Options Trading: THE BEST TIME TO TRADE OPTIONS | Scott Reese | Skillshare

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Options Trading: THE BEST TIME TO TRADE OPTIONS

teacher avatar Scott Reese, Engineer & Investor

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Taught by industry leaders & working professionals
Topics include illustration, design, photography, and more

Lessons in This Class

6 Lessons (1h)
    • 1. Introduction

      1:19
    • 2. Theta & Vega Overview

      15:44
    • 3. When to Sell Options

      20:33
    • 4. Gamma Risk

      8:23
    • 5. When to Buy Options

      13:15
    • 6. Wrapping Up

      0:49
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About This Class

Understanding when it's appropriate to be selling options, when to be buying them, and which expiration cycles to choose is paramount for your success as an options trader.

This course will take a deep dive into each of these concepts with plenty of examples backed by real data and research!

After finishing the class, you'll be equipped with the knowledge that few others are, and your trading will likely improve significantly as a result!

Meet Your Teacher

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Scott Reese

Engineer & Investor

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Transcripts

1. Introduction: If you're interested in learning how to trade options, or maybe you're already in the process of learning how to trade options. This is going to be a critically important course for you to watch because one of the first and most fundamental things that you need to understand about options trading is when you should be selling options, when you can be buying them, and then which exploration cycles should you be choosing, right? Should you be trading options with only one week left to go until expiration, or maybe 30 days, three months, six months, a year. All these questions and more will be answered right here in this course. And this is the first class of mine you've come across. My name is Scott Reese. I currently work as a software engineer in the financial services industry. And I'm also an entirely self-taught and self-directed trader and investor in the stock market. And it's my goal here with this Shanda of crud on skill share to help people like you also become confident and self-directed traders and investors also. Now one thing to know before we get started here is this class does require just some very basic knowledge on how options work. So as long as you understand what a call option is and what a put option is. And you have a basic understanding of some terminology like in the money and out of the money, you'll be totally fine working through this course. If you are brand new to options, whoever I recommend, you first watch my more introductory class called stock market options introduction. And I'll teach you exactly how options work and also get you up to speed on the various terminology and the ones you don't want that you can come back to this course and continue forward. So with that being said, let's hop over to the computer and get things started. 2. Theta & Vega Overview: Alright, thanks for joining me here in the first video of this course on the best time to trade options. And I do mean this quite literally in the sense that not every market environment or every stock is going to make for a great training opportunity when it comes to options trading, there are certain particular market environments and certain aspects of option pricing that you need to keep in mind in order to fill trial all of the bad trading opportunities to find only the good ones. And so the goal of this course then is to guide you through the process of finding those good training opportunities. And how we figured out when you should be selling options and when you can be buying options. And then also, which exploration cycles should you be choosing, right, for the options that you're trading? Should you be trading options that expire in a week or maybe a month, three months, six months, a year, so on and so forth. But before getting into that stuff, coming over to the next slide, the first thing I want to talk about in the focus of this video is I want to give you an overview of theta and Vega and specifically their effects on option pricing. Now for some of you, especially if you've watched some of my other options trading courses, this might be a bit of a review. And for others, this might be the first time you are being exposed to theta and Bega, What is this? Either way, definitely pay close attention to this video because you will need a very salt understanding of these two concepts in order to then understand when it's appropriate to be selling options or buying options. And then also which exploration cycles you should be choosing when trading those options. So next line, we're first going to talk about what theta is. And theta is a concept which is derived from the Black-Scholes option pricing model. And the Black-Scholes option pricing model, if you haven't seen before, is a rather complex mathematical equation that allows you to calculate the theoretical price of either a call option or a put option based on some various inputs. Those inputs being things like the stock price, the level of implied volatility, which I'll talk about more on the next slide. Interest rates, time to expiration, et cetera, et cetera. And it's like I said, based on those inputs, you can literally run the numbers to calculate what the theoretical price for a call or a put should be. Now what you'll find in the real marketplace with real-time trading is the live trading prices of calls and puts may not exactly equal the theoretical prices that you would find from the Black-Scholes pricing model. And that's fine, right? The Black-Scholes model is meant to give you the theoretical pricing. And oftentimes, the theoretical price is usually pretty close to the actual trading price in the live markets. But the most important thing about the Black-Scholes pricing model is that it very accurately describes the behavior of option pricing. And that's what I really want to focus on here in regards to theta and Vega. And so going a bit deeper, theta is also referred to as time decay, meaning with each passing day, the value of an option decreases or decays. And this is simply just one characteristic of option pricing behavior. And so this daily decay of option value can be quantified by this theta concept. And so specifically, theta is just a number that tells you by how much the option price will fall every single day. And this applies to all options, both calls and puts on every stock, every ETF in the market, every single passing day, all else being equal. And I'll explain what that means in a second here. All else being equal, option prices will slowly decrease day after day until expiration date arrives. Now what all else being equal means is assuming the stock price were to stay the same every day. Implied volatility stays the same industry, it stayed the same, et cetera, et cetera. If all the other inputs basically to the Black-Scholes pricing model stay constant. And the only thing that is changing is simply the days passing. Then yes, you will see option prices slowly decay day after day. But of course, stock prices move every second, every day, every month. Implied volatility also changes all the time as well. And so even though time decay is always working, that decay, an option value caused by each passing day can certainly be offset by a particular change in the stock price or by a change in implied volatility or interest rates. So that's why in the real markets you don't see options only decreasing a price every day, stocks are moving, implied volatility levels are changing. And like I said, that can more than offset the slow decay of option pricing simply because of the passage of time. But time nutcase still is very important to keep in mind just because you don't see it in action every single day does not mean it's actually not working behind the scenes. And depending what your strategy is, whether you're selling options or buying options, theta can actually really work for you or against you. And I'll talk more about that later in this course. And so one other characteristic that you also wanna keep in mind about time decay is that time to K accelerates