Much like rugby, options can seem complex, intimidating, and unorganized to the untrained eye. Kevin Hincks breaks down options basics.
I played rugby in college and sporadically until age 50. There’s an old saying I often use when explaining the sport to a skeptical newcomer. I like to think that it applies to options trading as well.
“Rugby usually looks more violent from the sidelines than from inside the pitch.”
Options trading (like rugby) isn’t for everyone. And to the untrained eye, rugby can seem complex, disorganized, and intimidating – much like options trading. But as you continue to study the basics and intricacies of the game, your perspective starts to shift. Instead of seeing random chaos on the field, a fluid and highly calculated game emerges. You start to find order in the chaos on the field, and eventually, you might even appreciate the madness of “the scrum”.
The same could be said about trading options. Behind that wall of complexity and intimidating jargon lies a flexible and potentially useful trading vehicle that might fit your investing needs. But first, you have to learn the basics of a seemingly complex subject.
Now, remember that rugby quote? Let’s enter the scrum.
Among the first lessons for investors and traders entering the options realm is directional bias, shown graphically by the expiration payoff chart which, for single-leg options, I often refer to as a “hockey stick" because of its “L" shaped design).
If you’re ready to lace up and hit the pitch, here’s some of what you need to know about single-leg options:
Figures 1 and 2 show example payoff graphs of, respectively, a long call and a short put— two alternatives to consider if you’re bullish-biased on a stock.
Rugby players grapple, ruck, and maul for positioning on the field. In every scrum, there’s always a multitude of split-second decisions, movements, and scenarios that players need to consider while positioning themselves towards their broader goal. Similar to positioning yourself in a scrum, there are a ton of different factors and scenarios that you might need to consider as you position your option strategy.
If you have a directional stance on a stock and want to consider an options trade, certain factors such as your level of conviction, your time horizon and your willingness to tie up capital should play into your decision. Do you believe the stock is poised for that up move in short order, but you want protection in case you’re wrong? Perhaps you should consider buying a call. Remember, your risk is limited to the premium paid, plus transaction costs.
Do you instead believe an up move is coming, but not necessarily imminent, and you might be even slightly wrong in the short term? Consider selling a put. You’ll take in the premium up front, and as long as the stock stays above your strike price, you’ll keep the premium (less transaction costs).
But it’s important to keep an eye on your risks:
Again, options trading, like rugby, isn’t for everyone. But once you understand the basics, and can match to your objectives, you might decide to give it a try. And with options, no special jersey or headgear is required.
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