What is an Option?

Option Contracts In General

It helps to put this into context because the idea of an option can be a little bit confusing at first.  Options, in general, are born in contract law.  They are a paid for promise to keep an offer open for a specified period of time.  For example, if you wanted the “option” to buy a home, you could give them lets say $5,000 for the option contract.  That option contract would give you lets say 1 month to decide whether you actually want to buy the house before the offer expires.

For example, if you want the “option” to buy a home, you could give a seller lets say $1,000 for an option to purchase that home for $300,000.  That option contract would give you lets say three months to decide whether you actually want to buy the house before the offer expires.  During those three months, the value of the property could go up or down.  If something is discovered about the property within your three-month option window that drives the value of the property from $300,000 to $350,000 then you can still buy the property for $300,000.  On the other hand, if you discover that there are zoning restrictions or environmental issues below the land and the value drops to $40,000, then you are not bound to purchase the property at $300,000.  At the end of the three-month period, the offer is no longer enforceable, or in other words, it expires.  If you have not purchased the property within the window, your $1,000 dollars is gone, but that is significantly better than being bound to purchase a $40,000 property for $300,000.

Option Contracts in the Stock Market

Option contracts in the stock market follow the same concept.  Instead of the house as described above, you are buying a “stock” or “security.”  It helps to think of securities as a physical thing even though we do not actually receive the stock certificate in most circumstances.  The option contract here is a paid for promise to leave an offer open for the purchase of a security for a specific period of time.

Take this snapshot of apple for example.  Currently (or at the time of this post) AAPL is trading at $155.86.  This is the price that you would have the “option” to purchase Apple stock for.  If you purchase the option to buy 100 shares of Apple today for let’s say $10 and the exercise period is three months just like the house you could continue to purchase the stock at $155.86 for that entire three-month period.  This would be great if the stock went up to $170.00 because you would have the option to buy the 100 shares of Apple stock at $14.14 below market price.  That is a $14.14 profit per share, which times 100 shares is equal to $1,414.00 profit.

There is more terminology i.e. exercise price, strike price, puts, and calls but for now, I just wanted to get a general understanding of what an option is.  If anything is unclear about the general idea of stock options discussed above please leave a question and we will figure it out!

What We Are All About

I have started this website as a personal interest in learning the skill of options trading.  Options trading has always been a bit of a mystery to me and I want to demystify the art of trading options by learning the trade without a formal education program.  I am of the opinion that being resourceful and constantly curious is important to success for anything we try to accomplish in our society today.  I believe that we can find financial success by using the resources that are available to us as non-industry professionals.  We live in an information-based age and have the ability to tap into the great minds of our time through a few simple clicks online.

Through this page, I provide you a view into my learning process.  I will show you the trades I am making and the techniques I am using.  There will be wins and losses, but the failures that we face in life are there to help us learn lessons about what not to do to succeed.  Feel free to learn as I learn and comment on my posts because that is what this process is all about.  I look forward to collaborating with you to learn a new skill, and hopefully, bring us all closer to financial success.

Full disclosure, I do not know the first thing about trading options.  Seriously, not a single thing.  I have never attempted to trade an option because I have only heard the horror stories about how risky options trading is for someone that does not know what they are doing.  With that said, I am a skeptical and conservative consumer and investor.  I take the time to learn something before I take risks because our hard-earned money does not grow on trees.  This process will be no different, I plan on learning from the authority figures in the industry before I begin actually making trades.  This blog will not be one where I promise to make you rich quick.  I will, however, show you what it really takes to learn something that sounds so scary.  I hope to show you that any skill is obtainable with time and effort.  If you are not willing to put in the work for something, you likely will not succeed in that endeavor.

I expect to follow a general plan throughout our journey to options success, but as with any plan, you have to be ready to adapt and change.  This process will be no different, as we proceed through the vast world of options trading, expect there to be hiccups along the way.  We will need to veer off course and make adjustments to find the correct path.  Hopefully, showing you all of the wrong things to do will be just as helpful as the correct moves. The plan that I expect to follow is as follows: (1) Do the initial research by finding the best resources available (as of right now I have decided that Option As A Strategic Investment by Lawrence McMillan is the best starting place to learn because it seems to be the best book as a consensus in the options trading industry.  More to come on my choice and how I got there in my next post.); (2) Practice and simulate trades using the options trading techniques I learn from industry authorities (I will post as I simulate the trades so you can see that I am actually doing them in real time.  This way you can see my wins as well as my failures.  I am human and expect to make mistakes along the way.); (3) begin trading my real hard-earned cash (when I feel ready to begin risking the money I have earned I will begin real trades).  Obviously, the process will not be as simple as 1. 2. 3. but this is the general framework I plan to follow along with our options trading journey.