as option expiration approaches. So for example, if you're looking at a particular call option on Apple with maybe three months left to go, that's a decent amount of time. The Daily Time to k might be $2 per day, meaning all else being equal, you would expect a value of that option to drop $2 every single day. However, when expiration is only three weeks away, that time decay is no longer going to be $2 per day. It might be 789 or $10 per day. And time decay will continue to accelerate faster and faster and faster all the way until expiration finally arrives. And then lastly here before moving on to the next slide, I have a screenshot here that is pulled from the thinkorswim web platform. And this screenshot is just showing you the option chain for Apple stock. You can see down the middle in that grayish column, those are the strike prices, 107.5111 told 0.5, and so on to the left of that column. Those are all the important metrics about the various Call Options. And on the right-hand side, same thing, the various important metrics for the put options. And then you can see where I've circled in yellow. Those are these smaller sub columns, if you will, that show all the theta values for each of those options. So for example here let's focus on the 1-10 strike call option. So go to the 1-10 strike in that grayish column in the mill. And then directly to the left of that you can see the bid and ask price. The bid price is $13.70 and the asking price is $13.90. So going right in between, the fair price for this option would be $13.80. And one thing to keep in mind here is all these numbers are quoted on a per share basis. And since options are typically tied to 100 shares per contract, you have to multiply all these numbers by 100 with the exception of the strike price, of course. So in reality that fair price for either buying or selling this call option would be 1000, $380. And so with that in mind, if you go all the way to the left and you look at the theta value for that particular call option, you'll see it's negative 0.05. 58. So again, multiplying that by 100, you get negative 5.58. And so what this means is all else being equal if the stock price were to stay the same tomorrow, implied volatility or to stay the same by tomorrow, so on and so forth. Then come tomorrow, you would expected value of this call option to drop by about $5.58, right? Whenever you look at the theta values in your trading platform, they're going to be coded on a 24-hour time basis. So like I said, 24 hours from now, you would expect the price of this option to drop by $5.58. And that's all there is to it. Theta is a very simple concept. So don't let the numbers here and maybe the visual complexities of the screenshot tried to over-complicate things, theta simply tells you how much the option price will fall every single day, nothing more, nothing less. And so not coming over to the next slide, we're going to talk about what Vega is. And just like with theta, they get is also derived from the Black-Scholes option pricing model. But instead of at corresponding to the daily passage of time, Vega corresponds to the implied volatility of the underlying asset and the underlying asset going off, for example, from the previous slide would be Apple stock, right? It's simply the stock that the contracts are tied to. And so now what is implied volatility, or also referred to as IV for short? Implied volatility is simply the market's expectation of the asset's price movement over a certain period of time. Now typically when you go into your tritium platform and you look up the implied volatility for whichever stock you are considering trading, it will be coated on a one-year basis. That'll be the default period of time. And implied volatility is often quoted as a percentage. So as an example, if you went into your tritium platform and you looked up the implied volatility for Apple stock, you might see that it's 30%. And so what this would mean is one year from today, right, one year out in time, the market is currently expecting Apple stock to be either up or down by 30% from today's price. And it's important to remember that this is a up or down expectation, either plus 30% or minus 30%. If Apple was trading for $100 per share today than one year from now, the market is expecting Apple stock to be either $130 per share or $70 per share plus or minus 30%. And this implied volatility number can definitely change just as frequently as the actual stock price can change. It's a very dynamic thing that can grow and expand or contract based on what's happening in the market, what's happening in the world. And most importantly, what's happening with Apple as a company. And so now what Vega does is Vega is also a number just like theta. And I will show you how much an option's price will change for a 1% change in the implied volatility. Right, as I mentioned earlier in this video, implied volatility is one of the inputs into the Black-Scholes pricing model, which means implied volatility is used to actually calculate the price of options. And so going back to my example here, if the implied volatility level for Apple stock was currently 30%, then at the implied volatility increased or decreased by 1%. So if it increased to 31% or decrease down to 29%, Vega will show you how much that will affect the prices of all of the apple options, both calls and puts. And so specifically the way implied volatility affects option prices is if implied volatility expands, if it increases, that's also going to increase the price of all options. And then conversely, if IV contracts that's going to decrease the price of options. And so vega, then we'll just show you how much this increase or decrease will be. Now one of the most important characteristics of implied volatility that you never want to forget is that implied volatility is quote, unquote mean reverting. And what this means is that implied volatility tends to fluctuate closely around the long-term average. So if you were to look at the implied volatility for Apple over the past ten years, you might see that the average value is right around 30%. I have no idea if that's the actual number. But let's just say for the sake of this example, that the average implied volatility for Apple over the past ten years is 30%. And so this would mean going forward into the future. You can expect that most of the time the implied volatility for Apple stock is going to remain somewhere close to 30%. It might go up to 35% or down to 25. But the point is, it's going to fluctuate very closely around that long-term average. And so then the most important thing that comes from this is that when implied volatility does spike, if you see a very significant expansion of implied volatility, you will most likely see very soon after a quick contraction back down toward the averages and then vice versa too. Sometimes implied volatility gets very, very low if the market gets very complacent. And then what typically happens going forward is implied volatility will start to expand and go back up toward the averages. And these spikes or significant drop-offs in implied volatility can happen for a variety of reasons. Typically, when implied volatility spikes, there's usually an earnings announcement that's coming up soon. Or maybe there's some supply shock or other economic condition that's affecting the company in adverse way. And then on the flip side, when implied volatility gets very, very low, well below the average. That's usually a sign of complacency where people are just buying the stock lazily every single day because so far everything is good, there's no bad news. Nothing that caused the market's expectation. Apple will be to really widen or to expand over the next year. And so that can cause implied volatility to get to very low levels. But of course, nothing in the marketplace stays perfect forever. So at some point, something's going to happen where uncertainty about the company or about the stock is going to increase, which is going to make the market's expectation of where Apple will be a year from now, a bit more uncertain, that's going to cause implied volatility to expand again. And so then lastly here, just like in the previous slide, I have another screenshot, again showing the apple option chain. And now what I have circled in yellow, you can see the Vega values for each of those call