:

Important to note here is that the UVXY ETF (technically an exchange-traded note ETN) is correlated to VIX Futures and NOT the VIX Index. Is there a material difference here?

Absolutely!

Though both the VIX Index and VIX futures have a negative correlation to the equity market, huge differences exist. The most important difference is the performance of the two.

VIX Index vs. VIX Futures (UVXY): Performance

The below image (taken from spglobal.com) shows just how dramatic the performance of the VIX Index and VIX futures deviates over a 9 year period:

So why the huge difference?

Spot vs Futures: Rolling UVXY

The VIX Index is a spot index. Unlike VIX futures (which UVXY tracks on a leveraged basis), no underlying products (like shares) trade on spot indices.

This means that the VIX Index product does not need to be “rolled” to a different expiration to stay alive. Though options trading does occur on indices, since there is no tradable underlying security, contracts are settled in cash instead of shares.

Futures indices do indeed offer tradable securities. Since all future contracts expire, they must be “rolled” to the next month to stay alive.

During calm/”normal” market periods, VIX futures contracts often trade at a premium to the VIX Index.

This premium is known as “contango.” Here’s why contango in the VIX futures market causes UVXY to bleed value over time.

UVXY: Contango vs Backwardation

When the VIX futures contracts are trading at a premium to the VIX index, the VIX futures are in contango.

UVXY tracks the daily performance of the two nearest monthly VIX futures, such as February and March in the above example.

If the VIX index remains at 15 as time passes, the February and March VIX futures will steadily lose value as they converge to 15 because a VIX futures contract at maturity will be equal to the spot price (the VIX index).

And since UVXY tracks the daily percentage change of a mixture of these two contracts that are steadily losing value in this scenario, UVXY loses value.

UVXY in Backwardation

If the VIX futures contracts are trading below the VIX index, then the futures are in backwardation and will gain value as they converge towards the higher VIX index (assuming the VIX index remains elevated over time).

In this scenario, UVXY will gain value because it tracks the daily percentage change of a mixture of these two contracts that are gaining value as they converge towards the higher VIX index.

So do we have any idea how fast, or at what rate ETFs like UVXY will decay? Maybe, and that leads us to the VIX Term Structure.

UVXY and VIX Term Structure

Understanding the VIX term structure can help us predict the rate at which products like UVXY will decay. Take a look at the below visual, which shows the historical prices of the VIX futures contracts on April 1st, 2016:

We can see the VIX index was trading at 13. We can also see that the VIX futures contract expiring in August is trading at 19.

In this snapshot in time, UVXY would have been tracking the daily performance of the April and May VIX futures, which were at approximately 19% and 32% premiums to the VIX index.

If the VIX index remained at 13 over time, the April and May VIX futures would both fall from their 15.5 and 17.1 levels to 13. Since UVXY tracks the daily percentage changes of these contracts, UVXY would bleed value.

But what actually happened?

Over the following month, the VIX index rose 12%, but UVXY lost 17.4% because the April and May VIX futures were trading at such large premiums to the VIX index and lost substantial value over the 30-day period:

It should also be noted that at the time, UVXY had 2x leverage, tracking 2x the daily percentage change of a weighted basket of these two VIX futures contracts.

For instance, let’s say UVXY was tracking a 50% weighting in the April contract and a 50% weighting in the May contract in the middle of the roll period.

If the April contract gained 10% and the May contract also gained 10% on the same trading day, UVXY would have gained 20%.

Today, the same daily changes in the VIX futures contracts (assuming the same weightings on the trading day in question) would result in a 15% UVXY gain after its leverage was reduced to 1.5x in 2018.

UVXY: Positions and Holdings

The below visual (taken from UVXY’s issuer ProShares) shows the funds current holdings:

Notice the fund has exposure to both March and April futures.

Why two months? The UVXY ETF attempts to track a 30-day VIX futures contract, but since there’s not always a futures contract with exactly 30 days to settlement, they hold a specific weighting of the nearest monthly contracts that gives them a weighted 30-day portfolio.

Put more simply, if the March contract had 15 days to settlement and the April contract had 45 days to settlement, a 50% weighting in each contract would give them a “weighted 30-day VIX futures contract.”

15 Days to Settlement x 50% Weight = 7.5 Days to Settlement

45 Days to Settlement x 50% Weight = 22.5 Days to Settlement

7.5 + 22.5 = 30 Days to Settlement.

The proportion of front month and next month futures are in a state of perpetual flux. As March settlement approaches, ProShares will increasingly shift its holdings to the April contract, reaching a 100% weighting when the March contract settles.

Each day after that, the fund will sell a portion of its April VIX futures and buy some May VIX futures. The process repeats indefinitely.

But what about that short-term swap? This is where the leverage comes into play.

UVXY's 1.5X Leverage: SWAPs

Many savvy investors are familiar with options trading. Options provide traders with great leverage.

But sometimes these derivatives are not feasible for leveraged funds.

Instead, swaps are used.

Swaps are non-standardized contracts. Swaps are exceedingly opaque for this reason. We truly don’t know how ProShares obtains its 1.5x leverage, but the secret is in the sauce of that swap – whatever it may contain!

UVXY: Expense Ratio

Future-based ETFs are notoriously expensive. Why?

All that rolling is costly from both manpower and commission-based perspective. This leads to the current expense ratio for UVXY:

UVXY Fee's

ProShares UVXY management fee of 0.95% comes in at about twice the average expense ratio of other ETFs.

When added to the cost of contango, UVXY could be a huge drag on your account.

UVXY: Historical Returns

We said before that UVXY is reserved for short-term traders. Hopefully, the below one-year chart of UVXY will drive that point home.

UVXY: 1 Year Chart

Source: Google Finance

Let’s take this one step further and look at a 5 year chart of UVXY:

UVXY: 5 Year Chart

Source: Google Finance

So we can all agree that UVXY over the long run is a horrible idea (pending an economic apocalypse).

But UVXY is a leveraged ETF; how does this product compare to unleveraged ETFs (like VXX) that track VIX futures?

UVXY vs VXX vs VIX

The below image compares UVXY to the VIX index as well as VXX. VXX, issued by Barclay’s, is similar to UVXY in that they both track futures on the VIX. However, VXX is not leveraged as UVXY is.

Consequently, VXX will gain less than UVXY in times of increasing VIX futures, and will lose less than UVXY in times of decaying VIX futures.

Let’s see how the performance between these products looks over one year (ending in March 2022).

UVXY vs VXX vs VIX: 1 Year Chart

Source: Google Finance

As we can see, the leverage that UVXY provides has hurt the fund over the long run when compared to the VIX. Additionally, the normally present contango in the VIX futures curve has hurt both VXX and UVXY.

Now seems like a good time to quickly recap three reasons why UVXY is not a good product to trade for more than a day:

3 Reasons UVXY is NOT Worth the Risk

Contango contributes to the massive decay in ProShare’s UVXY leveraged ETF.
UVXY uses swaps to achieve its leverage – leveraged ETFs decay faster than non-leveraged ETFs (VXX), particularly in adverse markets.
UVXY charges a very high management fee of 0.95%.

When Should you Trade UVXY?

Proshares UVXY ETF (sometimes referred to as an ETN) is best suited for traders who:

1. Want to speculate on a rise in the price of VIX futures.
2. Want to hedge equity positions in the event of a market downturn.
3. Have a very short duration for both speculation and hedging.

Does UVXY Pay A Dividend?

Since UVXY does not hold any equity, this product does not pay a dividend.

