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The 10 Essentials of Options Trading You Need to Know

We’ve now completed the first five parts of my Cash Course. You can catch up on each section here.

By the end of this course, I want you to walk away with the confidence, knowledge, and skills to successfully trade the markets and create a path toward financial freedom. But, before we continue, I want to check in and see how you’re doing on the goals you set when we began last month.

Remember, in Part 1, I asked you to think about three goals you want to achieve within the next 30 days… six months… one year… five years… and beyond. And I’d love to hear how the education you’ve been getting here at Patterns & Profits has helped you on your journey so far…

Whether it’s learning which stocks to target for the best profit opportunities (and which ones to avoid)… learning how to choose a broker… placing your first trade…

Whatever you’re most proud of, send me message as soon as you can.

And now that we’ve covered some of the fundamentals of picking stocks, identifying trading opportunities, and choosing a broker, I want to focus on options trading.

I co-founded and built, along with three of my business partners and friends, the successful options education company, Optionetics. To emphasize the importance of the success of our students, our mantra was “Empowering Investors with Knowledge.” We were the largest and most respected options education company in the world, teaching students in North America, Europe, and Asia, with offices in the U.S., Australia, and Singapore.

Optionetics became so successful and highly reputable that a large brokerage firm acquired us. At that point, I could have packed my bags and walked off into a very comfortable retirement. But I made it my mission to give back by teaching others how to trade their way to a lifetime of peace and success – using options.

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And over the years, the three reasons most of my students gave for not trading options sooner were that they’re too risky, too expensive, too complicated – or all of the above.

So, as we cover topics outside of the Cash Course, like where to find the market’s cheapest options and how to profit during earnings season, it’s important that you have the basics and foundation to be able to put this knowledge to work.

That’s why, starting next week, we’re going to spend some time on the essentials of options trading, including opening an account, understanding clearance, order types to use, and much more.

And to get you prepared, I want to share the most commonly asked questions I’ve received from new traders over my decades of teaching.

Let’s jump in…

Q: What is an option?

A: A contract to buy or sell a specific underlying instrument, such as a stock or exchange-traded fund.

Q: What is a call?

A: A call gives you the right, but not the obligation, to buy the underlying stock at its strike price up until expiration.

Q: What is a put?

A: A put gives you the right, but not the obligation, to sell the underlying stock at its strike price up until expiration.

Q: What are the main components of options?

A: There are three main components of options:

  • The premium: the amount you pay for the option.

  • The underlying security: the stock or ETF that the option allows you to buy or sell.

  • The expiration date: the date by which the option can be exercised. Upon expiration, the option expires and cannot be acted upon.

  • The strike price: the agreed upon price at which the underlying stock can be bought or sold.

Q: What can you do with an option?

A: You can buy or sell call or put options. Remember …

Call buyers have the right, but not the obligation, to buy the underlying stock at its strike price up until expiration.

Put buyers have the right, but not the obligation, to sell the underlying stock at its strike price up until expiration.

Q: What does in-the-money (ITM) mean?

A: A call option is ITM when the underlying stock price is higher than the exercise price. A put option is ITM when the stock price is lower than the exercise price. In other words, an option is ITM when you can make money upon exercising it.

Q: What does at-the-money (ATM) mean?

A: This is when the underlying stock price is the same as the exercise price of the option.

Q: What does out-the-money (OTM) mean?

A: A call option is OTM when the underlying stock price is lower than the exercise price. A put option is OTM when the underlying stock price is higher than the exercise price.

Q: What do bullish and bearish mean?

A: A trade is bullish when the stock is expected to move up in price. A trade is bearish when the stock is expected to move down in price.

Q: How do I read an options symbol?

A: An option symbol can look more intimidating than it is to read. It’s broken down into the stock, year, month, day, call or put, and the strike price.

Here’s an example of an options symbol – called an option chain – on one of my 10 stock picks I gave you for Q2 earnings season, Arm Holdings plc (ARM):

ARM240726C00105000

This chain represents the ARM July 26, 2024, $105 call. Here’s how it’s broken down…

ARM 24 07 05 C 00105000

Stock Year Month Day Call Strike price ($105)

Q: How can I look up an options symbol?

A: I use my own software, but you can contact your broker, use your trading platform, or search financial websites, such as Yahoo Finance, to look up an options symbol. If you’re using Yahoo Finance, for example, you would simply type in the stock and click on options if you don’t know the option chain – or paste the option chain into the search bar if you do.

Next Wednesday (July 31), I’ll be back to talk about options clearance and the process for opening an options-trading account.

Until then, enjoy the rest of your week!

Tom Gentile
America’s Pattern Trader