and put options listed there. So again, let's focus on the 1-10 strike call option. So go to the 110 in the middle and that grayish column, and go directly to the left. And then looking at the Vega value for that 110 strike call option, you can see it's 0.0997. So again, multiply that by 100, which would give you 9.97. And so this would mean if the implied volatility level for Apple increased by 1%, then you would expect the price of that call option to also increase by $9.97. Again, that's all else being equal, but that's what the vegan number will tell you. And then conversely, if implied volatility contracted, if it decreased by 1%, then you would expect the price of the option to also decrease by $9.97. Again, all else being equal, perhaps a more realistic example would be, let's say 24 hours from now and one day implied volatility does increase by 1%. So the price of the option would increase by $9.97 just from the vega component. But then don't forget the time decay component as well. And as you saw in the previous slide, the time decay or the theta value for that 110 strike call option was about $5.50. So in reality, when you combine these two things together, that means 24 hours from now, the price of that call option would not have increased by almost ten bucks, right? Just kinda rounding up the 9.97 to ten, it would actually have increased by about $4.50, right? Because if the expansion in implied volatility increased the price of the option by about ten bucks. But then you had 24 hours of time pass, which reduces the price of the option by about $5.50. That would leave you with only a net increase of about $4.50. So that might give you a better idea of how the real markets are actually working with all these different aspects of option pricing behavior that are counteracting each other in real time. Because of course, it's not necessarily realistic to assume that the stock price and implied volatility and everything else is going to stay exactly the same every single day. And only time decay is going to be taking effect. All these things are moving every single day, every single second. But again, that does not mean that each of these aspects of option pricing behavior implied volatility, time decay, Industrial Age, the stock price movement, et cetera, et cetera. That does not mean all these things are still not working behind the scenes. They all do have an effect on option pricing all the time. You just may not see their individual effects every single day. And so with that being said, that concludes this video here on my overview for theta and Vega. And in the next video coming up, we'll be talking about when you should be selling options. And we'll be using time decay and implied volatility to help us figure that out. So whenever you're ready, I'll see in the next one. Thanks. 3. When to Sell Options: All right, welcome back to the next video in this course. And so in this video and now we're going to talk about when you should be selling options. And this is my recommended strategy when it comes to options trading. You know, if you've watched my other options trading courses, you will know that pretty much a 100% of what I do is strictly selling options. And I'm not gonna go too in depth into all the reasons why you can watch those other courses to see that in-depth explanation. But it mostly comes down to the fact that there is an embedded edge two options selling because of implied volatility and time decay. And we're gonna get into that here in a second. Coming over to the next slide, we're going to first discuss some of the rules for options selling. And then halfway through here I'm going to switch over to a spreadsheet or I have an analysis prepare for you that's going to demonstrate visually with some graphs and some actual data. It's going to be showing you the most advantageous time to be selling option contracts based on their expiration dates. But first off here, the first rule when it comes to options selling is you want to be selling out of the money. Option contracts or OTM for short. Meaning for example, if you want to be selling call options on his stock, that's killing trading for 50 bucks per share than an out of the money option you might want to be selling or specifically and out of the money call option that you might want to sell would be a contract with a 55. Strike the case. If you want to be sling put options on that stock, then you might want to be selling options with a 45 strike for those puts. And the reason why you want to be selling out of the money options is because time decay is going to affect their pricing the most. And that's because as long as those option contracts state out of the money, they're going to be completely useless come expiration. So even though they might have some value today, you know, there's maybe 12 or three months left to go to expiration. If the stock never moves in such a way to make them in the money, to make them useful come exploration, then went expiration day actually arrives. Those contracts are going to have no value. You're going to be priced at $0.$0. And so when it comes to selling options, the main goal or the objective here is you want to buy those contracts back for a much lower price than where you sold them, right? So for example, if I sell a call option on some stock for a 100 bucks initially, maybe two weeks passes, and as time decay takes effect and the price of the option dwindles down from a 100 down to 50. Well, like it by that contract back for 50 bucks. And in that case, I would walk away with a $50 profit, sulfur, a 100 Baalbek for 50, leaving me with 50 bucks left over as my profit. And so with that example in mind, that's why time decay is such an advantageous thing for option seller's, it naturally works for you, right? Because even if the stock goes nowhere and implied volatility stays at the same level, simply with a passage of time day after day, those contexts are going to be losing value, which is obviously going to be very beneficial for the person who's sold those contracts. Now the second rule for options selling that is very, very important as well, is you want to make sure the implied volatility for that underlying asset is significantly higher than usual. So ideally you want to wait for it. Implied volatilities spiked to occur before you actually go into your platform and starts selling those options. And let's think about why here for a second. As you saw from the previous video, when implied volatility expands, when it increases, that's also going to increase the prices of all the option contracts. And so as an option seller, and that's going to be a very beneficial thing. You're gonna wanna sell options with inflated prices to take in the most amount of money right? Now, if you also recall from the previous video, implied volatility is mean reverting. So typically after a large spike, you will very likely see soon after a contraction back down toward the average usually is. And as implied volatility contracts, that's going to decrease the prices of all option contracts. And that's exactly what you want to happen as an option seller. You sell them at a very high inflated price because implied volatility spiked for whatever reason. And then as the implied volatility contracts, it comes back down to the average. That alone might allow you to buy back those options for a much cheaper price and make a significant profit. And so that's the implied volatility component or the vega component of options selling. But what about the time decayed component? As you've learned already, time to k is always working. Every single day. The option prices are going to slowly decrease in value. But time to Kate does accelerate as you get closer and closer to exploration. But still, what expiration date should you be choosing when selling option contracts? Should you be selling options with only a few days left to go until expiration or maybe two or three weeks out, or maybe a few months, six months, a year. What is the magical number, so to speak, of? How many days left until exploration should you be allocating for the contracts that you want to be selling? And to answer that, I'm going to come out of the PowerPoint here and slide over to this spreadsheet where I had the analysis prepared for you. And so what I have shown here is basically a calculator that will use the Black-Scholes