Final Word

Futures-based ETFs are inherently risky. Add leverage to the mix, and you have even more risk.

I personally only use leveraged ETFs to hedge against imminent market news, such as jobs reports and the release of inflation data.

ProShares designed UVXY to be held for a very short duration, typically a day only. To see why, revisit one of those charts we looked at above!

If you’d like to learn more about leveraged ETFs, feel free to check out our video below!

UVXY FAQs

Is UVXY a contango?

UVXY experiences profound contango. Rolling futures in this ETF can result in monthly losses exceeding 5%.

What is UVXY and SVXY?

Both UVXY and SVXY are futures based ETFs. However, UVXY profits during times of heightened volatility and SVXY profits during times of low volatility.

When can you buy UVXY?

Traders can purchase UVXY in both the normal market and extended market. To trade UVXY in the extended market, make sure to tag your order with the correct ” EXT” TIF Designation.

What causes UVXY to go up?

UVXY goes up in value during times of heightened volatility. If short-term VIX futures are up 1% in value, UVXY aims to be up 1.5% in value because of its leverage.

Can I hold UVXY overnight?

You can hold UVXY for any time period, including overnight. However, holding UVXY for long periods of time is not advised due to contango.

Is UVXY an ETN?

UVXY is technically an ETN (exchange-traded note), though its issuer, ProShares, refers to it as a ETF (exchange-traded fund).

UVXY Next Lesson

Supplemental Reading

UVXY: It’s Just Not Worth The Risk – Seeking Alpha

UVXY ETF Report: Ratings, Analysis, Quotes, Holdings

Options: Buy to Open vs Buy to Close & Sell to Open vs Sell to Close

Posted on March 10, 2022May 4, 2022 by Mike Martin

Last updated on May 4th, 2022 , 09:23 am

When placing an options trade, traders have one of four transaction “position types” on the order confirmation box to choose from:

But to Open (BTO)
Buy to Close (BTC)
Sell to Open (STO)
Sell to Close (STC)

On some trading platforms, this box will be pre-selected for you. Other trading platforms give traders the choice to choose whether or not the trade is closing or opening.

However, regardless of what you choose here, the order will default to the proper opening or closing transaction.

So why the choice? Sometimes, trades are filled and then allocated to different accounts. This option is mostly reserved for advisors who trade in bulk, and then allocate trades to the proper accounts.

But since all options traders see this choice, let’s go through every possible type of opening/closing transaction for derivatives.

TAKEAWAYS

All initiating long option trades are marked “Buy to Open” (BTO).
All closing long option trades are marked “Sell to Close” (STC).
All initiating short options trades are marked “Sell to Open” (STO).
Closing short positions in options are marked “Buy to Close” (BTC).
Spread trading can involve both Buy/Sell to Open as well as Buy/Sell to Close.
Rolling options can involve using contrasting position effect designations (e.g., BTC and BTO).

Buy to Open (BTO): Long Call and Put Options

If a trader is going long a call or put option, that order should be designated as “Buy to Open”.

Buy to Open: Long Call Option

Call options are bullish trades that bet on a rise in the value of an ETF, index, or stock price. Long call options need the underlying asset to rise significantly in value to profit.

Traders establishing an opening trade in a long call option should tag that order “Buy to Open” (BTO).

Buy to Open: Long Put Options

Put options are bearish trades that profit when the underlying asset decreases significantly in value.

As with call options, all opening long put option positions should be tagged “Buy to Open” (BTO).

Sell to Open (STO): Short Call and Put Options

Just as with stock, options can be both bought and sold. A short option position has the exact opposite profit/loss profile as its long counterpart.

All initiating short option positions should be tagged “Sell to Open” (STO).

Sell to Open: Short Call Option

The short call option is a neutral to bearish options trading strategy with unlimited loss potential.

All initiating short call option positions need to be tagged “Sell to Open”. Regardless of whether you’re buying or selling, if a trade is initiating, that trade needs to be marked “opening”.

The below image shows how selling call options to open on Google should be setup.

Sell to Open: Short Put Option

The short put option is a neutral to bullish options trading strategy with great loss potential.

All traders initiating a short put option position need to tag their order “Sell to Open” (STO). The below images shows the order confirmation box for a short put position in Tesla (TSLA).

So far, we have covered the basic “position types” used for initiating option orders.

When closing option trades, the exact opposite (“To Close”) designation is used. Let’s look at a few examples next!

Sell to Close (STC): Exiting Long Options

Whenever trading out of a long option position, that order should be tagged “Sell to Close”. Let’s start off by looking at how closing a long call option should be setup.

Sell to Close: Exiting Long Call Option

When selling a long call option, you are conducting a “Sell to Close” (STC) transaction.

The below image shows how closing a pre-existing call option on GOOGL should appear on your order confirmation page:

Sell to Close: Exiting Long Put Position

The same STC position effect is true of exiting long put options. The below image shows the proper setup for closing a long GME put option.

Buy to Close (BTC): Exiting Short Options

All short option positions are exited in a “buy to close” (BTC) transaction. Let’s take a look at the proper setup for exiting a short call in AAPL first:

Buy to Close: Exiting Short Call Option

If a trader were short the 167.5 strike price call on AAPL and wanted to close that option out before it expired, that trader would place a “buy to close” order. This order would look similar to the one below.

Buy to Close: Exiting Short Put Option

Exiting short put options would have the same setup as exiting long call options. All short options are marked “Buy to Close” when buying back.

The below image shows how closing a short 417 strike price put option in SPY expiring on March 18th should appear:

Buy to Open vs Sell to Open: Spreads

Spread trading can involve buying and selling different options in one transaction.

This may require you to mark different legs of the trade with different position effect designations.

Consider a vertical spread in AAPL that involves both buying and selling options:

Since we are both buying and selling initiating options here, both legs should be marked “To Open”.

The same is true for the closing transaction: both sides must be marked “To Close”.

Rolling Trades

Sometimes, trades don’t go our way. When this happens, we may want to roll our call or put option out to a different expiration date. This is an alternative way to opening a new position.

Let’s say we are long a call option on NFLX. Time decay (or theta) has worked against us, and our long position has declined in value from the price we bought it for.

If we are still bullish on NFLX, we could roll that trade out to a different expiration. This would involve using both the “Buy to Close” and “Buy to Open” designation:

Order Confirmation: Other Information

In addition to the position effect, a few other vital designations must be set in the trade confirmation box before a trade is placed.

Time-in-Force (TIF) Designation:

Time in Force (TIF) tells your broker the time and duration you want your order working for. These can include:

DAY (day order)
GTC (good till canceled)
EXT (Extended market)

Option Order Type:

In addition to TIF, an option order type must be selected. These include:

Final Word

Most trading platforms choose the position effect of your order for you. But even if you have to choose this on your own, chances are your broker will automatically change this to the correct buy/sell designation should you choose the wrong one.

On tastyworks, this work is already done for you. Just another reason why we use tastyworks as our preferred broker!

Position Effect FAQ

When should you sell to open options?

The “sell to open” designation should be used for initiating trades only. This can include selling a single option to open, or selling the short component of a vertical spread.

What is the difference between buy to open and sell to open?

All initiating trades should be marked “To Open”. Long option positions are established by marking the order “Buy to Open”; short option positions are established by marking the order “Sell to Open”.

How do you buy to close a put option?

Buying to close a pre-existing short put position can be accomplished by either creating the opposite order of your initiating sell trade, or by finding the option you wish to buy back on the options chain.

