3 Important Concepts Options Traders Should Know | Options Trading Concepts

[Music] [Music] hey everyone welcome back to the show my name is mike this is my whiteboard and today we're going to be talking about three concepts that beginner traders should master so when we're just getting into the space and we're talking about learning about options and all of the things that go into it it can be very easy to get overwhelmed with just the massive amount of content and the massive amount of concepts and strategies that we can get into but there are a few things that i found really important when i was learning and

i think if we master just these three concepts concepts we can easily translate any of these things into future learning and make learning about different strategies and different concepts a lot easier but first i actually have a big announcement to make so let's go into the next slide and we'll talk about that just a little bit so this show specifically is actually going to end this week so this is going to be the last week and then over the next two weeks we're going to be showing you some of the top videos over the course

of the last about year and a half this will be the 160th episode so by friday we'll have 163 episodes that are all evergreen and they're all basically episodes and segments that you can go back to and check out for different strategies and different concepts where we take talk about them from a beginner to intermediate level and really what we're going to be doing is we're going to be moving this show and we're going to be merging it with jim schultz so if you are familiar with jim's show from theory to practice we're actually going

to be merging that so he's going to move to this time slot i ideally and then we're gonna talk about different concepts and strategies together so it's gonna be a show with me and jim together and we're gonna be talking about a few different things so i'm really excited about this because i think we have an opportunity to present you guys with a lot of great content in this manner so number one we're going to be doing some beginner dough tutorials because jim is a toss guy but i am a dough guy so i'm going

to show him how to use dough and it's going to i'm going to make it in a sense to really show someone that understands thinkorswim and really bring them into the dill world and show them all the benefits and the cool things about that we're doing here with dough so we're going to be doing that and we're also going to talk about concepts and strategies so you'll see a lot of the similar slides and concepts that i've already talked about and some things that he's already talked about as well we're going to merge it together

and we're going to bring you a discussion similar to ryan and beef and liz and jenny so it's going to be really cool and we're going to bring a lot to the table in that sense and we're also going to be trading in dough so it's going to be another show that will be trading in dough exclusively so just another awesome show and i'm really excited for it it is bittersweet because i have had a ton of fun with the whiteboard show but i think we have had a lot of concepts and we've got a

pretty much everything down over 163 episodes of concepts and strategies that are evergreen which means we can always go back to them and check them out for concrete information so be sure to do that they'll always live in the archives and again we'll be talking about a lot of the content that i presented here on the new show so look out for the new show on 7 18 that will be our first day as tom mentioned this morning as well so let's get right into today's concept and that's going to be the three concepts that

beginner traders should master so the very first one that i want to talk about is really just mastering the fundamental options when i was learning about the options and different strategies i was actually learning and trying to force myself to learn too many things at once so what i did was i took a step back and i really made sure that i understood just the fundamental concepts so when i say fundamental concepts i'm talking about what is a long call and what is a long put and what are the implications of that and then i

looked on the flip side so what is a short put and what is a short call so let's review them really quickly so a long call is just the right to buy 100 shares of stock at a certain strike price so if i own the call contract i can either exercise that before expiration which gives me the right to buy those 100 shares or i can let it expire and if it's in the money it will automatically exercise into long shares similarly if i have a put it's just the opposite but i still have that

right to exercise so if i have a long put i have the right to sell 100 shares at the strike and at expiration if it's in the money just like a long call or any of these options for that matter it'll automatically exercise into those short shares so i have the right to sell 100 shares but if i don't actually own those shares but i still actually own the put it'll turn into short 100 shares so when i have a short put it's just the opposite of a long put so it would get it would

have the obligation or really present me with the obligation to buy 100 shares at that strike if the long put owner ended up exercising it prior to expiration so when we're dealing with short options that is where we have that early assignment risk we are not at we don't have the ability to exercise those options the long option holders do so when we're dealing with short options that's where the early assignment risk can come into play but it really only comes into play when we're dealing with in the money options so a short put is

a situation where i have the obligation to buy 100 shares at that strike if the option is exercised and just the opposite for a short call so we're looking at a short call which is really just the obligation to sell 100 shares at that strike but what's really important is once you understand and master the fundamentals of these where i can eliminate all of these descriptions here and i can know exactly what is implied when i look at a long call or a long put or a short call or a short put what's really interesting

is that once you start to add these together or create different scenarios and different spreads like for example a vertical spread all i'm doing is taking a short put here and i'm combining it with a long put so what does that mean well it'll mean that my risk is defined because if the short put is the obligation to buy 100 shares and a long put is the right to sell 100 shares if i have both of those options at different strikes it doesn't matter if it's completely in the money my risk is going to be

defined at the difference between the strikes because one of these options is going to get me long shares at expiration and the other option is going to get me short shares at expiration and really all the option strategies are just combinations of these four things so if you really hone in and master each of these four things and really learn when this option is profitable when another option is profitable once you start to combine those you can start to say okay a short put will start to increase in value or gain money when the stock

goes up where the opposite is true with the long put but if i combine them together and my short option is sold more or sold for more than my long option is purchased for that's really where the profitability comes into play so when we start to add all these together you can clearly see that all the strategies that we talk about here are just combinations of these four things so i would say the very first thing a beginner trader should really hone in on is focusing on these four options and really learning and mastering the