pricing model from the previous video that I talked about. And based on these inputs right here, is going to calculate the prices of a call option over a spectrum of days until exploration. So for example here, let's say we have a stock that's priced at 50 bucks per share. And I'll zoom in here to make it little bit more easy to read. 50 bucks per share is the current trading price for the stock. And let's say we want to sell a call option with a strike of $55. So this would be an out of the money option contract, which is the first rule for options selling. And let's say the implied volatility currently is 75%. Now for some stocks, for some very volatile stocks, a seventy-five percent implied volatility might actually be pretty typical and pretty average. And the key thing here is to sell contracts where the implied volatility is much higher than average. And you can definitely leverage your trading platform to show you a graph of previous levels of implied volatility. And you'll be able to see whether the current level of implied volatility is much higher or lower than where it typically is. So let's say for the sake of this example, the average implied volatility value for this stock is 30%. So 75 would be a significant expansion from the average, which would make this situation here very advantageous for an option seller. And then let's say also the short-term interest rate is 1%. Interest rates are also important for the Black-Scholes pricing model. You need to know this value to calculate the price of an option. So, so just for this example, let's say the interest rate is 1%. And so now coming over here, based on that setup, that particular call option with 365 days to go until exploration. That's what DTD stands for. Days till expiration. So with one year left to go, the price of that call option will be $13.14. And again, that's on a per share basis. So multiplying this by a 100, the true price would be 1314 bucks. And then don't worry about these D1, D2 values. They are simply intermediate calculations that are used in the Black Shoals pricing model. So you can basically ignore the stuff in between, just focus on the days till expiration and the subsequent option price as a result. Once then you can see the following day with only 364 days left to go until expiration, the price of the call option is going to drop by $2 or $0.02 on a per share basis. And then from 363 days till expiration, it drops again by $0.03 and so on and so forth. So the decrease in the call option price here is simply due to time decay. That's because again, we're not changing any of these input values here, the stock price is staying the same, implied volatility is staying the same and the interest rate is not changing either. Saw all else being equal and just looking at the effect of time decay by itself, this is the result of that component of option pricing behavior. And so now if I zoom out a little bit here, come over, I have a graph that will actually show all the information that you just saw there. So this graph is just depicting that information in a visual way. You can see on the x-axis here, these are the days till expiration. So starting from 365 days all the way down to expiration day basically. And on the y axis here, this is the price of a particular call option with these varying amounts of days until expiration. And so clearly you can see with this blue line right here, the effect of time decay on this particular call option, right, with one day left to go, The Price is Right around 1300 bucks. But if that option stays out of the money, right, the stock is at 50 and the strike of this call option here is 55. Then as the days roll by this contract is going to be losing more and more value until eventually come expiration day. It's going to have no value. It's going to expire worthless, and just disappear. And so the most important thing I want to direct your attention to in this graph here is the acceleration of the devaluing of this contract as you get closer and closer to exploration, right, for the majority of the year that decrease the decay in the value of this option contract is pretty constant, right? It might be two or three or $4 per day. But as you get much closer expiration, you can see the curve starting to steepen and start to decrease at a faster and faster rate. And so if we were looking to sell this call option, we'd want to do so at a moment where time decay is accelerating faster and faster and faster every single day, right? The more quickly the value of that option decays, the sooner we can buy a bag for a cheaper price and take our profits and then look for another trade. And so now if you look at this graph more closely, you can see that right around 45 days or so coming up to the curve, this is right when the curve starts to steepen the most, right? Because prior to that, the time decays pretty constant, right? Two or three or $4 per day. But once it gets right around 45 days left until expiration, that time to care really starts to accelerate. And so if you've watched some of my other option trading courses, I've said many, many times that my sweet spot for selling option contracts, whether they be calls or puts, is right around 45 days until expiration. Now of course, it's not always possible to be sung opsins with exactly 45 days. So my general rule of thumb is I like to sell option contracts between 3060 days till expiration, right? Because even around 60 days left to go, you can still see right around this zone here, the curves still starts to slowly steepen at a faster and faster rate. And then of course, come around 30 days left to go until expiration. The curve is much, much steeper here than anywhere previous to it. So combining the approaches of selling options when implied volatility is significantly elevated over where it usually is. Plus selling those contracts when they are losing their value at a very significant rate. Combining those two things is going to be really advantageous as an option seller. Now of course, one thing you might be thinking here, looking at this graph is, you know, why am I only saying between 3060 days till expiration, you should be assigned as option contracts. Why not 15 days to expiration or seven days? Because clearly as you get closer and closer to expiration, the curve continues to steepen, meaning time decay is going to continue, accelerating faster and faster and faster. So wouldn't it be more advantageous to sell and option with only a few days left to go until expiration. Well, if you just look at time decay, then yes, that's certainly correct. However, the reason why I do not sell options with less than 30 days until expiration is because of a thing called gamma risk. And I'll talk much more about that in the next video. But gamma risk is the reason why I do not sell options with less than 30 days until expiration. And so instead, selling options with 30 to 60 days left to go will allow you to avoid that gamma risk, but still alighted capture the increasing acceleration of time decay. And just as a side note here, I know I'm only talking about a particular call option or call options in general here, but the put option graph would look exactly the same. And so as a result, everything I'm saying here, you can also apply to put options as well. Just for the sake of simplicity, I'm just gonna be focusing on call options for this video. Now one more thing you want to keep in mind, whoever is, how far out of the money are you going to be selling these option contracts? Because the further out of the money you sell a contract, the less valuable that contract is going to be selling for. And so for example, if I come over here to our input arguments again, let's say I'm still interested in selling the 55 strike call option. But now the stock prices only trading for $30 per share. So in this case, the strike here, 55 is very, very far away from where the stock is currently trading. So this would be an extremely far out of the money option that we could be selling. And so now if we come back over to the graph though, it has a very different shape. And you can see here that now as you get closer and close to expiration, that actually slows down in this case. And that's because if there's only a few weeks left to go till expiration, and if the stock is still only at 30 bucks per share, that call option with the