When should you sell to close an option?

The best time to sell to close a call or put option is when that option breaches your pre-established lower limit or upper bound. Having these prices in place before a trade is entered can help take emotion out of trading.

Next Lesson

Additional Resources

How to Trade Options: Buying or Selling Call and Put Options

Buy to Open Definition – Investopedia

Master Option Order Types: 7 Complete Guides

Posted on March 3, 2022April 27, 2022 by Mike Martin

Last updated on April 27th, 2022 , 07:46 am

Order Types

An introductory guide to option order types. Get started here!

Market Order

Markets order are filled immediately regardless of price. In both illiquid stocks and options, market orders can lead to horrible fills.

Always avoid market orders on the market open/close!

Limit Order

In options trading, limit orders are the only way to go. Why? They set an upper bound on the maximum debit you are willing to pay and a lower bound on the minimum credit you are willing to receive.

The downside? Fills aren’t guaranteed!

Stop-loss

A stop-loss order is simply a market order in disguise. Your broker holds these orders until the stop price is breached. They are then sent to the market makers. In the eyes of exchanges, stop-loss orders are the same as market orders.

Stop-Limit

A stop-limit order is a great alternative to the stop order. Unlike a stop-loss order, the stop-limit order triggers a limit order.

However, if the limit price is breached, stop-limit orders may never get filled.

TIF Orders

So now you know the order types. But for how long do you want that order working, and during what market period? Read all about time-in-force (TIF) order types here!

BTO vs BTC

The “position effect” box lets us choose whether our order is opening or closing. Which is right for your trade?

Supplemental Video

Next Lesson

Here’s What Happens When Options Expire In-The-Money

Posted on March 2, 2022March 21, 2022 by Mike Martin

Last updated on March 21st, 2022 , 03:38 am

In-the-money options can pose a significant risk to traders going into expiration. This is unlike out-of-the-money options, which expire worthless post expiration and require no action.

It is almost always best to trade out of in-the-money options before the closing bell on the expiration day.

If no action is taken, both long options and short options are converted into 100 shares of stock. The cost and risk of this stock can be much greater than the cost and risk of the original option position.

However, not all in-the-money options are exercised and thus assigned into stock. Let’s first explore a few of the key differences between European and American Style Options.

TAKEAWAYS

It rarely makes financial sense to let an in-the-money option be exercised or assigned.
European style options (indices) are cash-settled; no transference of stock takes place.
American style options (ETFs and equities) are settled via physical delivery; a transfer of stock takes place.
Long in-the-money calls are exercised to +100 shares of stock; short calls are assigned -100 shares of short stock.
Long in-the-money puts are exercised to -100 shares of stock; short puts are assigned +100 long shares of stock.
If an option has intrinsic value at expiration, it will be assigned/exercised.

In-The-Money European Options at Expiration

Options that trade on indices such as SPX and NDX are styled in the European fashion. Here are a few characteristics of European Style Options:

European Options Don’t Offer Stock
European Options Can Not Be Exercised Early
European Options are cash-settled.

Since no stock trades on European options, how can in-the-money European style options be settled in stock?

They can’t. A simple transfer of cash takes place at expiration between the long and short parties. Let’s look at an example:

European Style Option Example

SPX 4,300 Call

➥ Index Value at Expiration: $4,305

➥ Call Value at Expiration: $5

For the above trade, the long party owns an in-the-money call worth $5 post-expiration.

The short party must therefore deliver $500 cash to make good on the contract. If this were an American-style option, a transfer of 100 shares of stock would take place at the call strike price of 4,300. Let’s look at American style options next!

In-The-Money American Options at Expiration

All options are either European or American style. As we learned above, European-style options are generally indices.

American style options are everything else. This includes options on ETFs and equities. Here are a few characteristics of American style options:

American Options Do Offer Stock
American Options Can Be Exercised Early
American Options Are Settled via Physical Delivery of Stock

Since American-style options are settled via an exchange of stock, traders both long and short in-the-money call and put options need to take action by expiration to avoid being assigned/exercised on the stock.

Let’s take a look at an example.

American Style Option Example

SPY ETF $430 Call

➥ ETF Value at Expiration: $432

➥ Call Value at Expiration: $2

An expiration, only intrinsic value exists in options. Since both the risks of time (theta) and implied volatility no longer exist, extrinsic value is discounted completely from the options price.

Read! Intrinsic vs Extrinsic Value in Options Trading

Our SPY option is in-the-money by $2, therefore its (intrinsic) value is $2.

Now if you are long this call, wouldn’t it make sense to exercise it? The call gives you the right to purchase the stock at $430/share. This is a better price than the current SPY market price of $432.

In this scenario, the long would indeed exercise their right, and the short would be forced to deliver 100 shares:

Long Call Ending Position: +100 shares at $430/share
Short Call Ending Position: – 100 shares at $430/share

In-The-Money Options and Assignment/Exercise Cost

In the above example, we showed the net post-expiration position for both the long call and the short call.

The long call owner exercised his call (valued at $2, or $200 taking into account the multiplier effect) into 100 shares of stock. How much will this stock cost? $430 x 100 + $43,000.

That’s a lot of money. If a trader doesn’t have the funds to hold this position the next day when the stock appears in their account, their broker will put them in a margin call.

The same is true with the short party. If they can’t hold -100 shares of SPY stock (valued at 43k) their broker will liquidate the account.

Let’s next go through the process of what happens to in-the-money American style options at expiration.

In The Money Long Call at Expiration

Long call options that are in the money by 0.01 or more on expiration will be automatically exercised by a broker, resulting in +100 shares of long stock.

Alert! You Don't Have to Exercise! Long call and put options have the right, but not the obligation, to buy/sell stock at the strike price. If the owner of a long option does not wish to exercise their right at expiration, they must communicate this to their broker. Otherwise, long in-the-money options are automatically exercised.

In The Money Short Call at Expiration

Short Call options that are in the money by 0.01 or more on expiration will be automatically assigned by a broker, resulting in -100 shares of short stock.

In The Money Long Put at Expiration

Long put options that are in the money by 0.01 or more on expiration will be automatically exercised by a broker, resulting in -100 shares of short stock.

In The Money Short Put at Expiration

Short put options that are in the money by 0.01 or more on expiration will be automatically assigned by a broker, resulting in +100 shares of short stock.

Check Out Our Video On Option Expiration Here!

Should I Exercise My In The Money Option at Expiration?

The vast, vast majority of the time, it does not make sense to allow long in-the-money options to be exercised or assigned.

Personally, I have never done this. Why?

Risk! As we said before, long options generally have less net risk than long stock. We have no idea where a stock is going to be trading on the day it opens post-expiration.

Let’s say you are long an AMZN call going into expiration. Right before the bell, it’s trading at $2. Your downside risk here is $200.

But if you choose to exercise that option, you must buy 100 shares of AMZN. The current cost of 100 shares of AMZN? About $300,000!

That’s a lot of risk! There is hardly ever a reason to exercise an option.

Sometimes, covered call positions allow their short call to be assigned, but they already have 100 long shares of stock, so the risk is offset.

It rarely, if ever, makes sense to exercise (or be assigned) on naked call and put options going into expiration. In addition to the market risk, there are also additional exercise assignment fees that go along with holding in-the-money options through expiration.

Simply trade out of the position before the bell and you’ll sleep much better. Trust me!

Is My Option In The Money?

Determining moneyness is quite simple.

Call options are in the money when the strike price is below the stock price.
Put options are in the money when the strike price is above the stock price.

