Thread by @MrJGBanks

📚Options Basics: A Quick Rundown on Option Contracts (Thread) @unusual_whales

There are two types of options, a call option and a put option. Understanding what each of these is and how they work will help you determine when and how to use them.

The buyer of an option pays a premium to the seller of an option for the right, not the obligation, to take delivery of the underlying futures contract (exercise). This financial value is treated as an asset, although eroding, to the option buyer and a liability to the seller.

For simplification:

● Call options allow the holder to buy the asset at a stated price within a specific timeframe.
● Put options allow the holder to sell the asset at a stated price within a specific timeframe.

Option contracts are composed of two key aspects: a key "Strike price" and an "Expiration date."

1. Strike Price: The price at which the buyer of a call option has the right to purchase the futures contract, or the buyer of a put option has the right to sell a futures contract.

This is also referred to as the exercise price. 👆

2. Expiration date: each option contract will have a specific expiration date by which the holder must exercise their option.
Let's talk about pricing or valuation of an option contract. Don't worry we break them down for you.

Option Price=Intrinsic Value+Extrinsic Value
The intrinsic value of an option is the amount that
the market price is higher than the strike price for a
call and lower than the strike for a put.

Tell it to me simple... 👇

In other words, the intrinsic value is the amount of money that the option would be worth if it expired today. For the option to have intrinsic value, the option must be in-the-money.

Now... You may be wondering- what does in-the-money mean?

● In-the-money—The futures price is above the strike price.
● At-the-money—The futures price is at the strike price.
● Out-of-the-money—The futures price is below the strike price.

The intrinsic value of an option can easily be calculated, but the extrinsic value of an option is impossible to estimate at any given time in the future other than expiration. This is because the extrinsic value is made of a combination of time, volatility, and demand.

To learn about intrinsic value, let's assume we own the following contract: 4/26 130 calls.

So, in this case our Strike Price will be $130, as indicated by the blue doted line on that chart. As we already know, this would imply we have option (but not the obligation) to buy XXXX shares at $130 a pop up until our expiration date.

The next line we can see is that green dotted line on the chart. This indicates what XXXX is currently trading at. In order to calculate our intrinsic value, we would utilize the following formula:

Intrinsic Value = (Current Market Price - Strike Price) x 100. The x 100 is because each option contract is composed of 100 shares.

Therefore, the intrinsic value of our XXXX contract is ($134.50-$130) x 100 = $450

Now, let's look at the other part of the equation, extrinsic value.

Extrinsic value is based on a combination of the strike price, time, volatility, and demand. We like to think of extrinsic value as the “icing on the cake.”

It is impossible to estimate extrinsic value. Beginning traders often ask questions such as, “If I buy a call and the market goes up x number of points, what will it be worth?” Unfortunately, the answer depends on factors that can’t necessarily be measured quantitatively

The extrinsic value of an option is based on a combination of the following factors:

● Time
The longer the amount of time until an option’s expiration, the greater the time value of a particular option will be.

● Volatility
If the price of the underlying futures contract is fluctuating considerably, there is both a greater profit and a greater loss potential.

● Demand
If the number of traders willing to buy an option at a given price is greater than the number of traders willing to sell the same option, the value of that option appreciates.

Now, let's finish off with our last topic: Option Greeks
Option Greeks are used to measure the risk of an option and to gauge an option’s sensitivity to the variables that make up that risk — The variables are represented by the Greek letters Delta, Gamma, Theta, Vega, and Rho.

Basically, option greeks are just a mathematical aggregation of those big three things we learned above- Time, Volatility, and Demand.

Quick Rundown on Option Greeks:

Greeks dictate the value of expected change in an option.

Delta: Represents the expected change in the option value for each $ 1 change in the price of the underlying stock.

Gamma: Represents the expected change in delta for each $1 change in the price of the stock.

Theta: Represents the option’s expected daily decline due to time.

Vega: Represents the expected change in the option value due to changes in volatility expectations for the underlying stock.

Thank you @unusual_whales for all that you do! I hope all of you new to options learned a lot and the veterans had a good refresh.

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