strike of 35 is most likely going to be useless. Calm exploration. The chance that the stock is going to rally all the way from 32 and above 55 bucks per share and only a few days is very unlikely. And so as a result of that, the value of this call option is going to be very, very small, practically 0. And so obviously there's not really any more room for that option to decay in value. Option prices can't go below 0. You can't have a negative price for an option contract. So if it's already near 0, time to K has no choice but to slow down significantly. And so that's why in this case, only in this case when you are selling super far out of the money option contracts, which I actually don't even recommend you do. But if you wanted to, you'd want to sell option contracts with much more time baked in before they expire. So you can see down here if this option contract, if we sold this option contract with maybe 90 days left to go until expiration, the price of the option at that time would be about thirty-six cents or times a 136 bucks per contract. And so you can see with 90 plus days left to go until exploration, there is still significant room for the price of his options to decrease in value. And that's because even though super far out of the money options are most likely going to be useless by expiration. If given a lot of time, there is still a small chance that the stock could have a huge move. And by exploration, those options could be valuable. That's why the further out you go, the further away you get from exploration, the more valuable, even these super far out of the money contracts are going to be. Now again, I advise against selling options that are very, very far away from where the stock is currently trading. Because even if you go, let's say a 155 days out from expiration, the price of these contracts are only going to be worth $0.97 or multiplying by a $197 and total. Now that's not terrible in terms of the amount of premium you be collecting for a slang as contracts. But keep in mind that you will likely have to wait many, many weeks or months for the values option contracts and to decay enough in order for you to buy them back at a satisfactory discount to make a nice profit. And that's a long time to have risk on the table. Ideally, when you're selling option contracts, specifically naked contracts like a nick Call or naked put, there is a lot of risk inherent in that kind of strategy. And so that's why you want to put yourself in a situation where the value of those contracts can decrease as quickly as possible, thereby allowing you to take your profits as quickly as possible and remove risk off the table. And especially with these super far out of the money contracts, even if you sell them very, very far out from exploration, the longer you hold them, then the more slowly time decay is actually going to have an effect on those contracts, particularly when you get closer and closer to expiration. And so this is why I recommend you selling moderately out of the money option contracts. Because if we go back over here with our first example where the strike was F MD5 still, but the stock price was at 50 in this case. And then coming back over to our graph here, if we sell this kind of call option with only 43 days left to go until exploration. You can see that we can sell this contract not for just a measly few pennies, but we can sell this 14, $337. And with time decay accelerating faster and faster and faster as you continue to hold deposition, it's very likely that within a pretty short period of time, maybe a few days or a couple of weeks, so that you could be completely out of that position for a nice insignificant profit. And so another rule of thumb that I have when it comes to selling options is tell me figure out the right strike or how far out of the money I should go when selling an option, I will one always makes sure that I'm selling a contract with at least 30 to 60 days left to go until exploration. And then two, I collect at least two or 3% of the value of the underlying asset. So in the case of our example here, the value of the stock, the underlying asset was 50 bucks. That's the current treaty and price in our scenario here. So planter calculator here, 2% of 50 bucks, I would just take 50 and multiply it by 0.02. That would be $1 per share. So times a 100, maybe $100. So at minimum, at the very least, I want to collect at least a 100 bucks when I sell and out of the money option. So that's why selling a super far out of the money contract with only 45 days left to go, is not going to be trading for over a 100 bucks, is going to be training for maybe $20 or $10. And that's definitely going to be worth the risk of selling a naked call or naked put with this setup with 43 days up to go, like you just saw, we could sell this contract for over 330 bucks. So that's well beyond the minimum amount that I personally would require to sell this contract. And so this would mean that I could also a little bit further out of the money if I want to reduce my risk a little bit. So instead of selling the 55 strike call option, maybe I could go out to the 58 strike call option and then come back to the graph over here, go to for three days and the price of this contract would be right around $230. So obviously a lot less, about a 100 bucks less, but still well beyond the minimum amount that I would require for selling this contract. So that's just my general rule of thumb. And you can definitely use it to help you figure out the right strikes if you want to be selling options. And then lastly here, just to prove my point of why you want to be selling out of the money contracts as opposed to in money contracts. Let me reset the strike back to the original 55. Let's say instead the stock price being 50 bucks per share. Let's say it's 65 bucks per share. So the option I'd be selling here in this case would be a full $10 in the money. And then coming over to the graph, you can see the curve here is almost a straight line. It does still accelerate a little bit when you get closer to expiration. But for the most part it's much more flat and straight than selling an out of the money contract. And so in these cases, even though you'd be collecting a lot more money for selling in the money option, right? If you go to 43 days left to go, the price of the option at this time would be one hundred, two hundred and thirty seven dollars or so. So definitely a lot more and credit. But you can see the time decay is pretty marginal here. There's no real big acceleration of time decay. And so that's why selling in the money contracts is not nearly as advantageous as selling out of the money contracts. So coming back to our powerpoint here, and just to wrap things up, the last few rules for selling option contracts. So for super far out of the money options, which is what I do not recommend. But in case you want to consider it for some reason, I would definitely choose explorations beyond 60 to 90 days out. And that's going to depend obviously on how far out of the money you're going. But just keep in mind my 2% general rule of thumb where I like to collect at least 2% of the value of the underlying asset. So depending on how far out of the money you wanna go, might have to go 60 days out from expiration or 90 days, 150 days. You just wanna make sure you're collecting enough credit to actually justify the risk or taking. But again, I would not recommend this approach. And so that brings me to my final point here. So for moderately out of the money options, which is what I recommend you be selling, then choose expressions between 3060 days, because within this range, within this time interval, the time decay is going to really start to accelerate very significantly. And like I said earlier, when you combine that plus D contraction of implied volatility, right? Because again, you want to be selling options also went implied volatility has a spike. Those two things together are going to really help you to get out of your trades very quickly, hopefully for a profit. And so with that being said, that concludes this video here. And in the next video, like I mentioned earlier, we'll be talking about gamma risk, which is the reason why I do not sell options with less than 30 days left to go until expiration. Even though time decay continues to accelerate after 30 days left to go