Options Trading For Beginners (Complete 4 Hour Course)

Before we get into option trading strategies and all the technicals, let's talk about the basic definition of options and why they even exist in the first place. So, what is an option? An option is a contract that you can purchase that gives you the right to buy or sell stock at an agreed price on or before a particular date. Now, you can also sell an option contract where you would be selling this right to someone and collecting a premium for it. Okay, I'm sure that sounded very confusing, especially if this is new to you, but just bear with me as we get through a few more definitions. Once we get through these definitions, we'll be able to show you some examples and it will all start to make sense. But go ahead and take notes and write down these definitions so you can refer back to them during the rest of this course if you need to. Okay, there are two types of options, calls and puts. A call option gives the option holder the right but not the obligation to buy shares of stock at an agreed upon price on or before a particular date. And a put option is the same thing except it gives the option holder the right to sell shares of stock at an agreed upon price on or before a particular date. And the agreed upon price is what we refer to as the strike price. and the particular date is what we refer to as the options expiration date. Now, we got those out of the way, but in layman's terms, let's say you bought a call option. So, you are the option holder and the strike price of this call option is 120 and it expires in 30 days. Owning this call option will allow you to purchase the stock at 120 any time during the next 30 days, no matter where the stock goes. So, if the stock goes up to 135 within the next 30 days, then fortunately for you, you own a call option that allows you to buy stock at 120, even though the stock is currently trading at 135. Now, instead of a call, let's say you bought a put option with a strike price of 120 that expires in 30 days. This will allow you to sell the stock at 120 any time during the next 30 days, no matter where the stock goes. This is cool because what if the stock tanks down to $100 per share? Well, you own a put option that gives you the right to sell stock at 120 even though the current market value is 100. So, you have a much better sale price than if you were to just sell stock at the current market value. Okay, simple enough. But why might someone actually want to purchase an option? First, we're going to explain to you why you might want to buy a put option, which if you remember, would give you the right to sell stock at a certain price on or before a particular date. And let's put this in terms anyone can understand. Let's say you just bought your dream car. You just bought a new Ferrari. And to protect this Ferrari, you're going to need insurance. So, you go to Flo from Progressive and you purchase insurance. This financially protects your new Ferrari in case you get into a crash. And this is the exact same concept as options. Now, instead of a car enthusiast, let's say you are an investor and you just bought 100 shares of XYZ stock at $125 per share. So, the total cost of this investment is $12,500. We all know that stock prices fluctuate and stocks can even go to zero if something catastrophic happens. So your total risk on this investment is technically $12,500. Now just like we purchased insurance on the Ferrari, we can also purchase insurance on this investment. We would do this by purchasing an option contract. Specifically in this example, we would purchase what is called a put option. By definition, buying a put option gives us the right but not the obligation to sell stock at an agreed upon price on or before a particular date. Now, let's recap. You own stock and you want to buy insurance on that stock investment. So, you buy a put option. Simple enough, right? Now, if you bought an option, someone had to have sold it to you. But who? The answer is any other trader who is willing to be paid to take on your risk just like an insurance provider. That's the basic idea of options. An investor has risk, but he's willing to pay someone to take away his risk. And the person who gets paid now assumes that investor's risk. Now, let's look at a real example. You bought $12,500 worth of XYZ stock and you also purchased a put option as insurance. The price of this insurance is going to be determined by several factors and you're going to learn about these factors in chapter 3. For now, let's just say you had to pay $500 for this put option. And this gives you full coverage insurance for the next 30 days. Now, let's look at two different scenarios. In the first scenario, after you buy the stock and the put option, the stock price goes from $125 per share up to $132 per share. So, you made $7 per share on 100 shares of stock. That totals to a profit of $700 on the stock that you own. But remember, you also paid $500 for an option contract that now has no value to you. So, your net profit is only $200. At this point, you're probably saying, "What a ripoff. " And the person who sold you the option is saying, "Thanks for the easy money. " Because they got to keep the $500 that you paid them. But let's look at another scenario. Now, in this scenario, rather than the stock price going up, let's say the stock price goes down to $113 per share. So, the stock's share price is now $12 cheaper than where you initially bought it. And since you own 100 shares, that means you've lost $1,200. But thankfully, you bought a put option as insurance. Now, you go to the person who sold you the option and say, "Hey, remember our contract? " Now, even though the stock is at 113, you are able to exercise your option to sell your shares at 125 per share. So, you lost nothing on the stock. Your only loss in this scenario is the $500 you paid for the put option. Much better than the $1,200 that you would have lost if you did not purchase this option contract. Now, remember, the person who sold you the option had an agreement with you. They were obligated to purchase your shares from you at $125 per share. So, they got to keep the $500 that you paid them for the put option, but they are now sitting on a $1,200 loss on the stock that they own. Now, they can hold the stock and hope it goes back up, or they can sell it at the current market price of 113 for a total net loss of $700. So, that's all options are, guys. They're simply insurance for an investor. That's why they even exist in the first place. Now, you may or may not have already been introduced to options before you purchased this course. If you were introduced to them, it's likely that they were not introduced to you in this way. They probably weren't explained to you as insurance. So, a few thoughts may be running through your head at this point. You might be saying, "But I don't want to buy insurance on my stock portfolio. " Or maybe you don't even own any stocks and you're hoping to just learn option strategies that you can trade with very little capital without ever even touching the stock. And you can, that's the cool thing about options. You don't have to own stock to trade them. You can actually just trade the fluctuating option prices with your brokerage account just like you can trade stock. But we just had to lay the framework because understanding how options relate to insurance is crucial for you to understand how options are priced, which we're going to cover in chapter 3. Okay, you get it by now. Buying a put option is like buying insurance on a stock investment. And selling a put option is like selling insurance on a stock investment. But let's look at another reason one might want to buy an option. And this time we're going to explain to you why you might want to buy a call option. This time, let's say you don't own any shares of stock yet, but you have your eye on a stock that you really like. There's just one problem. That stock is expensive. So if you were to buy shares, it would require a lot of capital. What you could do instead is you could buy a call option. This would allow you to pay a small premium for the right to buy shares at a later date if perhaps you are correct about the stock and the price goes higher. So let's look at a real example. Stock XYZ is currently trading at $125 per share. To buy 100 shares of the stock, it would cost us $12,500. So, instead of putting up $12,500 to buy the stock, let's instead buy the 125 strike call option that has 30 days until it expires. This gives us the right to purchase 100 shares of stock at 125 per share any time during the next 30 days. Now again, the price we have to pay for this call option will be determined by several factors that you're going to learn about soon. But for now, let's just say we had to pay $500 for this call option. Let's look at two scenarios. In the first scenario, after you buy the call option, the stock goes from 125 up to let's say 137. Now you own the 125 strike call option. What you could do now at this point is exercise your call option. Exercising your option just simply means that you have decided to take advantage of your right to buy stock at a lower price. So in this case, you exercise your 125 strike call option. So you now own 100 shares of stock at 125. You are up 12 points on this stock. And since you own 100 shares of stock, this means you're up $1,200. But remember, you paid $500 for the call option. So, your net profit is really only $700. Now, you might be thinking, well, if I would have just bought the stock to begin with, I would have made more money. Yes, this is true. But let's quickly look at one more scenario. In this scenario, the stock goes down. It moves down to, let's say, $100 per share. Now, remember, you own the 125 strike call option that you bought for $500. And this call option gives you the right to buy stock at 125 per share. But why on earth would anyone want to purchase stock at 125 if the stock is currently at 100? The answer is you wouldn't. And thankfully you don't have to. Let's think back to the definition of a call option. It gives you the right but not the obligation to buy stock. So owning this call option doesn't require you to buy stock if you don't want to. And of course, you aren't going to exercise your right to buy stock at 125 if the current market price is cheaper than that. So in this case, you simply lost the premium you paid for the option, which was $500. If you would have bought stock at 125 instead, you would currently be down $2500. So that's the benefit of buying an option rather than just buying the stock. You can put up much less capital and therefore have much less risk. But in exchange for that, you will have to pay a premium for it. And by the way, you can also trade put options in this way as well. If you buy a put option without already owning shares of stock, then you are simply betting that the stock will go down. Because if you exercise your right to sell stock that you don't own, then you will just end up with a short stock position. So again, if you buy a call, you are betting that the stock is going to go up. And if you buy a put, you are betting that the stock is going to go down. Now, before you go out and start buying calls on every stock you think is going to go up and puts down, keep watching because there are big negatives to buying options like this. And of course, we are going to show you much better ways to trade options. One last note before moving on. You don't actually have to exercise your option contracts when you trade them like we showed you in the examples. You can simply buy an option and then sell the option hopefully at a higher price than you bought it for. And we're going to cover that more in the next two chapters. Hey guys, before we jump into the next chapter, if you're enjoying the course so far, please do us a quick favor and hit that like and subscribe button. It really helps us out. Plus, we've got a ton more content. I don't think you're going to want to miss. I also quick want to mention that if you're serious about automating and scaling your trading, we actually work with traders on a case-byase basis as well. There's a link in the description with more details if you want to check it out. Now, back to the video. Enjoy.