Enough talking your ear off about what we will learn, let’s get to the action!  If you want to learn as I learn, feel free to sign up for my e-mail newsletter, follow me on social media, or bookmark this page.  I am excited to share this options trading educational journey with you and cannot wait to see what we can accomplish together.

Newsletter Signup Form

Where to Begin Our Journey

To figure out where to start I always begin with a simple google search.  There is such a wealth of knowledge floating around out there that it is hard to ignore when specific authorities show up the most in your online search results.  The trick is to get past the advertisements and sites that are obviously trying to sell you get rich quick schemes.  I was looking for a starting point that did a couple of things, (1) teach the basics of options trading to help build our foundational skills; and (2) teach strategies that are not promising crazy instantaneous returns but rather have a long-term approach that shows how to reduce risk.

The reason I like to focus on foundational skills is that you can get yourself into a lot of trouble by jumping into more advanced techniques before learning the basics.  I always like to say that the scariest thing while learning a new skill where risk is involved is that you do not know what you do not know.  In other words, if there is something important to learn that can prevent you from losing a lot of money, it is scary that you could bypass learning about that foundational skill because you did not know the skill even existed in the first place.  And the reason I like to focus on long-term and risk-reducing techniques is that there are no get rich quick schemes in life (unless you are stealing from or taking advantage of other people).  The things that pan out and create true value only come with time and effort.  If someone is trying to tell you otherwise they are probably giving you a line to sell something quick for their own personal.

Throughout my online search, I found the following quotes about Options As A Strategic Investment by Lawrence G. McMillan.  In addition to these good quotes, I always like to read some of the negative feedback on Amazon before buying a book.  In this situation, the negative feedback seemed to be about lack of change in the new version and to be careful about making sure it is the real version, not the study guide.

“McMillan’s options books are biblical in reference to your options knowledge[.]”

  • This quote is from Jim Cramer’s website The Street, which is a great resource for news and investing in general. Jim Cramer is an authority in the investing world and has also written some great books on investing for the long term.

“Options As A Strategic Investment by Lawrence G. McMillan is really good. It covers all the basics in the beginning by explaining calls and puts. Moves on to various option strategies involving calls and puts. Then goes deeper into complex strategies using options on derivatives and volatility. It’s probably one of the best books on options and is fairly easy to follow as you read along.”

  • This quote is from an online forum Quora. I usually like to look at a few forums just to see what people are saying about what to read when they do not have as much incentive to do so like authority sites do.

“This is the bible of options trading. It’s tough to get through and sometimes sections won’t apply to your trading style, but it’s great to have on hand as a reference, especially if you have a longer-term timeframe in mind.”

  • This quote from “Investing With Options” was helpful because it discussed the type of investing I am looking for in a book, the long-term timeframe.

“Options as a Strategic Investment by Lawrence McMillans is a great resource to help novice investors wrap their heads around the world of options investing. It covers the basics of how options work and offers numerous strategies for a variety of different markets. The newest edition of this guide showcases a variety of options trading products now available, as well as contains a section on volatility trading. If you’re thinking of using puts and calls, read this book first.”

  • This quote from “Minyanville” was also helpful because it discussed the contents of the book a little. As it discusses, I look forward to learning about some of the products we can use to trade options, but that will come after the basics.  I also plan on doing some research on simulation software, but once again, one step at a time.

The other book that most frequently showed up in my search was Option Volatility and Pricing: Advanced Trading Strategies and Techniques by Sheldon Natenberg.  Because this was also highly recommended during my search as a book on the basics I will keep it in mind for a next step in the learning process.  On the other hand, if Options as a Strategic Investment teaches the basics well, we may move on to a more advanced book on technical analysis or something that reveals itself to us during our learning process.