until expiration, the Gemara risk that starts to reveal itself beyond 30 days is the reason why 30 days is my cutoff point. So thanks for watching and I'll see you in the next one. 4. Gamma Risk: All right, welcome back to the next video in this course. And so now we'll be talking about gamma risk, which as I said in the previous video, is the reason why I do not sell options with less than 30 days left to go until expiration. And so I'll be covering cameras just on a conceptual level in this video. It can definitely be a very technical concept and perhaps I'll save that for a later course in the future. But conceptually speaking, cameras just has to do with the fact that option prices become significantly more sensitive as expiration approaches. And specifically this option price sensitivity is tied to the underlying asset price movement. So going back to the example that we've been using throughout this course, namely looking at options on Apple stock. Apple stock would be the underlying asset, right? And so all this means is that as the expiration date for a particular set of options, both the calls and puts, as that expiration date gets closer and closer and closer, the price movement of Apple stock will have a greater and greater effect on the prices of all those options. So if we initially sell a call option on Apple with maybe 60 days left to go until expiration, which is a decent amount of time. It $1 price movement in Apple stock might only affect the price of that option by ten or $20. Not a very large amount, but now fast forward into the future when the expiration date is only one week away, a $1 movement in the price of Apple stock might move the price of those options by 5060 or $70, right? It's going to be a much greater amount. And so because of this increased option price sensitivity or because of this gamma risk, this is going to be extremely dangerous for short naked option positions. So like if you sold just a naked call option or a naked put option on Apple, gamma risk is a very dangerous thing for those kinds of positions. And it's because when you are selling Naked Options, you have undefined risk. There is no way of knowing up front when you sell us options how much money you could lose. And so if you hold those kinds of positions too close to the expiration date, a large move in the stock price against your position could totally blow you out. But instead, if expiration was two months away, even if the stock had a very large move against you. Of course, that's going to hurt, you're going to lose money with that kind of a move. But the magnitude of those losses is not going to be nearly as intense as if expiration was only one week away. And yes, technically gamma risk can also work for you in some cases, right? Because for example, if you sold a naked call option on Apple with only one week left to go until expiration. And Apple stock had a big move in your favor, basically moving down by significant amount. And that case gamma risk would work for you because that big move in the stock price would have a huge move and the price of the option, specifically, it would reduce the price of the option significantly and very quickly, allowing you to take that position, offer a prophet. But because of the fact that cameras can also work against you and can be the cause of huge significant losses. In my opinion, that is reason enough to ignore the fact that yes, sometimes it can work for you and that we should simply be trading to avoid gamma risk entirely. And so this increased option price sensitivity as expiration approaches really only becomes problematic once you hit right around 21 days or three weeks out from exploration. Just like you saw in the previous video with time to once, Once you get about 45 days left to go. The case starts to really accelerate and gets faster and faster and faster with each passing day. Gamma risk works in the exact same way. The only difference is that it starts to really accelerate right around 21 days left to go. Now if gamma risk only becomes an issue once you hit three weeks away from expiration, why do I stop selling options at 30 days left to go? And the reason for that is because when I do sell options, I need to give that position time for the price of the option to decay in value, both from implied volatility contracting and also fun just the natural process of time decay. And most of the time the prices of options are not going to decay enough to make for satisfactory profits in only one day or two days? Yes, it's certainly can't happen, but that's definitely the exception and not the norm. And so if I sell an option with 30 days left to go until expiration, that gives me nine-fold days until I hit that 21-day mark, the point at which gamma risk starts to become an issue. And so within that nine days, within the interval of time, I am hoping that implied volatility does contract, and also nine-fold days of time decay with those two things combined, I'm hoping that that is enough to reduce the price of the options I have sold, enough for me to remove that position at the 21-day mark for a nice profit. Now, of course, not every position I have is profitable at the 21-day mark. And so what I will do for those positions, and again, this really only matters for short naked option positions. So if you'd just have a naked put, a naked call or a strangle, meaning selling both a call and a put at the same time, right? If you have undefined risk than the 21-day mark, is a point where you want to take some action to avoid the gamma risk that's gonna start presenting itself. And it's like I was saying, if I do have short naked positions that are not profitable at the 21-day mark, then what I will do is I will roll those positions out in time to the next exploration cycle. And so what that means is, let's say I sold a naked call option on Apple with 45 days left to go, and the option expires in the December monthly expiration cycle. And so as I hold on to that position, once I hit that 21-day mark, if that position is still not profitable, I'll buy the option back for whatever price is trading for. And then I will sell the same call option with the same strike, but in the January expiration cycle, and that would give me a full extra month of time baked into that option, allowing me to extend my duration in the trade and giving it a greater chance to become profitable. And then also at the same time avoiding gamma risk. And this leads me to my next point as to why I stopped selling options with only 30 days left to go. And so the second reason is once you hit that 30 day mark in the current monthly expiration cycle the following month, we'll likely be right around that 60 day Mark Ryan, if you recall from the previous video, I saw options between the window of 30 days and 60 days until exploration. So if for some time I'm selling options in the December expiration cycle. Once December exploration comes within 30 days of today, the January expiration cycle will likely be right around 60 days out from today. And so I can naturally just shift over to the new expiration cycle and start selling options in the January expiration. And so then as I start selling options in the January cycle for the remaining December positions that I have. Once those positions hit the 21-day mark from the December exploration, I will roll those out to the January. And so once I've done that, all of my positions, both the new ones and the old ones, will now be all within the January expiration cycle. And that process will just naturally continue forward. Once I hit the 30 day mark of the January expiration, I'll stop selling January options and start selling February options because those will likely be right around the 60 day mark. And then once my existing January positions hit the 21-day mark, and gamma risk starts to become an issue. I'll roll those out to February and then boom, all my positions will now be within the February cycle. And so if you're always selling options within this process, you will always be selling options between 3060 days out from exploration. And you will always be avoiding gamma risk because you will never have a short naked position on with less than 21 days left until expiration, right? Because once that happens, you're either going to take that position off for a profit. If it is profitable or if it's not, you're going to