You've been introduced to the idea of options. You learned that you could buy a call if you think the stock might go up and you could buy a put if you think the stock might go down. But at this point, it's probably still a pretty abstract concept to grasp. Hang with us as we explain further. If you haven't already guessed, option contracts aren't actually physical pieces of paper. It's all done electronically. And you can buy or sell an option contract with your brokerage account within a few milliseconds at the click of your mouse, just like we can buy and sell stocks. What you are looking at is what we call an option chain. An option chain is simply just a list of all the options that we can trade. And it also shows the price of each of these options. You can find an option chain in your trading platform and also a few different places on the web such as Google Finance, Yahoo Finance, etc. But the one we are looking at right now is provided to us by the Thinker Swim platform by TDMatrade, which is the brokerage firm that we use to trade. Again, what you're looking at right now is an option chain. It shows you all of the available options and the prices of each one. All we have to do to see this information is type in the ticker symbol of the stock we want to see options on. And just a heads up, most of your favorite companies and even stocks you might already be trading have options. And to see if a stock has options, all you have to do is simply type in the ticker symbol. And if it does have options, you will see them listed below. And if it doesn't, it will say this instrument has no options. So, let's just look at Apple stock options by typing in the ticker symbol A APL. You can see there are many option contracts that we can trade. And there's actually so many that it might seem overwhelming at first glance. But don't get intimidated. We're going to explain this in the simplest way possible. Now, before we get into why these option prices are what they are, we're going to go over some very basic characteristics of options and also show you how to even read this option chain. First, we have to select our expiration. The expiration date, if you remember, is simply the date that the option contract will expire. So you can see there is a list of all of the available expirations and what you are looking at is the actual date that they expire and the number in the parenthesis simply tells us how many days are left until that expiration date. So clicking on this expiration cycle for example would show you all the options that expire on the 18th of November 2016. And the number in the parenthesis shows us that date is 36 days from now. And remember, we are still covering the very basics. So, we're not yet going to go over which expiration you should be trading in. There are pros and cons to choosing certain expiration dates. And again, and I know I keep saying this, you're going to learn about this later in the course. Right now, it's just important for you to get the basics down. So, we're just going to choose the expiration date with 36 days to expiration. Once you click on the expiration date, you can see a whole list of options for that expiration. On the left side, you will see the call options that expire on this date. And on the right side, you will see the put options that expire on this date. For now, let's say we want to trade a call option that has 36 days expiration. Now, we just have to choose our strike price. The strike prices of each option are listed vertically through the center of your screen. And just a side note, I don't know who decided how an option chain should be laid out, but for some reason they decided to list the strike prices in ascending order. And you know, I would think it would be the opposite where the higher strikes are higher on your screen. But you know, it is what it is and this is just something that you get used to. Now, just like with selecting an expiration, we also have to choose our strike price of the option we want to trade. And again, we aren't going to get into which strike you should be trading until later, but for now, let's just choose the 120 strike call option. Okay, so that's it. We know how to navigate the option chain to find a certain option. You can find a call option or put option with a certain expiration date and a certain strike price. But you can also see the price of each of these options. Just like stocks, options also have what is called a bid price and an ask price. And we're going to assume that you already know what the bid and ask price is. If you want to buy an asset, you're going to have to buy it at the ask price because that's where the sellers are. And if you want to sell an asset, you're going to have to sell it at the bid price because that's where the market is willing to buy it from you. Simple enough. Now, let's take this option off to the side and we're going to talk about its pricing a little bit and what it would actually look like if you wanted to trade this option. Now, stocks trade in shares, but options trade in contracts and one option contract is going to control 100 shares of stock. Let me explain. Remember, a call option gives us the right to buy stock at its strike price at a later date. Okay, so if we wanted the right to buy 100 shares of stock at a later date, then we would have to purchase one option contract. But if we wanted the right to buy 200 shares of stock at a later date, then we would have to purchase two contracts. So that's what we mean when we say one contract controls 100 shares of stock. So let's just say we wanted to purchase one contract of this 120 strike call option. How much money would this actually cost us? Well, looking at this call option, you can see the bid price is 228 and the ask price is 233. So, to buy this option, we would have to pay the ask price of 233. But here's the thing to understand. It's actually going to cost us $233 per contract. This is because since one option contract represents 100 shares, option prices will have a multiplier of 100. Now, we know this may seem confusing and this is also just something that you get used to and with practice it will become second nature very quickly. One trick you can do is just think of these prices without the decimal place. If the price says 2. 33, just remove the decimal and it's really going to cost you $233. Now, remember, we mentioned that you don't actually have to trade stock and you can just simply trade the options. So, what do we mean by this? Well, just like stock prices fluctuate and move around each day, option prices also day. And in chapter three, you're going to learn about what causes option prices to fluctuate and why they might go up or down in price. But for this example, let's just say we bought one contract of this call option at 233. So we actually paid $233. And over the next week or so, let's say the options price goes from 233 up to three. Now, just like trading any asset, we constantly have to make decisions about when to sell. And we could, of course, hold this and hope it goes higher. But let's assume that we have decided to sell this option and take our profit. So, we close this position by selling the call option that we own at three. So, if we bought something for $233 and we sold it for $300, it's pretty clear that we made a profit of $67. Now, let's look at one more example for practice. Instead of buying one contract of this call option at 233, let's say we wanted to purchase two contracts. The concept is the exact same here. we're just purchasing twice as many contracts, right? Instead of buying one contract, we're buying two contracts. So, if one contract cost us $233, then to find our cost of two contracts, we would simply just multiply that by two. So, two contracts would cost us $466. So now if the price of the option goes up and we can sell both of our contracts at three, then that means we turn $466 into $600. So our profit would be $134. Now again, there are three factors that would cause an options price to move up or down, resulting in a profit or loss. The first factor that causes this, we've already vaguely touched on in chapter 1, and that factor is the movement of the underlying stock price. The price of a call option will typically go up in value if a stock's price goes up, and the price of a put option will go up if a stock's price goes down. So, to put it simply, if you buy a call option, you are betting that the underlying stock's price will go up. And if you buy a put option, you're betting that the underlying stock's price will go down. But remember, there are also two other factors that affect an options price, and they are extremely important. So, don't go buying options yet. You're going to learn about these in the next chapter. Now, before we move on, let's recap what you've learned in this chapter. You learned what an option chain is. This is simply what you'll look at to find all the listed options and the price quotes of each option. You can find an option chain in multiple places, but you're probably going to want to view options in your trading platform provided by your brokerage account. And again, our favorite is the thinker swimw platform, which is provided by TDMAT trade. You also learned that option prices have a bid and ask price just like stocks. One option contract controls 100 shares of stock. And because of this, option prices have a multiplier of 100. Okay guys, now in the next chapter, we're going to go in pretty deep and you're going to learn the three factors that cause an options price to fluctuate. This is where it gets cool because then you will have the base knowledge you need that will allow you to start learning strategies to profit from option price fluctuations. In chapter 1, we used the insurance analogy to explain options to you. And we're going to go back to that analogy

quite a bit in this chapter because thinking about options as insurance is the best way to understand the way they are priced. Now, of course, we've mentioned several times that you don't have to use them as insurance and you can actually just trade the option prices, but to understand the way they are priced, try to think of option prices as insurance for a stock investment. Now, there are three factors that will cause an options price to move around each day. Once you understand how these three factors affect option prices on a daily basis, we will be able to dive into different strategies we can use to take advantage and profit from option price movements. And you know that's where the fun starts. But we have to lay the groundwork first and focus on understanding these three factors. The three factors that an options price is determined by are number one the price of the underlying stock, number two time to expiration, and number three the volatility of the underlying stock. First, let's talk about how the underlying stock's price will affect the price of its options. Let's think back to the basic definition of a put option. Buying a put option gives you the right to sell stock at an agreed upon price on or before a particular date. And of course, the agreed upon price is determined by the strike price. Right now, you can see Twitter stock and its options that expire in 28 days. Let's say you own 100 shares of Twitter stock at $18 per share. You could buy the 18 strike put option and that would be like buying full coverage insurance, right? If for some crazy reason Twitter tanks, then your put option would allow you to sell your shares of stock at $18 per share right where you bought it, even though the current market price is much lower than that. And looking at the option pricing, you can see that it would cost around 159 for the 18 strike put option. And of course, multiply that by 100 and the cost of one contract of this 18 strike put option would be about $159. Now, if