In-The-Money Options at Expiration FAQ's

Can I still sell options on expiration day?

You can sell an option at any time before the closing bell on expiration day. This includes expiration day itself. It is best to not wait until the final seconds of trading to trade out of options. If technology fails, you may find yourself in a bit of trouble.

Can I exercise options on the expiration date?

Yes, you can exercise options on expiration day. You can even choose to exercise options (or not exercise them) after the market closes on expiration day. The cutoff time for exercising an option is 4:40pm CT.

Are in the money options automatically exercised at expiration?

Brokers automatically exercise in-the-money options at expiration. You can, however, communicate to your broker that you do not want to exercise an option. If your broker is not informed, you will be automatically exercised on your long call/put options that are in the money by 0.01 or more.

What happens when calls expire ITM?

When a long call expires in-the-money (ITM), a broker will automatically exercise the option. This will ultimately result in +100 shares of long stock.

Next Lesson

Additional Resources

What Happens When Options Expire | tastytrade

Option Expiration – Investopedia

Long Call vs Short Call: Option Strategy Comparison

Posted on March 1, 2022March 1, 2022 by Mike Martin

Last updated on March 1st, 2022 , 09:08 am

Long Call Definition: The long call is a low probability bullish options trading strategy with unlimited profit potential.

Short Call Definition: The short call is a high probability bearish options trading strategy with unlimited risk.

As with stock, options can be both bought and sold. The profit/loss profile for a long call is the polar opposite of a short call.

Before we dive into comparing the short and long call options, it is necessary to understand the fundamental difference between long and short options.

Long option positions give the owner the right to buy or sell a security (call & puts) at a specific price (strike price) on or before a specific date (expiration date).
Short option positions have no rights and must stand ready to either sell stock (call options) or buy stock (put options) when and if the long party exercises their right.

TAKEAWAYS

The long call is a low-probability bullish strategy with limited risk.
The short call is a high-probability bearish/neutral strategy with unlimited risk.
Long calls profit when the underlying moves up significantly in value.
Short calls profit in both neutral and bearish markets.
The maximum loss for long calls is the debit paid; the maximum loss for short calls is infinite.
The maximum profit in long call options is unlimited; the maximum profit in short calls is the credit received.

	Long Call	Short Call
Market Direction	Bullish	Neutral and Bearish
When To Trade	Best for traders very bullish on a security	Best for traders who believe a security will either be neutral or fall in value.
Maximum Profit	Unlimited	Credit received
Maximum Loss	Entire debit paid	Unlimited
Breakeven	Strike Price + Debit Paid.	Strike Price + Credit Received.
Time Decay Effect	As time passes, and both implied volatility and stock price stay the same, a long call will persistently shed value.	As time passes, and both the implied volatility and stock price stay the same, a short call option will shed value – which is desirable for short calls.
Probability of Success	Low	High

Long Call vs Short Call: Key Differences

When it comes to the profit/loss profile, the long call is the exact opposite of the short call. Before we dig into the individual strategies, let’s explore a few of the fundamental differences between the long call and the short call.

1.) Long Calls vs Short Calls: Trade Cost

Long Call Option: Whenever you buy an option, the cost of that option will be the cost of the trade. If a long call option is trading at 3.50 and you purchase this option, a debit of $350 will be deducted from your account.

When buying options, the true cost of the trade is calculated by moving the decimal of the quoted price two places to the right. This is because of the multiplier effect, which gives options a 100×1 leverage.

Short Call Option: The trade cost of selling call options is a little murkier than buying call options.

Whenever you sell naked options, a credit is made to your account. Since there is no upfront debit paid, and the trade does indeed have risk, your broker will require that funds be held in margin.

At tastyworks, this margin requirement is the greater of:

2.) Long Calls vs Short Calls: Maximum Profit

In long calls, the profit is unlimited. There is no upside cap on how high a stock can run, therefore, the profit potential in a long call is infinite

In short calls, (as with all short options) the maximum profit is always the credit received. You can never make more than the initial credit received.

3.) Long Calls vs Short Calls: Maximum Loss

In long calls, the maximum loss is limited to the initial debit paid for the call option. Since options can never fall below zero in value, the maximum loss for long calls is the upfront debit paid.

In short calls, the maximum loss is unlimited. We mentioned earlier that the maximum profit on a long call is unlimited. Therefore, the maximum loss on short calls must be infinite.

4.) Long Calls vs Short Calls: Breakeven

➥ The long call breakeven is Strike Price + Debit Paid.

➥ The short put breakeven is Strike Price + Premium Received.

5.) Long Calls vs Short Calls: When to Trade?

Long calls are best suited for bullish investors who believe the underlying will go up significantly in value. If a stock goes up just a little or stays the same, long calls decay in value.

Short Calls are reserved for traders who believe a stock is not going to move by very much over the duration of an options life. Short calls can profit in any market, including bearish, neutral, and minorly bullish markets.

Long Call Trade Example

In this example, we are going to look at an at-the-money call option (strike price near the stock price). Here are the details of our trade:

‣ Initial Stock Price: $105

‣ Call Strike and Expiration: 105 call expiring in 31 days

‣ Call Purchase Price:$3.40

‣ Call Breakeven Price: $105 call strike price + $3.40 debit paid for call = $108.40

‣ Maximum Profit Potential: Unlimited

‣ Maximum Loss Potential: $3.40 call purchase price x 100 = $340

Long Call Trade Results

In this long call example, the stock price never traded higher than the call’s breakeven price. Additionally, the stock price also never fell significantly below the call’s strike price. As a result, our call experienced a slow decay, which lead to losses.

However, there were opportunities for us to close this call for a profit.

To close a long call position before expiration, a trader can simply sell the call option at its current price.

Short Call Trade Example

In this example, we are going to look at an out-of-the-money short call. Here are the details of our trade:

‣ Initial Stock Price: $119.94

‣ Call Strike and Expiration: 125 call expiring in 71 days

‣ Call Sale Price: $1.52

‣ Call Breakeven Price: $125 call strike + $1.52 credit received = $126.52

‣ Maximum Profit Potential: $1.52 credit received x 100 = $152

‣ Maximum Loss Potential: Unlimited

Let’s next see how this short call performed!

Short Call Trade Results

In this short call example, the stock price gradually increased in price from $120 to $126. Our short 125 call never experienced material losses during this time.

With 11 days to expiration, the stock price was above the short call’s strike price of $125, and the position had small profits.

Time decay was able to fight against any directional losses in this trade.

The decrease in the call’s price from its initial sale price of $1.52 offered us the opportunity to buy back the call for a profit before the option expired. At 40 days to expiration, the 125 call’s price fell below $0.75, which represents a $77 profit for the call seller at that moment.

If we held this option until expiration, the position would expire worthless. Why? The stock price was below the short call’s strike price.

In this trade, our full potential maximum profit of $152 was realized.

Long Call vs Short Call FAQ's

What does long and short mean in options?

In options trading, “long” implies either ownership of a single option(s), or a net debit transaction. The term “short” implies the sale of an option(s), or a net credit transaction.

What's the difference between a naked call and a long call?

A naked call is a neutral to bearish strategy with unlimited risk; a long call is a bullish strategy with only premium risk.

What is the difference between a call and a long call?

A “call” option is a broad term used to describe a security. You can both buy and sell call options. When a trader purchases a call option, they are “long” that option; if a trader instead sells a call option, they are “short” that option.

Are long calls worth it?