roll it out to the next exploration cycle and give yourself much more time. And the cool thing is, if you are selling options on a consistent basis within this process, you will see that if you take the average, the average days to expiration of all the options you have sold, right? Because sometimes you'll be selling options with 58 days left to go until expiration. Sometimes there'll be selling options with 43 days up to go. Sometimes there'll be sun than with 32 days up to go. If you take the average of the dazed exploration of all the options that you sold, you'll find that the average is right around 45 days, which as I showed you in the previous video, is pretty much the perfect time to start selling options. And so with that said, I believe that covers it for this video. And in the next video coming up, we'll be talking about when you can be buying options. And once again, we'll be using theta and Vega to tell us when we could be doing that. So thanks for watching, and I'll see in the next one. 5. When to Buy Options: Alright, thanks for joining me again here. And in this video we'll be talking about when you can be buying options. And this is mostly for the purpose of just staying engaged in the market, right? Because ideally you want to be selling options as much as possible. And I mentioned earlier in this course at the reason for that is because the edge and option trading always leans in favor of the option seller. And again, that has to do with things like when implied volatility is high, it'll most likely contract thereafter. Time decay is always working for you and there's other things as well like implied volatility is usually overstated compared to what actually happens in the market. Basically mean that the market's expectation of where the stock is going to move in a year or in a month, whatever the timeframe may be. Expectation is usually overblown compared to what actually plays out over that time. So like I said, options selling is where you want to be the majority of the time. But there are times where the general implied volatility across the market is very low and it's hard to find opportunities to actually be selling those options. And so in those periods of general low volatility across the market, then like I said, buying options is just a nice way to stay engaged and keep trading as often as you can. So moving over to the next slide, just like what you saw with selling options, that I have some rules for option buying. The first of which is you want to be buying moderately out of the money or moderately in the money options, right? Again, OTM stands for out of the money. Itm stands for in the money. And I'll be going back to the spreadsheet to show you more examples of how this will work. Some moderately out of the money or moderately in the money options are the ones you want to be buying. And then secondly here, and very importantly, the implied volatility for the underlying asset must be lower than usual. And the reason for this is very similar to the options selling rules, right? Because implied volatility is mean reverting, so on. It's much higher than usual. It will likely contract back down to the average. And when it's much lower than usual, it will likely expand and increase back up to the average. And as an option buyer, right? If you are buying these contracts to get into a position, in this case, you want the price of those options to increase. You buy a low price and you sell at a higher price and make the differences profit. So this is why you implied volatility to be lower than usual. Because if you do get that expansion in implied volatility, right? As implied volatility expands, it's going to increase the prices of all the options. And that can happen without the stock even moving. And it can also happen in a very short period of time. So time decay wouldn't really have an effect on the prices of those options either simply by the expansion in implied volatility, that alone could allow you to sell those options at a much higher price and then book a nice profit. But now once again, what explorations cycles should we be choosing when buying these options? Should we be buying options with only a week clips ago or maybe a few months, a year. Is it going to be the same thing as what you saw with selling options, right? Well, to answer that question, we're going to come over to my spreadsheet and we'll take a look. Let me hop out here. And so we're going to have a very similar setup here. The stock price is going to be at 50 bucks. We're considering buying now the 55 strike call option interest rates are still at 1%. The major difference here is that implied volatility is much lower, right? When you saw in the selling options video, the implied volatility in that video was 75%, right? Because in that example, and we'll use the same thing here. Let's say the average implied volatility for this stock over the past ten years was right around 30%. So a spike to 75 would be advantageous for selling options. Dropped down to 15 would be advantageous for buying options. And so now if I scroll over, we can take a look at the graph and see what's going on here. Alright, so now you can see in a low implied volatility environment and going a moderately out of the money. You can see from most of the year, there is a rather constant decay in the price of that call option as a result of time decay. But as you get closer and closer exploration, the time decay really slows down. But you might notice with implied volatility being so low, which is going to really depress the prices of options. And with not much time baked in left until expiration. The prices of these options around this time, maybe one or two months out from exploration. The prices of these options are very, very low, right? For example, if we go to 64 days out in time, go to the curb. The price of this option is only $0.10. So times a 100 shares would be ten bucks for one full contract. So when it does come to buying options that are out of the money, this kind of trade is much more like playing the lottery, right? Because you're buying some super cheap options that are most likely going to be absolutely worthless come exploration. But if you buy them with not too much time baked in and until expiration, there's not gonna be that much time decay that will take effect. So that will certainly help. But again, the chance that the stock is going to have a big enough move by expiration to make these options actually worth something significant is pretty unlikely. However, if that does happen, if there is a big move and you are correct, right? This doc has a huge rally in the last few weeks, near expiration, the prices of his options could go from a measly $10 per contract to well over one hundred two hundred three hundred the sky's the limit. So you can imagine if you bought ten of these call options for ten bucks apiece, that'll be $100 in total of capital that you would have tied up for that position. And you're basically playing and hoping for that big significant move in your favor. Moreover, if you do good, they move and implied volatility expands. Both of those things could really increase the prices of these options. And you could see returns of hundreds or even thousands of percent. And of course, I'm sure that does sound quite enticing. But again, keep in mind, this is mostly like playing the lottery because this kinda thing happens very, very rarely. And so again, this is why I reiterate that buying options is mostly an engagement tool just to help you stay active in the market. That being said, however, if you do wanna buy options, but you wanna give yourself a much higher chance of making a profit. You're not really interested in playing the lottery game. I totally get that. Then in that case, you might wanna be looking at buying moderately in the money option contracts. If we go back to our inputs here, if we're still interested in buying the 55 strike call option. But now the stock is at 60 bucks per share, right? So the call option we'd be buying would be $5 in the money. Coming back to our graph here now, we can see that the time to K is pretty much constant all the way. And also the time decay is pretty insignificant as well. It does also drop off a bit and decrease as you get closer and close to expiration. But really for the majority of this time here. Whole year, that