you were to buy the 16 strike put instead, you can see that it would cost you much less money. It would cost around $75 for one contract. The reason it's cheaper is because it would only ensure $16 per share worth of your investment rather than the full amount of 18 per share. Now, let's look at an entirely different example. Let's say you own the 120 strike call option on stock XYZ. You don't own any stock. you just own the call option and this call option would of course give you the right to buy shares of XYZ stock at 120. So what if the current stock price is at 125 per share? Well, and you own an option that gives you the right to buy stock at 120, then that option is going to be worth at least $5, right? Because if you exercise the option, you would have an immediate $5 per share profit. In this scenario, we would refer to this option as being in the money because it has value. It allows us to purchase the stock at a discount to the current market price. So again, this option is referred to as being in the money. Now, one more scenario. Again, let's say you own the 120 strike call option, but this time the stock is much lower than that. It's currently at 115. If you own an option that gives you the right to buy stock at 120, but the current stock price is below that at 115, assuming there's no time left expiration, how much is this option going to be worth in this case? Right? it's going to be worthless because who in their right mind would want to exercise their right to buy stock at 120 when they can just simply purchase it at its current market price of 115. In this scenario, we would refer to this option as being out of the money because the call option strike price is above the current stock price and therefore does not allow us to purchase the stock at a discount. Again, this is referred to as out of the money. Now, I know this seems like a lot to keep up with and a lot of information to digest all at once. And of course, we're going to recap all of this again at the end of the chapter for you to take notes on. The cool thing is if we look at an option chain, you can see that the in the money and out of the money options are highlighted. The in the money calls inputs have a bluish shaded background and the out of the money calls inputs have an empty or black background. So, just one more time, in the money calls are calls with a strike price that is less than the current stock price. And the out- of-the- money calls are calls with a strike price that is greater than the current stock price. And for puts, it's the exact opposite. Now, this is where it will start to come together. You'll notice that the further in the money an option is, the more expensive it is. This is because if an option allows you to purchase the stock at a bigger discount, it's going to be more valuable than an option that only allows you to purchase the stock at a small discount. Now, here's the thing. Stock prices are always moving. So, if you own a call option and the stock price goes up, then that call option will increase in value because it is becoming more and more in the money. Let me repeat because this is important. If a stock's price rises, then that stock's call options will increase in value. And if you own a put option and the stock price falls, then that put option will increase in value. Now, if you buy an option today and are wondering what it will be worth at the expiration date, it will simply be worth the difference between the stock price and the option strike price. To put it simpler, the options value will be determined by how far in the money it is. This is also referred to as intrinsic value of the option. An option will simply be worth its intrinsic value at the expiration date. To demonstrate this, let's look at the options that are about to expire in Twitter. So, these options basically have no time left on them. The stock is currently trading at 1809. And if we look at the 17 strike call, we can see that it's worth $15 by 114. So, around 109. The reason is because the 17 strike call would allow you to purchase the stock at a discount of a $19. And if we look a little further in the money, you can see the 16 strike call is worth around 209. It says 215 on the screen because it's so deep in the money and the bid ask spread is kind of wide, but its actual worth is around 209 because it would allow you to purchase the stock at a discount of $29 per share. And remember, if an option is out of the money, then it will be worthless at the expiration because nobody wants to purchase stock at a higher price than the current market value. And similarly, out of the money puts will also be worthless because nobody wants to sell stock at a cheaper price than what it's worth. And you can see that on these options here. All the out- of-the- money options are worthless. So, just to recap real quick, at the expiration date, in the money options will be worth the difference between the strike price and the stock price, and all out of the money options will be worthless. But let's look at the options that are not yet about to expire. You can see that even the out- of-the money options still have value. So, if all out- of-the- money options will be worthless at the expiration date, then why do they have value now? This leads us into our next point, which is time to expiration. Let's talk about how time will affect an options price. We've talked about how options are basically insurance. And of course, you have to pay money for this insurance. Now, the thing about insurance is you don't get to just pay a one-time payment and have insurance forever. You have to pay month after month to keep your insurance. So, the longer you have it, the more money you will have to pay. options are the same way. They have expiration dates for the exact same reason you have to pay monthly for car insurance. If you want to insure your car for 6 months, it might cost you $600, but if you want to insure it for 12 months, it might cost you $1,200. In the exact same way, an option with 60 days to expiration is going to have a higher price than the same option with only 30 days to expiration. In the last section, you learned about in the money and out of the money. And you learned that out of the money options are options that have a strike price that does not allow you to purchase or sell the underlying stock at a better price than the current market price. So therefore, out-of-the-oney options are worthless. Now, this is only true if there is no time left on the option. Let me explain. Right now, you're looking at Twitter options that have zero days left. They expire this evening after the market closes. And you can see that the out of the money options are at zero. Now, let's look at the options that still have time left until they expire. We're going to look at the options with 28 days to expiration. You can see that the out- of-the-oney options with 28 days to expiration have value. But if they won't have value at the expiration, then why do they have value now? The answer is because stock prices move. And if there is still time left until expiration, then there is still a chance that the out- of-the- money option could become in the money. So the reason these out- of-the money options have value is because there is still time left for the stock to move around. Think of it this way. When you purchase car insurance, is it going to be worth the price you paid? Well, we don't know, right? Because we don't know if you're going to get into a crash. it could end up being worthless or you could get into a crash and you'll be very happy that you had the insurance. Now, I realize that car insurance is required for all drivers, even if you know it's overpriced, but the analogy still stands. Now, you can see that the further out of the money an option is, the cheaper it is. That's because the likelihood of it being of any value is less than an option with a strike price that is closer to the current stock price. Right? This stock is more likely to get to $20 per share within the next 28 days than it is to get to $25 per share because it would have to make an extremely large move to get to 25 whereas it would only have to make a small move to get to 20. So therefore, the 25 strike call option will not cost that much money because it isn't very likely that it will be of any value at expiration. Now you see the prices of these options with 28 days to expiration. Again, let's take a look at what these option prices will look like with 0 days to expiration. All of these outofthe-oney options are worthless. And the in the money options are worth the difference between the stock price and the strike price. This is because since there is no time left, there is no time value left on these options. This is also referred to as extrinsic value. Exttrinsic value refers to the amount by which an option's price is greater than the intrinsic value. And intrinsic value refers to the in the money portion of that option's price. Okay, so that may have sounded a little confusing. So let me just show you a quick example. Remember we mentioned that these options that expire today don't really have any extrinsic value. So let's again go back to the options with 28 days to expiration. Check out the 17 strike call option with 28 days. The price of this option is 220 and the current stock price is $1809. So this 17 strike call option is $19 in the money. So it's intrinsic value is 109 and the exttrinsic value is just whatever is left over. So in this case the exttrinsic value is 111. And remember at the expiration date there will be no exttrinsic value left on the options. The value of this option at expiration will be whatever its intrinsic value is. So in practice what does this actually mean for us? Well let's say we bought this call option right now at 220. We know that if Twitter stock doesn't move and just trades sideways for the next 28 days, then this option is going to gradually go from $220 down to 109. And we learned in the last chapter that option prices have a multiplier of 100. So in this case, we paid $220 and sold it for $19. So our net loss would be $111 and the stock didn't even move. For us to have made money on this call option, Twitter stock would have had to move high enough for the intrinsic value to exceed the premium we paid for the option. So, for example, we paid 220 for the 17 strike call. For us to break even on the trade at expiration, the stock would have to be at 17 + 220, which comes out to be 1920. Twitter is currently at 1809. So, it would have to move all the way up to 1920 for us to just break even. That's why we kept saying to keep watching before you start buying calls on every stock you think is going to go up and puts down. Because even though it costs much less than trading the shares of stock, you're going to have time decay against you. So, not only will the stock have to move in your favor, it will favor a significant amount for you to even break even. Options are constantly decaying as time passes. This is exactly why we don't trade options in this way. We never buy options as a way to guess direction of the underlying stock. We actually trade them in a way to take advantage of this time decay. And you're going to learn these strategies later on in this course. Now, one thing I want to quickly mention to avoid confusion is that an option's exttrinsic value or time value is gradually decaying. So, if you buy this option today and Twitter moves up to 1920 tomorrow, which is pretty unlikely to happen in just one day, but if it does happen, then you're going to have a pretty decent profit because there will still be time value left on this option. So, your break even that we determined of 1920, that is your break even at the expiration date. If that confused you, don't worry about it. We're going to touch more on