Long calls generally need the underlying security to rise substantially in value in order to profit. Because of time decay (theta), most out-of-the-money call options expire worthless, resulting in a maximum loss scenario. Maximum profit in long calls, however, is infinite.

Are long calls safe?

The total loss potential on a long call is the debit paid. This scenario will occur if the stock price is trading below the strike price on expiration. From a total risk perspective, long calls are safer than short calls.

What is the riskiest option strategy?

Selling naked calls is the riskiest options trading strategy. Since a stock has no upper bound, short call options have infinite risk.

Long Call vs Short Call Video

Long Call Tutorial

Short Call Tutorial

Next Lesson

Additional Resources

Long Position vs. Short Position: Key Differences – Investopedia

Short Strangle Adjustment: Rolling Up the Short Put

Posted on February 28, 2022March 2, 2022 by Chris Butler

Last updated on March 2nd, 2022 , 07:57 am

Sometimes, you’ll need to make an adjustment to your option positions when the stock price moves against you.

In this post, we’re going to discuss the short strangle adjustment strategy of “rolling up” the short put options.

What is "Rolling an Option?"

Rolling an option is the process of closing an existing option and opening a new option at a different strike price or in a different expiration cycle. This generally happens when in-the-money options are expiring.

Today, we’ll focus on “rolling up” the short put option in a short strangle position, which refers to buying back your current put option and “rolling it up” by selling a new put at a higher strike price.

When Do You Roll Up the Put?

Let’s talk about when a trader would most likely roll up the short put.

Consider the following visual:

As we can see, the stock price is rising quickly and approaching the short call’s strike price. Since short strangles have negative gamma, the position’s delta grows negative as the stock price trends towards the short call.

The result?

The trader starts to lose more and more money as the stock price continues to increase.

The most common short strangle adjustment to make in this scenario is to roll up the short put option:

To roll up the short put option, a trader simply has to buy back their current short put option and sell a new put option at a higher strike price (in the same expiration cycle).

What Does Rolling Up the Puts Accomplish?

By rolling up the short put option in a short strangle position, a trader accomplishes two things:

1. Collect more option premium since the new put you sell is more expensive than the put you buy back.

2. Your position’s delta becomes more neutral, which means you’ll lose less money if the stock price continues to increase.

Let’s cover each of these points in more depth.

#1: Collect More Option Premium

Consider a trader who is short the 220 put option in their short strangle position, but rolls the 220 put to the 235 put:

Put Strike Price	Option Price	Delta	Trade
235	$1.60	-0.30	Sell (Open)
230	$0.85	-0.16
225	$0.50	-0.09
220	$0.31	-0.06	Buy (Close)

Since the trader buys back the 220 put for $0.31 and sells the 235 put for $1.60, they collect additional option premium from rolling up the put:

Premium Collected:

$1.60 Collected – $0.31 Paid Out = +$1.29

In dollar terms, the additional $1.29 in premium means the maximum profit on the trade increases by $129 per short strangle, and the upper breakeven point is also extended $1.29 higher.

As a result, the stock price can increase even further than it could before and the trade can still be profitable.

#2: Neutralize Your Position Delta

By rolling up the put option, the position also becomes more neutral.

Let’s say that at the time of the roll, the short strangle’s position delta is -44 (the trader is expected to lose $44 from a $1 increase in the stock price, and make $44 from a $1 decrease in the stock price).

Here’s how the position delta would change after the rolling adjustment from the previous example:

Put Strike Price	Option Price	Delta	Trade
235	$1.60	-0.30	Sell (Open)
220	$0.31	-0.06	Buy (Close)

Old Put Position Delta: +6 (-0.06 Put Delta x $100 Option Multiplier x -1 Contract)

New Put Position Delta: +30 (-0.30 Put Delta x $100 Option Multiplier x -1 Contract)

Change in Position Delta: +24

New Short Strangle Position Delta: -44 + 24 = -20

After rolling up the short put, the position delta becomes more neutral.

With a new position delta of -20, the trader is only expected to lose $20 if the stock price increases by $1, as opposed to a $44 loss before the roll.

Of course, this also means the trader is only expected to gain $20 from a $1 decrease in the share price, as opposed to a $44 gain before the short strangle adjustment.

With that said, it’s clear that it’s not all peachy when it comes to rolling up the short put. Let’s talk about the downsides of rolling up.

What's the Risk of Rolling Up the Put?

While rolling up a short put increases the option premium received (higher maximum profit potential) and neutralizes your position delta, there are some downsides:

1. You decrease the range of maximum profitability, as your new put’s strike price is much closer to the short call’s strike price.

2. The position delta gets neutralized, which means a reversal in the stock price results in less profits than if the rolling adjustment wasn’t made. Even worse, the position delta will start to grow positive if the stock price continues to fall after rolling up the put (resulting in losses if the stock keeps falling).

As with any trade adjustment, there are benefits and downsides. However, if you’re looking for a short strangle adjustment to help reduce the directional risk after a rally in the stock price, then rolling up the short put is one option available to you (pun intended).

Concept Checks

Here are the essential points to remember the short strangle adjustment of rolling up the short puts:

When selling strangles, if the share price appreciates towards your short call, you can adjust the position by “rolling up” the short put (buy back the old short put, sell a new put at a higher strike price).
By rolling up the old put, you increase the amount of option premium collected and neutralize your position delta (resulting in a higher upper breakeven point and less notable losses if the stock price continues to rise).
The downside of rolling is that you decrease the range of maximum profitability since your new put strike is closer to the short call’s strike price. Additionally, you’ll make less money (or potentially lose money) from reversals in the stock price after rolling.

Next Lesson

Additional Resources

Options Roll Up Definition – Investopedia

Long Call vs Short Put: Comparing Strategies W/ Visuals

Posted on February 24, 2022May 4, 2022 by Mike Martin

Last updated on May 4th, 2022 , 08:58 am

Both the long call and short put options strategies are bullish. This is the limit of these option positions similarities. In terms of risk/reward, these two strategies couldn’t be any different. Before we get started, it is important to understand that the long call is not synonymous with the short put options strategy.

Let’s look at a couple definitions, then get to work!

Long Call Definition: A relatively low-risk bullish options strategy that involves the purchase of a stand-alone call option contract. For American Options, the call owner has the right to exercise their option and purchase 100 shares of long stock at the strike price at any time.

Short Put Definition: A high-risk bullish to neutral options strategy that involves the sale of a put option. For American style options, the seller must stand ready to deliver 100 shares of stock when/if the long party decides to exercise their contract. Short selling options involves great risks.

TAKEAWAYS

The long call is a low-probability derivative trade with limited risk.
The short put is a high-probability derivative trade with limited (but great) risk.
Long calls profit when the underlying stock, ETF or index moves up significantly.
Short puts profit in both neutral and bullish markets.
The maximum loss for long calls is the debit paid; the maximum loss for short puts is strike price – premium.
The maximum profit in long call options is unlimited; the maximum profit in the short put is the credit received.

	Long Call	Short Put
Market Direction	Bullish	Neutral and Bullish
When To Trade	Best for traders very bullish on a security	Best for traders who believe a security will either stay the same or increase in value.
Maximum Profit	Unlimited	Credit received
Maximum Loss	Entire debit paid	Strike price minus the premium received
Breakeven	Strike Price + Debit Paid.	Strike price minus the premium received for the put.
Time Decay Effect	As time passes, and both implied volatility and stock price stay the same, a long call will persistently shed value.	As time passes, and both the implied volatility and stock price stay the same, a short put will shed value – which is desirable for short puts.
Probability of Success	Low	High

Long Call vs Short Put: Key Differences

Before we dig into these two options strategies themselves, let’s take a look at some of the major differences between the long call and the short put:

1.) Long Calls vs Short Puts: Trade Cost

When buying call options, you must may a debit. This debit represents the total loss potential. You can never lose more than you pay.