time decay stays relatively constant. And so if you are buying in the money option contracts, these contracts are going to behave a lot just like stock in terms of how their pricing fluctuates as the stock price fluctuates, right? So for example, if you bought this call option and the stock price move by $1, the price of this option might move by 80 or $0.90, almost that same full $1. And of course that's on a per share basis, right? But the point here at the bottom line is in the money call options and put options to their prices, follow the change in the stock price a lot more closely. And so because of that, buying in the money option contracts is a great way to get a stock like investment, but to significantly reduce the capital needed to put on this position, right? Because think about it. If you were to buy 100 shares of a stock that's trading at 55 bucks per share, that would cost you $5,500. But instead, you could buy one call option with the strike of 50 or less, right? The further you go, the more like stop these options are going to behave. But let's say you bought this 50 strike call option with a 180 days or so left to go until expiration. The price of this call option would be almost $600. And this option contract is tied to 100 shares of stock. So you could either go out and buy 100 shares of the actual stock for $5,500. Or you could buy one call option, which is still tied to 100 shares of stock and only pay about $600. So like I said, this is a very stock like investment, but the capital requirements are going to be significantly less. Now that being said, whether you're buying in the money options or out of the money options, timed to k is always going to be working against you. So ideally if you can be binary options when time decay is slowing down, in my opinion, that's going to be the best time to be buying us options. So you can see in the case of this graph, right around this 60 to 90 day marker. So this is when the time decay starts to slow down. And then as you recall on the other graph, I'll go back to it here. So I'll change the stock price back to 50 and leave the strike price at 55. Still. Coming back over to the graph. And same thing here you can see right around this 60-day markers. So the time decay starts to slow down. Now of course, you could buy these options when there's only maybe 30 days up to go. And the time decay curve is almost flat. But the prices of these options is literally going to be like one or $2 per contract. So this would definitely be a lottery type of a trade, right? Because you could buy a 100 contracts for one or two bucks. A contract, they'll most likely end up worthless exploration. So you'll most likely lose full 100 or $200. Not a huge deal. It's not a huge amount of capital. But of course, if you do get that huge move in your favor, and perhaps implied volatility expands. And now if you're buying options with less than three weeks left to go, gamma risk is going to start becoming a factor which can work for you. So yes, on some very rare occasions, you could get all three of those things working for you in your favor and you could have a very significant payout. So either way, whether you are trying to play the lottery, so to speak, or you're trying to stay engaged in the markets and, and perhaps also reduce the capital requirements needed on some of your trades. Then I would say sticking between 6090 days until expiration is right around where you want to be. I don't think that really is a quote, unquote, perfect number when it comes to buying options, because these simply are much lower probability of success trades. And they're mostly meant simply as an engagement tool when implied volatility is low across the market. But of course, if you can't want to go very, very far out in time, if you have some more long-term assumptions about what a particular stock or what the market might do. You can do that as well. Bottom line, I would say though, just keep in mind that the longer you go out in time and the longer you hold that position, more time decay has to work against you. And yes, when you do go far and time time decay is going to be pretty constant and not that significant. But like I said, if you hold that kind of contract for many, many months, then even a little bit of time decay every single day can really add up. And before you know it, the call option, you paid $1000 for my only be worth $300 or even less. And lastly here before coming back to our PowerPoint slide, I do just want to show you why I like to stay away from buying at the money options. Meaning if the strike price is at 55 and the stock price is at 55, this would be an at the money call option that we'd be interested in buying. Coming back to our graph here, you can see there's a significant drop-off in the value of the option as a result of time decay. So in this case, if you were to buy those call option with a 60 or 90 days left to go, the time decay is going to be accelerating extremely quickly all the way until expiration day, right? And so this is the exact kind of thing that you want to avoid. So this is why going a bit further out of the money or going in the money is going to be a much better setup if you want to be buying options. So now coming back to our PowerPoint again and finishing this up. So the last rule I have here is for both moderately out of the money and in the money option contracts, both calls and puts. My recommendation would be to choose explorations between 6090 days. And again, I'm going to reiterate, it's important to be doing this when implied volatility is low, right? And that's because of implied volatility was high and you're buying an out-of-the-money call option, time decay is going to be actually accelerating within that 60 to 90 day window as opposed to decelerating, right? I'll actually come back to the PowerPoint here again, coming back over here. So let's go back to our inputs and change the stock price back to 50. So stock prices at 50, look into by the 45 strike call. And then coming back to our graph over here, you can see time decays actually slowing down right around that 60 day mark. But now if I were to increase implied volatility back to seventy-five percent. So from five, I'll tell you is high. Coming back to our graph here again. Now the graph is totally different. Time McKay's actually accelerating at the 60 day mark, not decelerating. So I know this can definitely get a bit complex, but if there's one thing to take away from this entire course, it would be that when you want to sell options, implied volatility must be high. And you want to be selling moderately out of the money. Options either calls or puts. That's it. When it comes to buying options, you want implied volatility to be low. And you can be buying either moderately out of the money call options or modally in the money call options. That's it. And then simply has to do with the way that time decay is affecting the prices of those options based on the implied volatility level for that underlying stock. So with that being said, that concludes this video and I'll see you in the final video coming up next. Just erupt, sum things up and then send you on your way. So see in the next one. 6. Wrapping Up: All right, so at this point you've finished the course. Congratulations, and I hope that by now you have a good understanding of the basic principles when it comes to selling options. Buying options in which exploration cycles you should be choosing when trading them and help get you started with some practice. You can take a look at the course project down below. And so with that being said, thank you so much for watching this course. I am Scott Reese again, and I do appreciate any and all feedback that you may have. And moreover, if you've got questions or unique clarification on something, please do post a comment in the discussion section of this course and I'll get back to you as soon as I can. And I also encourage you to check out the other courses I haven't skill share. I've got a lot of content already published and other options trading concepts, as well as a lot of stock market investing courses. And I even have a few classes on computer science related topics as well. And lastly, please do also follow me on skill share so that you'll get notified every time I publish new course. So thanks again for watching and happy trading.