this topic very soon. But I just wanted to mention that to clarify that you don't have to hold an option all the way to its expiration date. We are actually able to open and close the trade any time before the expiration date. Now, let's recap what you've learned in this section. Expiration dates. Options have expiration dates for the same reason you have to pay monthly for car insurance. With that being said, you don't have to hold an option all the way to expiration. If you own an option, then you can sell at any time before expiration at the current market price of the option. And more time equals more money. If you buy an option with 60 days to expiration, it's going to cost you more money than if you buy an option with only 30 days to expiration. You also learned about intrinsic and exttrinsic value. Intrinsic value simply refers to the in the money portion of an options price. And exttrinsic value is just anything left over. Exttrinsic value can also be referred to as time value. And remember, if an option has no time left to expiration, meaning it's about to expire, then it's going to have no time value left on it. It will simply be worth whatever its intrinsic value is. And lastly, option prices are always decaying due to the passage of time. So if you are buying options, you will be fighting this decay. Which is why we recommend you to finish this entire course before making your first option trade so you can learn other strategies to allow you to put yourself in a position to profit from this time decay. It's extremely powerful once you learn how to do this. So all right guys, there's just one more factor that affects an options price and that is volatility of the underlying stock. So make sure you understand everything up to this point and let's go ahead and get into it. Most option traders learn what you learn in the first two sections and they think that's enough. They just completely ignore this third factor and then they wonder why they can't figure out how to make any money trading options. So listen up because volatility is equally as important as the other two factors, if not more important. Especially when learning how to make money trading options, you have to understand volatility. And it's actually not that complicated. So what is volatility? Volatility is simply the magnitude of a stock's price swings. If a stock has high volatility, then that means it has large price swings. And if a stock has low volatility, then that means it has small price swings. Now, think about this. If you own a stock as an investment, then that stock's volatility is a good measure of your risk. Right? If a stock has high volatility and it makes large price swings, then you are going to be exposed to bigger losses on that stock investment. So, high volatility equals more risk for the stock investor. And since there is more risk involved, options will be more expensive. I know you're probably sick of the insurance analogy by now, but let's think of options as insurance. Again, if you buy an option as a way to protect your stock investment, you are paying the option seller to take on your risk. And if your risk is higher, then why would the option seller not demand more money, right? If they are assuming more risk, then they are going to want to be paid for that. Let me explain. Let's say you are an insurance company and you are providing life insurance for two different people. The first person is overweight, smokes a pack a day, and has a serious medical condition. And the second person is healthy, exercises regularly, and has no signs of any life-threatening medical conditions. Who do you think is going to have to pay more for life insurance? Exactly. The person who is at more risk of dying. Now, think of this person as a stock with high volatility and low volatility. So, a high volatility stock is going to have more expensive options just like a very unhealthy person is going to have to pay a ton of money for life insurance. And a low volatility stock is going to have cheap options in the same way that a very healthy person isn't going to have to pay that much for life insurance. Now, let's take a look at a real example. I found two companies who have stock prices that are right around the same price. And we have the option chain of each stock pulled up side by side for you to see. So on the left side you can see EWZ and on the right FXI. The difference in price between the two is only 6 cents. So basically nothing. And then of course the options displayed on your screen have 28 days to expiration. So the same price of the underlying stock and the same amount of time to expiration. Now check this out. The implied volatility or in other words the expected volatility for EWZ over the next 28 days is plus or minus 244. So in other words, it's expected to trade in a range of $2. 44 over the next 28 days. Now, if you look at FXI on the right side, you can see that its implied volatility, or in other words, its expected range that it will trade in over the next 28 days is $189. Now, don't over complicate it. The only reason I show you these expected ranges is simply just to demonstrate that EWZ is expected to have more volatility than FXI. Or in other words, EWZ is expected to make a larger move over the next 28 days and FXI is expected to make a smaller move. Now remember, we're looking at two stocks with a very similar stock price. And both option chains you can see are displaying options with 28 days to expiration. So same price of the underlying, same time to expiration, but different implied volatility. Check out the 37 strike put option on EWZ. The price of this put option is around 85. But if you look at the 37 strike put option on FXI, you can see that its price is only 54. This is a demonstration of how a stock that is expected to have high volatility is going to have expensive options and a stock that is expected to have low volatility will have cheap options. And this doesn't just apply to the 37 strike put. You can actually see that the puts and calls at every strike are more expensive on EWZ than on FXI. Okay, you get it. High implied volatility, or in other words, expected volatility equals expensive options. And low implied volatility equals cheap options. Simple enough. High risk means expensive insurance and low risk equals cheap insurance. Now, let's talk a little bit about what this would actually mean for your trading. Well, just like a stock's price can go up or down, its implied volatility can also go up or down. If implied volatility goes up, then the options, both calls and puts, will get more expensive. And if implied volatility goes down, its options will get cheaper. But you might be wondering, what the heck would cause implied volatility to go up or down? Well, here's the thing. The implied volatility of a stock is actually determined by its options prices, not the other way around. Okay, let me say that again in a different way. The option prices are actually what tell us the future expected move, also known as implied volatility, of a stock. It's kind of like the option prices are what they are and those prices spit out the implied volatility number and that tells us the expected move of the stock. Okay, so that doesn't really answer the question. And maybe your head is spinning at this point. But let me ask you, what causes a stock's price to go up or down? Could be a huge number of things, but it simply comes down to supply and demand. If there are a lot of buyers, the stock's price will go up. And if there are a ton of sellers, the stock's price will go down. Tons of option buyers would cause the options to get more expensive, and tons of option sellers would cause an option to get cheaper. Then the options prices would tell us what the implied volatility is. So again, what would cause the implied volatility to go up or down? Well, really it's just a question of what would cause a lot of buyers for options and sellers. To answer this question, let's think of options as insurance again. What would cause a lot of demand for insurance? Fear of the unknown. When investors are scared and feel like they have a lot of risk, they might start buying options to protect their portfolios because they expect a lot of volatility. And all of these option buyers would of course cause the options prices to go up and therefore the implied volatility number would also go up which makes sense right because the investors are expecting a lot of volatility. So in essence implied volatility is kind of like a fear gauge for the market. Now as a newbie if that doesn't make your head spin and make you want to give up then I don't know what will. If that didn't really make sense don't worry because fortunately it doesn't really matter right now. Just understand that if a stock's implied volatility goes up, then that means its options are getting more expensive. And if a stock's implied volatility goes down, then its options are getting cheaper. This is a huge part of our trading strategy because implied volatility is actually very predictable whereas stock prices aren't that predictable. We're going to cover this in depth in part two as the goal of this course is just to teach you the basic understanding of options. Now, one last thing before we end this section and move on. I'm going to show you where we can find implied volatility in the Thinker Swim platform. We can find it in multiple places actually, but I'm going to show you the most visual way to view this. If we go to a daily chart, we can actually view the implied volatility as a study. This is cool because you can see a visual of where implied volatility is now versus where it has been. All you have to do to add this study to the chart is click studies and edit studies. And I already have it on the chart, but I'll go ahead and remove it and read it so you can follow. So all we're going to do is type in the search box and it should pop up as imp volatility. Now just double click that and it should add it to the chart. Now the number you see here of 0. 455 is actually the expected volatility as a yearly percentage. So that's actually telling us that the expected volatility of this particular stock is 45. 