Selling a put option is a net-credit transaction. There is no debit paid. Instead, your broker will require you to set funds on the side in margin should that trade go against you and you have to buy the naked put back. When selling options, the margin can be substantial. Opportunity costs must be taken into account.

2.) Long Calls vs Short Puts: Maximum Profit

When you buy a long call, the upside is unlimited. Why? The stock can (in theory) go to infinity.

When you sell a put option (or any option), the maximum profit is always the credit received. You will never make more than the credit you take in initially.

3.) Long Calls vs Short Puts: Maximum Loss

For long call options, the maximum loss is always the initial debit paid. It doesn’t matter how much the stock moves against you, with long options, you can only ever lose the amount paid to purchase the option.

For short put options, the maximum loss is calculated Strike Price – Premium Received. If you sell an option at the 100 strike price for $1, you can, in theory, lose $99. This assumes the worst case scenario, with the price of the underlying security falling to $0 in value.

Note! Selling naked call options comes with unlimited risk. Learn more about short naked call options here.

4.) Long Calls vs Short Puts: Breakeven

➥ The long call breakeven is Strike Price + Debit Paid.

➥ The short put breakeven is Strike Price – Premium Received.

5.) Long Calls vs Short Puts: When to Trade?

Long calls are best suited for bullish investors who believe the underlying is going to the moon. If the stock goes up just a little or stays the same, you’re going to lose your entire premium and incur a 100% loss.

Short Puts are reserved for traders who believe a stock is not going to move by very much over the duration of an options life. Many investors use this strategy as a means to generate income. Read more on this strategy in our article, “Selling Put Options for Income“.

Long Call Option Explained

The long call is reserved for the most bullish of investors.

Not only does this strategy require the stock to move up to make money, but it must move up by a lot.

Because of the Greek theta, options perpetually shed value. In a stagnating market, this is bad news for long calls. Let’s jump right into a hypothetical example to understand how this Greek works against long options.

Long Call: Losing Trade Example

Here is our long position: a call on Meta Platforms (FB):

Position

➥ Option: Long FB 200 Call

➥ Option Premium: $5.40

➥ Days to Expiration (DTE): 8

➥ Stock Price: 190

So let’s say we are long the above call. Two days have passed, and the stock price is unchanged. What does this mean for our position?

Position

➥ Option: Long FB 200 Call

➥ Option Premium: $5.40 —> 4.50

➥ Days to Expiration (DTE): 8 —> 6

➥ Stock Price: 190 —> 190

So, as we can see, with the passage of two days (assuming both implied volatility and stock price remain the same) our option loses value.

Time is the enemy of all long call and put options! As time passes and the stock remains the same, the odds of it reaching our strike price dims. Therefore, the option falls in value.

But long calls also have great upside potential. Let’s take a look at a winning trade next.

Long Call: Wining Trade Example

Position

➥ Option: Long AAPL 165 Call

➥ Option Premium: $1.30

➥ Days to Expiration (DTE): 8

➥ Stock Price: 160

So we have purchased a call option on AAPL for a cost of $1.30 (which actually costs us $130 remembering the multiplier effect of option leverage).

Two days have passed, and the price of AAPL has skyrocket:

Position

➥ Option: Long AAPL 165 Call

➥ Option Premium: $1.30 —> $4

➥ Days to Expiration (DTE): 8 —> 6

➥ Stock Price: 160 —> 165

In this example, our option price has increased in value by more than 100%. When you buy an option, the most you can ever lose is the premium paid.

The upside for long calls is unlimited. Why? There is no cap on how high the stock can go.

From a sheer risk/reward standpoint, long calls make sense. However, their probability of success pales in comparison to the short put option.

Short Put Option Explained

Unlike the long call option, the short put option can profit in almost any market. Short puts always profit in neutral and bullish markets, and can sometimes even profit in minorly bearish markets!

When compared to stock positions, long options are decaying assets. Time is kryptonite for long options.

So if the effect of time decay is negative for long options, shouldn’t it be positive for short options? Yes!

Most professional traders sell options for this reason. Although these high-probability trades come not without risks!

Short Put: Losing Trade Example

Let’s jump right into an example with a short put ETF option on SPY (an S&P 500 index tracker).

Position

➥ Option: Short SPY 415 Put

➥ Option Premium: $2.75

➥ Days to Expiration (DTE): 4

➥ Stock Price: $423

So we have sold a put option here at the market price of 2.75. As long as SPY closes above our short strike price of $415, we will collect our full premium of $2.75 ($275).

The stock can even fall to $415 and we will still make our full profit potential!

Let’s skip ahead a 2 days and see how our short put option did:

Position

➥ Option: Short SPY 415 Put

➥ Option Premium: $2.75 —> $8

➥ Days to Expiration (DTE): 4—> 2

➥ Stock Price: $423 —> $414

So that trade didn’t work out too well! Although the short put strategy has a high probability of success, when naked options move against you, watch out!

The most we could have ever made on this trade was the credit received of $2.75. With two days to the expiration date (expiry), SPY tanked, and our short put option is currently trading at $8. We have lost $5.25 in a scenario where our max profit was $2.75. Not the best risk/reward profile!

Short Put: Winning Trade Example

For this trade, we are going to sell a put option on Tesla (TSLA)

Position

➥ Option: Short TSLA 710 Put

➥ Option Premium: $26

➥ Days to Expiration (DTE): 14

➥ Stock Price: $764

So since we are selling an option, the most we can ever make is the credit received, In this scenario, that will occur when the stock is trading at or above $710 on expiration (our short strike price).

Let’s fast-forward to expiration day now:

➥ Option: Short TSLA 710 Put

➥ Option Premium: $26 —> $0

➥ Days to Expiration (DTE): 14 —>0

➥ Stock Price: $764 —>$750

So in this example, the stock fell from $764 to $750. Since we are short a put option, you may think that is bad. But we are short the 710 put strike! The stock is trading way above this level. On expiration day, our option is safely out-of-the-money and we will collect the full premium.

This example just goes to show that short put options can profit in all market directions.

Short Puts Margin Requirement

Determining the margin requirements for selling put options will depend on your account type.

Selling puts in a cash account (cash-covered puts) costs more in margin than selling puts in a margin account. You must front the full potential maximum loss of the trade in cash accounts when selling put options.

According to tastyworks, the margin requirement for selling naked puts in a margin account is the greatest of:

20% of the underlying price minus the out of money amount plus the option premium
10% of the strike price plus the option
premium
$2.50

Trading options come with great risks. To learn more about these risks, please read this article from the OCC.

Long Call vs Short Put FAQs

Is a Short Call the Same as Long Put?

A short call is very different from a long put. Both strategies profit in bearish markets, but the short call has considerably more risk than the long put.

What Happens When You Short a Put Option?

When you sell a put option, your broker will require funds be held in “margin” should that trade move against you. With short puts, the risk is significant.

How Do You Short A Put Option?

Shorting a put option is simple – instead of clicking on the ask price in the option chain, simply click on the bid price and send the order. It is best to avoid market orders in options; limit orders are the better alternative.

What is The Difference Between Short Call and Long Put?

