Issue 67: Long Option Traders Can Sell Underlying Stock - Did You Know This? - Masters in Trading Digest

Long Option Traders Can Sell Underlying Stock

Welcome to Issue 067 of Masters in Trading Digest.

Today’s MIT Digest takes you back to the essential basics you need to know.

  • What’s the difference between stock and options?
  • How do traders manage an options position with underlying stock?
  • How to manage risk in today’s volatile markets

Excited to share an exciting new opportunity this Tuesday. Make sure you're on the list for all invites!

Options Trading 101 - A Necessary Lesson for All Options Traders

Let’s retrain your brain to think of options just like the underlying stock. I’ve trained over 1000 options traders and I’ve found this to be the simplest way to understand options contracts.

Options are a derivative of the underlying stock they represent. Let’s go through an example:

$ABC trading at $10.

For this example, let’s buy 10 ABC calls for $.50.

Risk is $500 (can never lose more).

Delta of the $10 strike calls = $.50.

First lesson: The delta of the “at-the-money” options is usually darn close to $.50.

If we use delta as the likelihood a position ends up in the money by expiration, we can then interpret that delta:

  • 50% chance to trade higher.
  • 50% chance to trade lower.

chart that supports text

Notice the delta in $SNAP?

These options expire in 155 days. The delta of the $23 and $24 strikes are $.62, and $.59 respectively.  Because there’s so much time in the above $SNAP options, all deltas are somewhat close to $.5.

Back to our $ABC example: Our delta exposure in $ABC will be 500 shares of stock.

Why 500? 

1 option contract = 100 shares of stock. 

Long 10 calls that expire in-the-money is the same as being long 1000 shares. If a market maker wants to trade ABC “delta neutral,” what does he need to do?

He needs to find 500 deltas to sell. Right?

Where to find short deltas?

  • Sell $ABC shares
  • Sell $ABC calls
  • Buy $ABC puts

Fun note – selling calls will not only get us closer to delta neutral, it will also get us closer to “volatility neutral.”

For this example, let's sell 500 shares of $ABC.

New position:

Long 10 Calls in ABC (.5 delta)

Short 500 Shares

Big News Hit the Wires!

$ABC won the lottery, $ABC stock skyrockets to $30! What happens to our position?

Long 10 Calls are now worth $30 – $10 = $20,000 less $500 paid = $15,000!

Short 500 Shares = <10,000 >

The delta on our long calls jumped to 1 after the news. With the stock trading at $30, those $10 call options are now trading with the risk profile as holding $ABC stock from $10; no difference.

That's why the delta is 1.

How are we doing? What's the delta of the $10 strike puts?

Let us know in our Discord channel.

How much risk is your portfolio exposed to?

What would happen to your portfolio if the market dropped 25% and volatility exploded?

Would you win?
Would you lose? 

Stop trading and watch this on-demand workshop if you can't answer that. 

In this two-part class, we cover it all: 

  • Why Options?
  • Are they risky?
  • How to price options.
  • How to evaluate an options tree and identify skew.
  • What to consider when looking for an options trade?
  • ITM Options or OTM Options?
  • How to construct a balanced portfolio so you don’t have to worry about big market swings.

WATCH OPTIONS 101 NOW

Masters in Trading Digest - Issue 67

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FINAL THOUGHTS

WHAT TO EXPECT IN THE NEXT MIT DIGEST

Volatility continues to be the dominant topic, and things do not look to be settling anytime soon. During times like this, we encourage account diversification.  Not just with long and short trades, but also with long and short volatility trades.  Moving risk to other markets like Futures and Web 3.0.

Trade less and hold positions longer. Be smart and always make sure we can live to trade another day.

Keep your feedback coming into support@mastersintrading.com. We’re excited to share your feedback along with fantastic suggestions for upcoming issues.

Until then, trade smart and always manage your tail-risk.

Thanks for reading & have a great weekend,
Jonathan Rose

P.S. If you want to spend your weekend getting back to the basics, Options 101 is available for $97 for a short time.

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