5% over the next year. Now don't worry yourself too much with this number. Okay? I just wanted to point it out so there are no questions to you. What matters is if this number goes up then the options will get more expensive and if it goes down the options will get cheaper. And again this is very predictable and we're going to cover how to predict if it will go up or down in part two. So all right guys, that's it. Those are the three factors that affect an options price. Now let's recap and show you some real examples of how all three of these factors are affecting an options price at the same time. So again, we're looking at Twitter options, and these options have 28 days to expiration. Let's use a tool on the Thinker Swim platform called Theo tool to try and estimate how an option you own might be affected by each of these three factors you learned about. Now, this is just for demonstration purposes, and you don't need to understand how to use this tool or even platform at all right now. It's just to help you understand what the price of these options will do in different scenarios. And actually, let's make this a little easier to see. We're going to set this up to only display one option strike. And all right, so we have the 19 strike option showing. Now, let's say we want to make a bet that Twitter stock is going to go much higher over the next 28 days. We could do this by buying a call option. So that's what we're going to do for this example. We're just going to say we bought one contract of this 19 strike call option. And you can see the current price of this option is around 128. So multiply that number by 100 and the real cost of this option contract is $128. Now whether or not this trade will be profitable on a dayby-day basis will be determined by all three of these factors you just learned about. price of the underlying stock, time to expiration, and the implied volatility of the underlying stock. So, first we're going to look at these factors individually. You learned that all out of the money options will be worthless at the expiration date. So, for our very first scenario, let's say the stock doesn't move and implied volatility doesn't change. The only thing that happens is time passes. So the only thing we're going to change is this date that you see here. You can see that as each day passes, this option's price is decaying and gradually going to zero. So if this scenario were to happen, you would lose the entire price you paid for the option, which was $128. Okay. Now, let's say the price of Twitter goes higher immediately after entering the trade. So no time passes and implied volatility doesn't change. So let's say the stock is instantly one point higher. You can see the price of this option is now at 179. Now let's say it went up another point. So it's up a full two points from where you entered. You can see that the options price is now at 238. So if you bought the option for 128 and sell it for 238, then you made $110 on the trade. Now, just a quick side note, you may wonder why the option went up 110 when the underlying stock went up two. Don't worry about this right now. You're going to learn why this is the case and also how to estimate this type of thing while trading options in the option Greeks chapter. Okay, so there's one more factor that affects an options price on a dayby-day basis, and that is the daily changes in the underlying stock's implied volatility. You learned that if a stock's implied volatility rises, then its options will get more expensive. So for this scenario, let's say the stock doesn't move and no time passes either. The implied volatility just magically jumps up by 25%. You can see that the call options price went from 128 to 179. So you would have turned your $128 into $179 for a total profit of $51. Now the reality is there will rarely ever be a time when only one of these factors changes without the other two also changing. The underlying stocks price and implied volatility will constantly be changing on a daily basis and time is always passing. So now let's look at a few scenarios where all three of these things are affecting the options price at once. So in this scenario, let's say that just one week has went by and the stock's price has risen by $1. 50 per share. You can see that the price of this option we own is now at 184. So that means we've turned our $128 into $184 for a profit of $56 on the trade. In this scenario, the stock's price went up quite a bit. And time decay, well, it hurt us, of course. You know, it's always going to hurt us if we are buying options, but it didn't hurt us that much. So, we were still able to make a pretty nice profit. Okay. Now, in this scenario, let's say the stock still went up by $1. 50 per share. But this time, instead of doing so in one week, it took 3 weeks. So, we'll move the date forward 3 weeks. And you can see the options price is $123. So, our total loss in this scenario is $5. So, the stock went up, which helped us, of course, but it took too much time to go up. So the time decay was too much here for it to even matter that the stock went in our favor and this resulted in a small loss on the trade. Okay. Now let's say one week goes by, the stock goes up by 50 cents per share and implied volatility goes down by 10%. You can see that the options price is now 112 resulting in a $16 loss. So the stock went up like we wanted and it didn't take much time to do so, but in this case the implied volatility went down. So the drop in implied volatility plus the little bit of time decay that occurred more than canceled out the fact that the stock price went up which caused us to lose money. Okay, just one more scenario. This time let's say the stock doesn't move. implied volatility goes up by a full 25% but a little over three weeks has gone by and there are now only 4 days left until expiration. You can see that the price of this option is now 53 resulting in a loss of $75. So the stock didn't move at all. Volatility went up huge, which is exactly what we would want to happen, but time decay more than canceled out the huge spike in implied volatility, which caused us to lose money on this trade. You'll notice that in most of these scenarios, we lost money. And the stock went in our favor. So, you might be thinking, why am I learning how to trade options again? Well, remember in all of these scenarios, we bought this option and we've repeatedly mentioned that this is our least favorite way to trade options. In fact, we don't ever trade options in this way. The bottom line is there are two sides to every trade and you can take either side. Now, these three factors are constantly changing and they are all affecting the options price. So options are a little bit more of a gray area product and that there are more things affecting its price than just whether or not there are buyers or sellers of the stock. Don't let this fact overwhelm you. It's actually a huge advantage to us and it's the reason we trade options in the first place. If you keep learning and studying, you're going to soon learn about how you can take advantage of time decay and volatility to add massive consistency and profitability to your trading that you just simply cannot find if your trading strategy were only focused on predicting direction of the stock. 90% of traders lose money. And those traders are the ones who focused most of their attention on trying to predict the next big stock move when they should be focused on what really matters. Learning strategies that will pay you even when you're wrong about market direction. Because it isn't about being right. It's about making money.

You learned that option prices are affected by three factors on a daily basis. underlying stock price, time to expiration, and the implied volatility of the underlying stock. But here's the question. How sensitive will an option price be to each of these factors? If the stock goes up by one point, how much will you make on that call option that you own? If 5 days pass, how much money will you lose to time decay? If volatility drops by 10%, how much will the options price change? Okay, you get the point. But all of these questions can be answered by what we call option Greeks. Option Greeks give us an idea of how an options price will react to changes in the underlying stock price, time to expiration, and the volatility of the underlying stock. They are simply used to measure an options price sensitivity to each of these factors. And guys, I know by this point you're probably so ready to get to the good stuff and actually start learning strategies that we use to make money trading options. And I promise we're getting close to that. But these option Greeks are important to learn and understand because they actually help us choose which strike prices and expirations to select when placing trades. And they also help us understand our risk, which is crucial to successful trading. There are four main option Greeks. Delta, gamma, theta, and vega. Let's first talk about delta. Delta is a measure of how much an option's price will change in value if the underlying stock price goes up by one point. So if an option has a delta of 65, then that would mean if the stock goes up by one point, then the option contract will go up by 65. And actually, let me just show you a real example. We can find delta as well as all of the other option Greeks on the option chain by clicking layout then clicking delta gamma theta vega. Now we can see all of these option Greeks for each of these option contracts. You'll notice that all the call options have a positive number for delta and the put options have a negative number for delta. This is because delta tells us how much an options price will change if the underlying stock price goes up by one point. So if the stock price rises by one point, the calls will go up in value, hence the positive number. And for puts, if the stock price rises by one point, the puts will go down in value. They will change by a negative number. Now, let's just look at one of these options as an example. It doesn't matter which one. So, we'll just choose the 123 strike call. You can see the delta is 47. This is telling us that if the stock price goes up by $1, then this option contract should go up by 47. This is important to know because if you own one contract of this call option, then that tells you that if the stock goes up by one point, you should make $47. Simple enough. Delta is the amount by which an option will change in value if the stock goes up one point. Now here's the thing about delta. It is not a fixed number. As the stock moves around, delta will actually change and it will change by the value of gamma. Let's talk about gamma. Gamma is the amount by which delta will change if the stock moves up one point. So for this option, you can see the gamma is 5 cents. What this means is if the stock goes up one point then the delta which is currently at 47 will increase by 5. So the delta would go from 47 cents up to 52. Now don't worry yourself too much with gamma at this point in your trading education. We actually don't even look at gamma much when making trading decisions. It's more just about understanding the concept and understanding that delta will constantly be changing. What's important for you to know right now is that as an option becomes more and more valuable, its delta will be increasing. Let me explain what I mean by that. Let's look at the option chain again so you can see all of these option contracts. You can see that the further in the money an option is, the bigger its delta is. And as we go out of the money, you can see that the delta gets smaller. So for gamma, that's all you really need to understand for now. Delta will grow bigger as an option gets more and more valuable. Okay, so you just learned about delta and gamma. And I hope gamma didn't confuse you too much. If it did, don't worry about it at this point. But these are the two option Greeks that help us understand how an option's price will be affected by changes in the underlying stock price. Now let's move on and talk about theta. Theta is the measure of an option sensitivity to time. To be specific, theta is the amount by which an option's price will change if one day passes. So for example, the option you are looking at has a theta of -12. So, if one day goes by, then this option's price will lose 12 cents due to time decay. Now, keep in mind this doesn't mean that this option will for sure be 12 cents lower tomorrow. Because remember, all three of these factors will affect an option's price each day. What this does mean is that if the stock's price doesn't move and implied volatility doesn't change, then the options price should be 12 cents lower than it is now. Now let's look at the option chain again. You'll notice that all of these options have a negative value for theta. This is because as each day passes, all of these options are going to decay. Time value is constantly being sucked out of all options. So any time you buy an option contract, you are going to be fighting this time decay. So again, theta is the amount by which an options price will change if one day passes. Now, there's one more option Greek and it's called Vega. Vega estimates how much an options price will change if the underlying stock's implied volatility changes. To be specific, an options price will change by the amount of Vega if implied volatility goes up by 1%. So, looking at this option, you can see that its Vega is 10 cents. This simply means that if the underlying stock's implied volatility goes up by 1%. Then the options price will increase by 10. If we look at the option chain again, you'll see that the Vega is a positive number on all of these options, both calls and puts. This is because an increase in implied volatility will cause all options to get more expensive. Okay, so those are the four main option Greeks we look at. Delta is the amount by which an options price will change if the underlying stock price rises by one point. Gamma is the amount by which an options delta will change if the underlying stock price rises by one point. Theta is the amount by which an options price will change if one day passes. and Vega is the amount by which the options price will change if the underlying stock's implied volatility rises by one percentage point. We talked about how each of these Greeks will give you an idea of what an options price will do as each day passes and the underlying stock's price and implied volatility move around. But the cool part is we can also view our position Greeks. Let me show you what I'm talking about. Let's check out our current position in ticker symbol S& P, which is the S& P 500 index. Now, this position is actually an option strategy that we haven't yet talked about. It's called an iron condor, and you're going to learn about this strategy later in the course, but let's check out the position Greeks and see what they are telling us. You can see the delta on this position is -8. 