A short call is a high probability trade with unlimited risk; a long put is a low probability trade with limited risk.

Long Call vs Short Put Video

Long Call

Short Put

Next Lesson

Additional Resources

Long Call vs. Short Put Differences: Macro Option

Option Chain Explained W/ Visuals and Examples

Posted on February 22, 2022April 25, 2022 by Mike Martin

Last updated on April 25th, 2022 , 11:09 am

Options Chain Definition: A matrix displayed on a trading software that shows the vital components of tradable call and put options, such as bid-ask, volume, open interest, and the Greeks.

The first lesson in any options trader’s education is mastering the option chain. Though this seemingly endless grid of data can be overwhelming at first, when broken down, the option chain can be easily understood.

TAKEAWAYS

An options chain lists all tradable call and put options in a selected security.
Vital option chain information includes the option type, expiration, strike price, and bid-ask spread.
Adding “volume” and “open interest” to an options chain helps traders understand the liquidity of an option.
Option chains can be customized to add the Greeks as well, including delta and theta.
An options expiration cycle is listed on the left side of an options chain; an option’s IV (implied volatility) is listed on the right side of an options chain.

What is An Options Chain?

The above image (taken from the tastyworks trading platform) shows the options chain for the Exchange-Traded Fund (ETF) SPY.

We have highlighted the most crucial components of this ETF option chain. These include:

➥ Option Type:

There are only two types of options contracts: calls and puts.

Long call options profit in bullish markets. Long put options profit in bearish markets.

In an options chain, calls are always listed on the left side; put options are listed on the right side. As we can see in the above visual, these two areas are divided by the strike price.

➥ Option Strike Price

Strike prices are always at the center of an options chain. The strike price is the price at which call and put options are exercised and thus assigned.

If you buy a SPY call option at the 435 strike price, that contract gives you the right to buy 100 shares of SPY stock at $435/share, which the short party must deliver.

➥ Bid-Ask Spread

Just like with stock, there is a bid and ask price for every option. You can sell an option at the bid price and buy an option at the ask price. The tighter the markets, the better the liquidity.

➥ Expiration

Options are decaying assets. Every single one will eventually expire at some future date. This date can be as early as today, or as far away as 2025. Longer-term options are known as Long-Term Equity Anticipation Securities (LEAPS).

The closer an option is to expiring, the better its liquidity will be.

Customizing Your Options Chain

Most trading platforms offer customers numerous options when it comes to customizing their options chain. In addition to the above basic information, columns can be arranged by:

Last (last traded price)
Mid (point between bid and ask)
Greeks
- Delta
- Gamma
- Vega
- Theta
Impl Vol (Implied Volatility)
Open (opening price)
Bid Size (contracts bid at shown price)
Ask Price (contracts offered at displayed price)
High (highest trading price all day)
Low (lowest trading price all day)

The above list is by no means exhaustive. The below screenshot from tastyworks shows a few different customizable layout options for their displayed options chains:

So which layout is best for you?

I personally believe that all elements of liquidity should be displayed first and foremost. In addition to the bid-ask spread, volume and open interest are vital in determining the liquidity of an option.

Markets with poor liquidity measures can result in horrible fills. You want high volume/open interest as well as tight bid-ask spreads.

The below image shows how I prefer to layout my options chains:

Option Chain and Expiration

An options expiration date is always displayed on the far left side of an options chain:

The further down the option chain you go, the less liquidity you are exposed to. Most people prefer to trade options with 0-60 days to expiration (DTE).

Some options trading strategies, such as the calendar spread, include more than one expiration cycle.

Option Chain and Implied Volatility (IV)

If we skip over to the far right side of the options chain, we will see Implied Volatility (IV):

In options trading, implied volatility (IV) is of utmost importance. This number tells us the expected volatility of a stock over an options life.

The higher the IV, the higher the option premiums will be. Option sellers are particularly drawn to high IV levels, as this means higher premiums can be collected.

IV levels are generally highest for front-month options and fall for long-term options, as seen in the image above.

Option Chain and The Greeks

In options trading, the Greeks are a series of calculations used by traders to measure various factors that affect an options price. The Greeks include.:

Delta (how much an option moves in response to a $1 change in underlying)
Gamma (the rate at which the delta changes in response to a $1 change in the underlying)
Theta (the rate at which an option decays with 1 passing day in a constant environment)
Vega (the change in an option’s price in response to a one-point change in implied volatility)

If you’re new to the Greeks, our article, “The Greeks for Beginners” is a great starting point. Pros use the Greeks daily.

You can set up your options chain to include these measures as well.

Option Chain and Moneyness

The last segment in our option chain tutorial is option moneyness.

All options reside in one of three moneyness states:

In-The-Money
At-The-Money
Out-Of-The-Money

Moneyness simply tells us whether or not an option has “intrinsic value“. Intrinsic value exists when an option has value on its own, discounting time and implied volatility. To read more about this topic, check our “Intrinsic vs Extrinsic Value” article.

Most options chains have a line dividing in-the-money options from out-of-the-money options. On the tastyworks platform, this line is displayed in the option chain as an orange line:

Option Chain FAQs

What is IV in an Options Chain?

In an options chain, IV stands for “Implied Volatility”. IV tells us the forecasted move of a stock over the life of an option.

What is Volume in An Options Chain?

In an options chain, volume indicates the number of contracts that have been traded in a given day for a particular call or put option.

What Does an Options Chain Indicate?

An options chain indicates all of the listed call and put options for a given security. Information about liquidity and the Greeks are displayed in an options chain.

When Do Option Chains Update?

As long as you have live quotes, option chains are updated in real-time.

Next Lesson

Additional Resources

Options Chain Guide- Investopedia

Market Order in Options: Don’t Throw Away Money!

Posted on February 18, 2022March 3, 2022 by Mike Martin

Last updated on March 3rd, 2022 , 07:14 am

Marker Order Definition: A market order is an order to buy or sell a security at the immediate and best available price. Fill price is unknown in market orders.

Market orders are the enemy of all options traders. Why? Because you have no idea the price at which you will get filled.

In the above definition, we can see that market orders are filled at the immediate and best price. However, due to the notorious illiquidity of call and put options, that “best” price can be very poor indeed.

Let’s find out why!

TAKEAWAYS

Market orders guarantee a trade will get filled, but the price at which that trade will be filled is unknown.
Stop-loss orders are simply market orders waiting to get triggered.
An options volume tells us how many contracts have traded all day; an options open interest tells us how many options are in existence.
The bid-ask spread of an option is the difference between its bid price and ask price.
The above two components of liquidity are vital for getting decent fills. Market orders in options with poor liquidity can result in horrible fill prices.
Limit orders are the best alternative to market orders.

Market Order in Options Explained

Whenever you place a trade, the order form on your trading software will require some basic information about the trade:

1.) The security you wish to trade.

2.) Whether or not you want to buy or sell that security.

3.) The time and duration you want that order working for (Time In Force “TIF”).

4.) The actual order type.

This article is concerned with the latter on the above list, order types.

When trading options or stocks (or any security) you must instruct your broker of the type of order you want to place.

Let’s explore the different order types next!

Order Types in Options Trading

Order types include, but are not limited to:

➥ Limit Order

The “limit” order type tells your broker you want to get filled at or better than your set limit price.

➥ Stop-Loss Order

The “stop-loss” order is triggered when the set stop price is breached. The order then becomes a market order.

➥ Stop-Limit Order

The “stop-limit” order is triggered when the stop price is reached. However, unlike the stop-loss order, the stop-limit order triggers a limit order.