implications of them but there are some other things that i want to talk about today so let's get on to the next slide and we'll talk about those so another thing that is really important to master is the concept of liquidity not only will it give us fair markets but it's also going to give us a smoother trading environment so when i talk about liquidity really what we're talking about here is a few things so we're talking about the bid ask spread open interest and volume so when we're looking at the bid ask spread when

it comes to liquidity basically the more participants there are in a market the more fair that price is going to be so if you think about 50 people trying to sell an item and 50 people trying to buy an item the closer the more people there are the closer they're going to be able to get on that fair price but if there's only one person trying to buy an option or item and one person selling it there's more of a chance that there's going to be a discrepancy between that price maybe i would think something's

worth 50 where another person thinks something's worth 20 but if there's 50 of us on either side we can come to an agreement that a fair price is at whatever level it is so the more people that are in the market usually we're going to see a much more fair price which is really going to be benefiting our bid ask spread which is ultimately where we can get into an option and where we can get out of an option or where we can get into a stock and where we can get out of a stock

if that spread is too wide it can lock us into situations that aren't favorable and really i did actually do a whiteboard on that so i'm going to include links for all of these concepts and include all the whiteboards that have previously done in this segment so you can always go back to the description below once this video is archived another thing we're looking at when we're talking about liquidity is open interest an open interest is really just the number of outstanding or open contracts for that specific strike so if i'm looking at an expiration

in july and i'm looking at maybe a 195 strike in spy the open interest will show me the number of open contracts in that specific strike and specific expiration so really what that tells me is that if i open a trade and there's a lot of open interest there then in the future if i wanted to potentially close that trade or roll that trade i should be able to as long as there's a lot of open contracts available because that just means that there's a lot of opportunity to place trades in the future volume is

very similar but just a little bit different so volume is going to give us the number of contracts that actually traded throughout that day so if someone opened a contract that would be one tick on volume and if someone closed that contract that would be another tick on volume so really volume is just showing us the total transactional the troll transactions in that specific strike or underlying for that trade and when we're looking at volume we also can see the volume of shares traded per day so we have volume for shares and the actual strike

and option but for open interest we're really just looking at the option but understanding these concepts is really going to get us a long way when we're looking at picking out underlyings that are liquid and picking out underlyings and specifically expirations and strikes that we can deal with because a lot of times when we're using spreads like things like vertical spreads or iron condors or j liz jade lizards what we don't realize is that we're we might throw out a trade and we might not get filled right away or the market might exceed the price

that we put in there and we might not get filled at all what we have to realize is that each of those legs must be liquid so if i have a three-legged trade or a four-legged trade or two-legged trade i need to make sure that each of those legs and each of those options is liquid because if one of them isn't regardless of whether the other ones are liquid or not we're not going to be able to get filled because in order for us to be filled the market maker has to account for each of

those legs so if one of those legs is a liquid we're probably going to have a hard time getting filled both in into the trade and also out of the trade so we want to make sure that we're very well versed on liquidity so that we're able to get in and out of trades quickly because the worst case scenario is that we've got a trade on and it's very profitable but we can't get out of it so we're forced to hold the risk because of the fact that we can't get out of the trade because

there's low liquidity so that's why we always stick to the liquid markets and the most liquid underlyings as well but i do have one more concept that i want to talk about today and that is implied volatility so on the next slide we're going to talk about the things that really matter with implied volatility and the implications behind it so why would we want to master the concept of implied volatility well really it's all about the overstated option pricing so implied volatility is really just the percentage implied move over the course of one year so

if i have an underlying that's trading for 100 and it has an implied volatility of 30 percent that basically means that the underlying has the ability to go up 30 or down 30 percent over the course of the year or at least that's what is implied for that movement so the underlying could go from 70 to 130 anywhere in that range over the course of a year that's basically what implied volatility is showing you but what is really important is understanding where implied volatility comes from so the option prices actually drive implied volatility not the

other way around and what's really interesting is that when you look at implied volatility what we found is that implied volatility generally overstates the realized implied volatility so in that same example if the implied volatility was 30 and i came back to that value a year later maybe it only actually moved 10 or 20 percent that would mean that option prices are more expensive than they actually should be or they how they should be priced so if we're selling options and realized volatility ends up being understated or realized volatility ends up being underneath where implied

volatility is that is what gives us the ability to be profitable when we're selling premium and that's really what we want to focus on here so be sure to master all three of these concepts when you're beginning and starting out as an options trader but let's drop all this together with some takeaways for you so the first takeaway is options education can be overwhelming as we learn more about certain things we might go into different rabbit holes and realize that there is a lot of content but if you really focus on one specific thing or

one specific strategy and really master it it makes it a lot easier to start learning about other concepts so i would say focus on one thing at a time and really understand that concept or strategy for me i really focused on the naked options as i stated and i also focused on just basic vertical spreads and iron condors from there once i realized what would happen with the option prices as the underlying moved i then was able to easily go into things like jade lizards and ratio spreads and all those other strategies that are a

little more complex and the real learning will obviously take place when we're trading so be sure to get your hands dirty if you have a paper money account that's great or if you have a real money account that's great but really the real learning comes when you're trading and you actually see these things being put into practice so thanks so much for tuning in my name is mike if you've got any questions or feedback shoot me an email here or you can follow me you know we've got jim schultz coming up next what's up youtube

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