98. This means that if SPX goes up by one point, then the P& L of this position will change by8. 98. So if our P& L changes by8. 98, then that means we will lose $8. 98 from where the trade currently is. We're already up $425 on this position. So if S& P goes up by one point, then in theory we would lose $8. 98 of that. So now we would only be up around $416. On the flip side, this is saying that if S& P goes down by one point, then we will make $8. 98. This is because the delta is a negative number. And that's one cool thing about viewing the delta of our position is that it tells us if we are long or short the underlying stock. In this case, our delta is negative. So we are short S& P and we want the underlying market to go down. So a negative delta indicates that you are short the underlying market and want it to go down. And a positive delta would indicate that we are long the underlying market and would benefit from the price going higher. Another cool thing about looking at the delta of our position is that it tells us our directional exposure and we can make sure that number is in line with our risk tolerance. If this number is bigger then that means we are more exposed. Right? In this case we traded 10 contracts and our delta is8. 98. But let's say we traded 100 contracts on this trade instead of just 10. this number would be around80 instead of just negative8. If this were the case and S& P went up by one point, then we would lose $80 on the position. So, delta is a good way to measure risk. And keep in mind, I said it's a good way, not the only way. Now, a delta of8. 98 is actually not that much. It's almost insignificant. And that's really just the nature of the iron condor strategy. And that's why the strategy is so powerful because we can let the trade make money from time decay and volatility and remove stock price from the equation as much as possible since predicting stock prices is very difficult. That's kind of beside the point right now. And again, you're going to learn about this strategy soon, but for now, just understand that this delta is saying that if S& P goes up by one point, then the position should lose $8. 98 from its current state. So, one last thing about delta before moving on. How do you know if a delta is big or small? Well, really, it's subjective and it depends on your risk tolerance and account size. But for any of you who might have a history of trading stocks, one way I like to look at it is this option position is the equivalent of being short eight shares of S& P. Now, I realize S& P isn't a stock, it's an index, and the index itself isn't tradable, but you get the point. Your delta basically tells you the equivalent number of shares you are long or short of the underlying market. Right? If you were long 50 shares of a stock, for example, then your delta would be plus 50 because if the stock went up by one point, then you would make $50. So if your option position shows a delta of -10, for example, then that's the equivalent of being short 10 shares of the underlying stock or market. Now, of course, this delta that you see can change and it will change by the amount of gamma. So in the case of this particular trade, if SPX goes up by one point, then our delta will go from8. 98 to -10. 57. Don't get too hung up on gamma. Again, it's really not something we look at much and it's more just about understanding that your delta will change as the stock moves around, which can increase or decrease your directional exposure. So again, gamma is the amount by which your delta will change if the underlying market goes up by one point. Now just a second ago, we mentioned that all options have a negative theta because all options are constantly decaying as time passes. But if you look at our position theta, you can see that the number is positive. What this means is that this position is benefiting from time decay. Or in other words, for each day that passes, this one position is bringing in $7263 from time decay. This is pretty cool because all the strategies we use here at Sky View Trading benefit from time decay. Making sure you are on the right side of time decay is extremely important. So again, looking at position theta will tell you how much your P& L will change due to one day passing. Now the last option Greek we'll talk about on this position is vega. You can see that the vega on this position is -176. 78. This means that for every percentage point that implied volatility goes up we will lose $176 and inversely for every percentage point that implied volatility goes down we will make $176. So, all right guys, that's it for the option Greeks chapter and I'll see you in the next chapter.

This is where things get fun because everything you'll learn from here forward will be specific strategies you can use to start making money trading options. In this chapter, we're going to talk about buying an option. We refer to this as a long option. And first, let's talk about buying a call option. There are two reasons someone might buy a call option. First, for whatever reason, you think the stock is going to go up soon. Now, the reason you would trade the call option instead of just buying stock is because it would allow you to make this bullish bet for much cheaper than it would cost to buy the stock. And because you can buy a call option for much cheaper, you can achieve a much higher return on your capital than if you were to instead buy the stock. Now, we're going to go through the entire process of buying a call option in a second, but first, let me show you what I mean whenever I say that buying an option can provide a much higher return. Let's take a look at some real option prices. You can see the call option prices on TLT. These options have 31 days to expiration. So, let's just take note of the stock price. The stock is currently at 12191. And actually, we'll just call it 122 to keep it simple. Then we're going to take note of a few of these options and the prices. If we look at the mark price of these options, which is simply just the mid price between the bid and the ask, you can see the 121 strike call is at 264. The 122 210. The 123 strike call is at 168 and so on. Now, let's just look at one hypothetical scenario and then compare the returns that each of these options would have provided to the returns that the stock would have provided. Let's say the stock goes from 122 up to 130. If you bought the stock at 122 and sold at 130, then you made $8 per share. So, a profit of $8 per share divided by your entry price of 122 means you made a percentage return on your investment of 6. 6%. Not bad, but let's compare that to the returns that these call options would have provided. Now, the first strike we're looking at is the 121 strike call option. This option is slightly in the money and the option was originally at 264. But if the stock went up and is now at 130, then this call option will be worth its intrinsic value, which is $9 per contract. You learned about this in chapter 3. So if you were to buy this option at 264 and sell it at 9, then that would have made you a profit of 636 per contract. And if you made a profit of 636, but you only paid 264, then your percentage return on capital was a whopping 240. 9%. Now, let's do the same thing for the other strike call options. And I just went through the calculation with you on this strike. So, I'm not going to go through that whole process for all of the others. We're just going to put the numbers up on the screen for you to see. You can see that some of these strikes provided a much bigger return than others. And you can see that the 125 strike even provided over a 400% return on your money. If you traded one contract, you could have turned $97 into $500. 10 contracts, you would have turned $970 into $5,000. And if you're a high roller and traded 100 contracts, you could have turned a $9. 7,000 investment into $50,000 in just 31 days. This is the exact reason someone might buy a call option rather than buying the stock. It simply provides leverage to make big profits with very little capital. This is the main reason for showing you this demonstration. The second reason I show you this demonstration is to talk about strike selection when buying options. You can see that the cheaper out-of-the-oney options provided a bigger percentage return and the more expensive in the money options provided a smaller percentage return. So, you might be thinking, why wouldn't I always just buy the out- of-the- money options if they're cheaper and also provide a better percentage return? Well, there's a trade-off for this. The further out of the money an option is, the lower your probability will be of making any money on the trade. We call this your probability of profit or pop for short. Let me explain. Let's calculate the break even point for each of these. is simply the price we need the stock to be at to at least break even on the trade. So first for the stock, our break even is simply just the entry price, right? If we bought the stock at 122, then we would just need the stock to be higher than 122 for us to make money. So our break even for the stock is 122. Now let's calculate the break even point for this 121 strike call option. To find your break even, you're simply going to add the price you pay for the option to the strike price of the option. So in this case, your break even would be our entry price of 264 plus the strike price of 121 and that equals 12364, which is our break even. So, go ahead and write down that formula in your notes for finding the break even price when buying a call option. It's simply the entry price that you pay for the option plus the option strike price. And whatever that break even price is, you need the stock to be above that price at expiration for you to make money. Now, we're going to do this simple calculation for all the other strikes as well, but again, we're just going to skip ahead and put the numbers up on the screen for you to see. You can see that the further out of the money options that provided a bigger percentage return had a worse break even point. So if the stock has to make a very big move for you to even make a penny on the trade, then that means you're going to have a very poor probability of profit because it's unlikely for the stock to make that large of a move. So to sum it