Lesson 3 How to trade options like stocks?
Different from the simple buying and selling of stocks, there are four conceptual ways to place an option order.
1. Buy to open
As the name implies, it is the order you submit when you want to open a position and buy a group of contracts. For example, if you are bullish on the stock FB, if you want to hold the call option contract of FB, you need to buy the call option of FB to open a position. However, it should be noted that buying and opening a call option on FB means that the price of the option contract will rise. Although the price of the option contract is highly positively correlated with the price of the underlying asset or stock, they are not equivalent. For example, the price of the underlying stock has risen a little, but the price of the call option contract that is about to expire and is deeply out of value (the exercise price is much higher than the current price) can still be cleared.
2. Sell to close
Corresponding to buying to open a position, selling to close a position is a method of placing an order to close a position after buying and opening a position. Just like selling a stock, you can lock in the profit or loss of the contract you hold by selling and closing a position.
3. Sell to open
Contrary to buying to open a position, if investors want to short the price of a group of contracts, they choose to sell to open a position. Taking FB as an example, if investors are bullish on FB, the price of FB put options will fall. Therefore, you can choose to short a group of put options to profit from the drop in option prices, which is actually equivalent to doing up FB.
4. Buy to close
Buying to close a position is a way to place an order to close a position after selling it. It is like buying a short position before covering up, locking in the profit or loss of the previously held contract.
Different brokerages may have subtle differences when opening and closing options positions. As shown in Figure 3-1, Interactive Broker only has two operations: buying and selling. That is, if you do not hold a position, both buying and selling are considered to be opening positions. And if you already hold a position, then buying and selling the same amount of position is to close the previous position. Most domestic options platforms are also shown in Figure 3-2, so there are four types of operations listed above.
Figure 3-1 Interactive Brokers Options Trading Interface
Figure 3-2 Domestic brokerage options trading interface
Now that we mentioned option orders, please review some order types and some noteworthy details of stocks and options.
1. Market order
The most basic order type, a market order is an order to buy or sell an asset at the current market bid or ask price.
2. Limit order
A limit order is an order that can only be executed at a price that is more favorable than the investor's limit price or at the same price. For example, submit a FB limit buy order (limit buy) with a price of $120, that is, buy FB at a price of no more than $120. Submit a FB limit sell order (limit sell) with a price of $120, that is, sell FB at a price of no less than $120.
3. Stop order (Stop order)
The stop loss order submits a market order to buy or sell after the stop loss trigger price specified by the investor is triggered.
Since the bid-ask spread of options is usually larger than the bid-ask spread of stock prices, especially for some relatively less liquid targets, the bid-ask spread can even reach more than 10% of the bid price (bid). Therefore, when investors place an order to operate options, they should try to avoid using market orders, because it is very easy to trade at a very unfavorable price. The ideal method is to use a limit order and set the limit price at the middle price between the buying price and the selling price, or set the limit price in a more favorable direction below the middle price, and then gradually move the transaction. For example, assuming that the call option price of FB’s Jan. 30 strike price of $120 is $3.1 for the buy price and $3.2 for the sell price. If you submit a buy order, you can first set the limit price at $3.12 to $3.13, and then gradually move up to $3.2 to complete the deal.
We can directly operate a single option by simply opening and closing positions. If we want to place multiple options contracts, we can operate by combining orders. For example, we need to buy a spread strategy consisting of two options. At this time, we need to place an order in the strategy window, and then submit this strategy together for trading. In this way, our position will show a spread option strategy, such as the strike price of $200 and the strike price of $190 call option spread, which means that we bought a call option with a strike price of $190 and sold a call option with a strike price of $200 at the same time, forming a bull market call spread. The advantage of this is that once we have more positions, the combination price difference looks very obvious. We don’t need to find out which two or more options in the position are a strategy. Similar strategies such as straddle strategy and iron eagle strategy can be operated in the way of combining orders.
Figure 3-3 is the option chain of S&P spy; Figure 3-4 is the option chain of SSE 50ETF, so that everyone can have some intuitive feelings about the option trading interface.
Figure 3-3 S&P spy option chain
Figure 3-4 SSE 50ETF option chain
Typically, most software will place the strike price in the middle, with calls on the left and puts on the right. Then the upper end can change the time to choose options with different expiration times. In the internal quotation column, the following indicators are worthy of priority to be displayed: Ask, Bid, Volume, Open Interest, Implied Vol, and Greek letters (Delta, Gamma, Theta, Vega). These are the more important basic parameters for option trading.
Next, let's talk about the difference between option trading and stock trading. In essence, there is actually no difference, they are all buying the same thing and putting it in their own positions. But if we analyze it from another angle, when we buy stocks, as long as the company corresponding to the stock is not bankrupt or delisted, our stock will always be there, only the price changes. Options are completely different. Options have time value, volatility value, and intrinsic value. When you buy an option, it may disappear from your account at some point in the future, but you never hear of buying a stock that disappears by itself. Therefore, when trading options, you must design a strategy and a stop loss and profit plan, which are completely different from stock strategies. For example, if a stock has fallen for a period of time, you can buy it again to spread the cost, and then if the stock rebounds back above the cost price, there will be a good profit. Once the option loses money, if you buy the same option, you may lose more and more. This is due to the impact of the time value of the option, so how to correctly trade options and design option strategies is very important. We will learn about this aspect in later courses.