➥Trailing- Stop Order

The “trailing-stop order” allows a trader to set an upper bound or loss percentage on a trade. This allows a trader to lock in profits or losses in connection with the securities movement.

➥ Market Order

A market order instructs the broker a customer wants to get filled immediately, regardless of price.

As we can see above, the stop-loss order is essentially a market order in disguise. Your broker holds stop-loss orders until the price is breached, and then sends the order to market makers. These order types are not visible until they get triggered.

So why are market orders a bad idea? It’s all about liquidity!

Market Orders In Options and Liquidity

When you’re trading stocks, liquidity is generally not a problem. This is assuming, of course, you’re not trading exotic penny stocks.

Most stocks have spreads a couple of pennies wide. This means if you want to turn around and sell a stock the moment after you buy it, you will only lose a few pennies.

With options, liquidity is not so plentiful.

Let’s take AAPL stock for example. Currently, you can buy AAPL for 436.77 and immediately sell it for 436.76. Here’s how that looks on the tastyworks software:

So why is there such great liquidity in AAPL stock? Because there is only one tradable equity! What you can’t see is the order size; there are about 10k shares of stock bid at 436.76 and 11k shares offered at 436.77. Using a market order probably won’t harm you here.

But there are thousands of options that trade on AAPL. Every one of these options requires its own market. Since there aren’t as many players, that spread can widen out considerably.

This can lead to wide markets and low volume/open interest. This is bad news for market orders! Let’s examine both of these next, as they are the crucial components of options trading liquidity.

Volume and Open Interest in Options Trading

The first two components of option liquidity are open interest and volume.

Option Open Interest: The open interest of a particular option refers to how many contracts are currently in existence. The higher the open interest, the greater the liquidity.

Option Volume: The volume of an option refers to how many contracts have been traded on a specific day.

Bid-Ask Spread in Options Trading

The next component of the liquidity of an option is the bid-ask spread.

Option Bid-Ask Spread: The difference between the bid price and the ask price.

This market essentially tells us what we can buy an option for, then immediately sell it for. If markets are wide, you’re going to start off with a huge loss right off the bat!

Additionally, you want to make sure the bid and ask size is appropriate. Sometimes, there is only one option bid at a certain price. If you are trying to sell more than one option, the next bid may be a dollar or more below the current bid!

These are known as thin markets. The bid-ask spread can be deceiving!

Let’s take a look at a couple of examples now.

Option Liquidity Example: High Liquidity

The below image is taken from the tastyworks software. It shows the volume/open interest and bid-ask spreads for call options on SPY options. SPY (an S&P 500 tracking ETF) is the most liquid ETF in the world.

SPY Call Options

The volume and open interest for these ETF options are mostly in the thousands. Additionally, the bid-ask spread is only a few pennies wide.

If you use a market order (or stop-loss) on these options, you’ll probably be OK.

But still – why risk it? Use a limit order!

Option Liquidity Example: Low Liquidity

The below image (taken from the tastyworks software) shows the option markets on a few call options for stock symbol R (Ryder Systems).

The above options are incredibly illiquid. Never trade options like these. The volume is almost non-existent. The open interest is shameful. And you can park a truck between the bid-ask spread.

What you can’t see is the size of these markets. Guess what? The size is as thin as paper on a lot of these options.

Placing a market order on these options may cost you an arm and a leg.

The solution? Don’t trade this security! If you must, use a limit order, and work that limit order up in nickel increments until you get filled.

Final Word: Market Orders on Options

I have personally never used a market order to enter or exit an options trade.

I have, however, used market orders under the instructions of advisors. I have sold options for 0.10 only to see them bid at 0.75 a minute later.

In particular, stop-loss orders on the open can result in abysmal fills.

At the end of the day, just use limit orders. It’s that simple. If you can’t be around to monitor your trades, don’t trade

FAQs: Market Orders on Options

Are Market Orders Bad?

If you’re trading liquid products, market orders can be relatively safe. When you’re trading illiquid products (or trading around the open/close) market orders pose significant risks.

What's the Difference Between a Market Order and a Limit Order?

Market orders are filled at any price immediately; limit orders are filled when the security trades at the limit price. Limit orders are not always filled.

What Does Market Order Mean?

The “market” order type communicates to your broker you want to get filled immediately, regardless of execution price.

When Do Market Orders Get Filled?

Market orders with the “Day” TIF designation get filled immediately. Market orders with the “EXT” designation get filled immediately in the extended hours market.

Do Market Orders Expire?

If you place a market order and the market is open, you will get filled immediately. Therefore, expiration does not apply to market orders.

VIX Contango: The Ultimate Beginner's Guide

What is Contango?

Why is Contango Important to Understand?

Futures Prices Converge to the Spot Price

The VIX Futures Curve

VIX Contango Example

VIX Backwardation Example

VIX Futures Contango vs. ETP Performance

Why Are VIX Futures Usually in Contango?

VIX Contango Trading Strategies

What Happens When VIX is in Backwardation?

VIX Backwardation Trading Strategies

Conclusion

Next Lesson

VIX Contango Explained

UVXY: Is it Worth the Risk?

Implied Volatility Guides

What is UVXY and What Does It Track?

VIX Index vs. VIX Futures (UVXY): Performance

Spot vs Futures: Rolling UVXY

UVXY: Contango vs Backwardation

UVXY in Backwardation

UVXY and VIX Term Structure

UVXY: Positions and Holdings

UVXY's 1.5X Leverage: SWAPs

UVXY: Expense Ratio

UVXY Fee's

UVXY: Historical Returns

UVXY: 1 Year Chart

UVXY: 5 Year Chart

UVXY vs VXX vs VIX

UVXY vs VXX vs VIX: 1 Year Chart

3 Reasons UVXY is NOT Worth the Risk

When Should you Trade UVXY?

Does UVXY Pay A Dividend?

Final Word

UVXY FAQs

UVXY Next Lesson

The Cost of Trading Volatility: VXX In Depth

How Options Volatility Products Work: VXST, VIX, VXV, VXMT

SWAR: 2X Leveraged Software ETF Explained

PSDN: AdvisorShares Poseidon Cannabis ETF Explained

Supplemental Reading

Buy to Open (BTO): Long Call and Put Options

Buy to Open: Long Call Option

Buy to Open: Long Put Options

Sell to Open (STO): Short Call and Put Options

Sell to Open: Short Call Option

Sell to Open: Short Put Option

Sell to Close (STC): Exiting Long Options

Sell to Close: Exiting Long Call Option

Sell to Close: Exiting Long Put Position

Buy to Close (BTC): Exiting Short Options

Buy to Close: Exiting Short Call Option

Buy to Close: Exiting Short Put Option

Buy to Open vs Sell to Open: Spreads

Rolling Trades

Order Confirmation: Other Information

Final Word

Position Effect FAQ

Next Lesson

Master Option Order Types: 6 Complete Guides

Options Trading for Beginners: The ULTIMATE Guide

Option Chain Explained W/ Visuals and Examples

Covered Calls Explained

Additional Resources

Order Types

Market Order

Limit Order

Stop-loss

Stop-Limit

TIF Orders

BTO vs BTC

Supplemental Video

Next Lesson

Options Trading for Beginners

The Vertical Spread Options Strategies: Beginner Basics

Option Greeks | 5 Visual Guides to Measuring Risk

Options Position Effect: BTO vs BTC and STO vs STC

In-The-Money European Options at Expiration