up, you can see that the larger potential payout is accompanied by a poor probability of profit. So that's where strike selection comes into play. When buying a call option, choosing a further out-of-the-oney strike will result in a larger potential payout because the options are much cheaper. But in turn, it will also result in a very low probability of profit. And a further in the money option will have a smaller potential payout, but it will have a higher probability of profit than the out- of-the- money options. And guys, this large potential payout is exactly what suckers the little guy into buying out of the money options because he wants to turn his tiny trading account into millions of dollars. This is why we refer to this type of strategy of buying cheap out-of-the-money options as a lottery trade because it's kind of like buying a cheap lottery ticket in hopes that some highly unlikely event will happen and you will get paid. But you're smart enough to realize that buying lottery tickets is not a sound investment strategy to build wealth. So I'm confident that you aren't going to get caught up in making this type of sucker bet. And by saying that, I'm not trying to crush your dreams or disempower you or anything like that. I'm just pointing out that this is the lowest probability option strategy that exists. So if you're trading this strategy, you're going to have very little consistency. But again, stay tuned because you're going to learn strategies where you can still make very sizable gains, but with massive consistency, and that's where the real money is made. Now, with that being said, let's actually go through the process of buying a call option so you can see how it works for yourself. Right now, you're looking at a chart of Facebook's stock price. Let's say that for whatever reason we think the stock price is going to go higher soon and we also think that implied volatility is low and might rise in the near future. Instead of buying the stock, let's buy a call option. If we go to the option chain, we can find an option to trade. We just have to select our expiration and also the strike price. First, let's choose our expiration date of the option we want to trade. Let's use what you learned about option Greeks in the last chapter to talk about the pros and cons of certain expiration dates. So, let's just look at two of these expiration dates and then compare. We're going to view the options with 4 days to expiration and then also the options with 60 days to expiration. You can see that the theta is much higher on the options that have fewer days left to expiration, which means that time decay will be hurting us a lot more. But at the same time, you can see that the gamma is also much higher. The higher gamma is good for option buyers because it means that you can make faster profits if things go in your favor. But the trade-off is that the much higher theta means we are losing more money to time decay. So we would have much less room for error if we don't time the entry perfectly. So let's just find a happy medium and choose the expiration cycle with 25 days to expiration. Now we just have to choose our strike price of the option we want to trade. Remember choosing a further in the money option will cost more money and therefore provide a smaller return. Also buying a further in the money will mean that you won't be fighting time decay as much because there is more intrinsic value and less exttrinsic value on a deep in the money option. Now, an out- of-the- money option would be cheaper and have a bigger potential return, but at the same time would cause us to have a very poor probability of profit. So, just like with choosing your expiration, there are also pros and cons to choosing different strikes. So, again, let's just meet in the middle and buy the at the money option with the strike price of 122. To do this on the ThinkersW platform, all we have to do is rightclick the option, then click buy single. Now you can see the details of the order to buy this option. You can adjust the price you want to submit the order at. You can adjust the number of contracts you want to trade, etc. For this example, we're going to just say we want to trade one contract at 262. Now, let's talk about our risk, our potential reward, and also our break even on this trade. If we click the confirm and send button, you can see a few different details about this trade. First, let's look at the cost of the trade. You can see that this trade will cost us $262 plus any commissions our broker charges. Our commissions here at TDM Trade are pretty cheap, so you can see it will only cost us $1 in commissions to enter this trade. So, the total cost of the trade is $263. Now, let's talk about our risk. Our risk when buying an option is simply the same as our cost of the trade. We can only lose the amount we pay for the option because the option can't go below zero. If the option ends up being worthless, then we will simply lose the money we paid for the option. Now you can see the max loss displayed on this order confirmation box does not include cost of commissions. But it's important to note that commissions are part of this risk. If the option expires worthless, then we will actually lose $263, not the $262 that is displayed. So just keep in mind that the max loss and max profit numbers displayed in this order confirmation box does not factor in commissions. Now for the buying power effect. The buying power effect is simply another name for your capital requirement on the trade. You can see that the capital required for this trade is $263. This is obvious really for buying options, but this will come in handy quite a bit when we talk about our next strategy, which is selling options. Now moving on up to where it says maximum profit. You can see the max profit says infinite. This is because theoretically a stock has no cap on how high it can go. Theoretically a stock can go to infinity. So therefore a call option is considered to have infinite profit potential. But guys this is theoretical. Have you ever seen a stock go to infinity? Me either. I think a better word for this would be undefined. So your max profit is undefined when buying a call option. Now let's check out the break even stock price and talk about what this means. You can see that on this trade the break even stock price is 12462. This is simply telling us that if the stock is at 12462 at expiration then we will break even on the trade. In other words, this tells us that if the stock is above this level, we will make money on the trade. And if the stock is below this level, we will lose money on the trade. The way this is calculated is by simply adding the entry price that we paid for the option to the strike price of the option. So in this case, the strike price is 122 plus the price of the option which was 262. So the break even on the trade is 12462. Earlier we briefly touched on the fact that probability of profit of a trade is tied to the break even of the trade. The cool thing about options is we can see exactly what our probability of profit is. If we make money when the stock is above our break even point and lose money when the stock is below that point, then all we need to do is figure out the probability of the stock being above that break even point and that would allow us to know our probability of profit. Let me quickly show you how to find this. Let's exit out of this order confirmation box and then we're going to rightclick anywhere on the order and then click analyze trade. This takes us to what we call the analyze tab, which serves many purposes. One of those purposes is to tell us our probability of profit. Now, I'm going to show you how to find your probability of profit step by step. But before that, I want to quickly explain this graph that you see here because we're actually going to use this type of graph through the rest of the course to explain other option strategies to you. This graph is called a risk profile. The risk profile is used to give us a visual of exactly what our profits or losses will be on a trade based on where the stock price is. So, let me quickly explain how to read this risk profile. The x- axis is the stock price and the y- ais is the profit or loss of the trade. So if we pick a point at which the stock price is at, that will tell us what our profit or loss will be on the trade. And we're focused on the blue line here. We don't care about the purple one for now. The blue line shows us our profit or loss based on where the stock price is at the expiration date. So for this strategy, you can see that if the stock price is at 130, for example, then this trade will have a profit of just over $500. Now you can see that the blue line flattens out when the stock price is anywhere below 122. This is because the long call strategy can only lose so much money. If the stock is anywhere below our strike price of 122, then this trade will be at its max loss of $262. Now you can also see that if the stock continues to go higher and higher our profits will get bigger and bigger. So basically anywhere the blue line is above the zero line that means that you have profits and anywhere the blue line is below the zero line then that means you will have a loss on the trade. So where this blue line crosses the zero line that's where our break even point is on the trade. pretty straightforward and actually you should be familiar enough with options at this point to not need a chart like this to tell you what your profit or loss will be if a stock is at a certain price. But understanding this risk profile and how to read it will come in handy when learning all the other option strategies throughout the rest of this course. Now, the main reason I show you all of this is to show you how to find your probability of profit if we were to buy this call option. So, let's go through how to do this step by step. We've already done step one, which was rightclick the order, then click analyze trade. Step two, make sure the probability mode at the top of your screen is set to ITM, which stands for in the money. Step three, at the bottom of your screen, make sure that only the box for this trade is checked. You can see that this is already the case, but if it weren't, you would want to make sure of this. Step four, change the date in the top right of your screen to match the expiration date of the option you are buying. On this option, you can see the expiration date is the 16th of December, 2016. So, we'll just make sure that the date up here matches this. And by the way, this is not to be confused with the date shown down here. This date shown down here is irrelevant to finding your probability of profit. So, just ignore that one. Now for the last step, just click on the button here, the one just to the right of the plus sign. Then select set slices, break even, and then click the blue date, which is the expiration date. So that will set a vertical price slice to the risk profile at our break even point. And you can see that here. Now you can see the probability of the stock being above this break even point is 34. 57%. So therefore, your probability of profit is 34. 57%. Or in other words, we have a 34. 57% chance of this trade being a winning trade at expiration. On the flip side, you can see the probability of the stock staying below our break even point is 65. 43%. This means that the probability of losing money on this trade is 65. 43%. This poor probability of profit that you see is the exact reason we prefer not to buy options. When buying an option, you will never have a probability of profit better than 50%. But that's okay because we're about to show you much better strategies anyways that will allow you to have a much higher probability of profit. So, let's recap. A long call is a bullish strategy where we want the underlying stock price to go higher. Time decay is against us. So, we'd really be hoping for a fast move of the stock so time decay doesn't hurt us too much. And we'd also benefit from an increase in implied volatility. Our max profit is undefined because theoretically a stock can go to infinity. So, as the stock goes higher and higher, we will make more and more money. And the max loss is simply the price we pay for the option. Since an option contract can't go below zero, then we can't lose more than what we purchase the option for. And you can also see this illustrated in the risk profile in the top right of your screen. And the break even price is simply the strike price plus the entry price of the option. If the stock is above this point at expiration, then we will have a profit. And if it's below loss. Now, we wouldn't really recommend you to trade this strategy. We feel there are much better ways to trade options. But if you decide to trade this strategy, just keep in mind that choosing a further in the money strike will provide you with a better probability of profit and choosing a further out of the money strike will give you a better potential percentage return. So all right guys, that's it for the long call strategy. Now let's talk about the long put strategy where we would buy a put option. Buying a put option is the exact same concept as buying a call option except instead of betting that the stock will go up, you're down. So buying a put option is a bearish strategy. That's the only difference. Time decay will still be against us and we're still hoping for an increase in implied volatility, but since this is a bearish strategy, the risk profile is going to look a little bit different. Basically, it will just be reversed. As the stock goes lower and lower, you will make more and more money. And if the stock price is above the strike price, meaning your put option is out of the money, then you will lose the entire amount that you paid for the option. Now, for the break even point, the calculation is slightly different. For the long call, the break even point is calculated by adding the entry price to the strike price. But for the long put, your break even is calculated by subtracting your entry price from the strike price. If the stock price is below this break even point, then you will make money. And if the stock price is above this break even point, then you will lose money. So that's really all there is to buying a call or a put option. But before we move on, let's talk about expiration. At the expiration date, if your call or put option that you own is in the money, then you're definitely going to want to close the option position before it expires. You would do this by simply selling the option that you own. If you don't close it, then it will turn into stock. Holding an in the money call option through expiration would turn into long stock and holding an in the money put option through expiration would turn into short stock. Most option traders prefer to avoid this because the stock position would require much more capital and you'll also have to pay your broker an exercise fee for turning the option into stock. The fee amount varies depending on which broker you are using, but at TDMIR trade it's $15. So, especially as a new option trader, just close all your option trades before expiration and you can avoid all of this. Now, if for some reason you do want to own the stock, then you can do one of two things. Number one, you can hold the in the money option through expiration and it will turn into stock. Number two, you could sell the call option and then buy the stock at the current market price. Both achieve the exact same thing. Let me show you why. Let's say that stock XYZ is trading at $130 per share and you own the 120 strike call option at 4. You could let the option turn into stock and you'd now own the stock at the strike price of 120. So, you'd be up $10 per share on the stock position, but you paid $4 for the option. So, really, you have a net profit of six points. Now, instead of doing this, let's say we just sold the call option and then bought stock at the current market price. We'd be able to sell the option for 10 because it's 10 points in the money. And since we bought the option at 4 and sold it at 10, we made a profit of six points on the option. And we'd own stock at the current market price of 130. So, we'd be at break even on the stock. So in this case, we'd still have a net profit of six points. Now, the reason I show you this is to show you that there really is no benefit of doing either. The pricing is always going to be fair anyways, so it's really all the same. Now, which one you should do really just comes down to the fees. If we were to let the option turn into stock, we would incur a $15 fee. But if we were to sell the option, then buy the stock, then our commission would be $1. 50 50 to sell the option plus $7. 95 to buy 100 shares of stock. So, it's obvious which one is more favorable for us because we want to pay as little in fees as possible. And by the way, this example is assuming you are on the Sky View Trading Group commission rate. So, it's up to you to know what your commission rate is so you can weigh each scenario and see which one is more favorable. Now again, most of you aren't going to want to have the stock position. So just close the option before expiration if it's in the money. Now if the option is out of the money and is worthless, then you don't need to close it in this case. You could just let the option expire. And of course, you lost the amount you paid for the option, but it will expire and disappear from your account. It won't turn into stock. The only way it will turn into stock is if it's in the money. So that's it for the long option strategy. In the next chapter, we're going to talk about the short option strategy. This is actually one of our favorites. So I will see you there.

In the last chapter, you learned about buying options. And you heard us mention several times that we at Sky View Trading don't trade options in that way. But now, let's talk about one of our favorite strategies, the short option, where we would sell an option as an opening trade with the hopes that the price of the option will go lower. First, let's go back to the basics and quickly review the definition of an option again. And first, we'll go over the definition of a put option. A put option gives the option holder the right but not the obligation to sell shares of stock at an agreed upon price, the strike price on or before a particular date, the expiration date. So if you buy a put option, then you'd be buying this right to sell stock. But there are two sides to every trade and you can take either side. So we could also sell an option as an opening trade. This is called being short the option, which is a bet that the option is overpriced and the price of the option will go lower. If this is a new concept to you, selling something before you actually own it, try not to let it confuse you too much. It's really not as complicated as it might seem. Rather than profiting from the options price rising like you would if you were buying an option, you'd simply profit from the options price going lower. So you would want to sell it as an opening trade at a higher price and buy it back as a closing trade at a lower price. So with selling an option, you are selling this right to someone. You're selling the right for them to sell stock. So you're taking on their risk and you're getting paid to do so. And if you think about it, selling a put option is just like providing insurance. So, let's say you sell a put option and then the stock crashes and the option holder decides to exercise his right to sell stock at the strike price. Well, remember you sold him this right, so you are now obligated to buy his shares from him at the strike price. So, just like a car insurance provider would prefer for you to not crash your car, someone who sells a put option as an opening trade is hoping that the stock will not crash. Specifically, if you sell a put option, you are hoping that the stock will stay above the strike price. Now, we can also sell a call option as an opening trade. It's the exact same concept, except we would do this in hopes that the stock would stay below the strike price. So selling a put option is a bullish to neutral bet. You want the stock to go up, but if it doesn't go up, that's fine, too, as long as the stock stays above your strike price. That's why we say it's bullish to neutral. And selling a call is bearish to neutral. So your head might be spinning a little bit at this point. And if it is, don't worry. Let me just show you a real example, and it should start to make sense. Check out this chart of Facebook. Facebook stock is currently trading at just above $117 per share. Now, we don't know where the stock will go, but let's say we'd like to bet that the stock won't go above 125 during the next month or so, knowing that all out of the money options expire worthless. We could sell the 125 strike call option. And the idea is we are hoping that this option that we sold will remain out of the money and the options price will gradually decay to zero. So that's the cool thing about selling options. Rather than betting where the stock will go, we are won't go, which is extremely powerful. So in this case, we're betting that the stock won't go above $125 per share. So, real quick, let's just check to see what the 125 strike call is trading for. Looking at the option chain, you can see the price of the 125 strike call is around 102 and this option has 46 days to expiration. So, we'll just say that we sold one contract of this call option at 102. And knowing that option prices have a multiplier of 100, this means we collected $12 to sell this option. Now, let's look at a few different scenarios and talk about how this trade will make us money and also how we can lose money on this trade. First, let's say the stock doesn't do much and just kind of trades sideways. Maybe it goes up a little bit and ends up at, let's just say, $122 per share. If the stock is at $122 per share, then this call option will be considered out of the money and will be worthless. So in this scenario, we simply get to keep the $12 we collected to enter this trade. And actually, this is true if the stock is anywhere below our strike price. It doesn't matter if the stock goes down, stays sideways, or even goes up a little bit. As long as it stays below our short call strike, then we will make the max profit of $12. Or in other words, our max profit is simply the amount we sold the option for. Now, scenario two. Let's say the stock doesn't cooperate and it ends up going to, I don't know, let's just say $128 per share. If the stock is at 128 at the expiration date, then the 125 strike call option will be worth its intrinsic value of three. So, if we sold this option at 102 and it's now trading at three, then we have a loss of 298 on the trade. Or, in other words, we are down $298. Now, here's the thing about selling options. If there is no limit to how high the stock can go, then theoretically selling an option like this is said to have unlimited risk, right? As the stock goes higher and higher, this option will get more and more valuable. And since we are short the option, that means we'd be losing more and more money. And this is exactly why the short option strategy gets such a bad reputation. You're taking tons of risk and have limited profit potential. It doesn't seem to make sense. Or does it? We say it does. It absolutely makes sense because in exchange for taking risk and capping your potential profits, you're being rewarded with a very high probability of profit. And real quick, I just want to mention something else just to make you think a little bit. Buying an option, like we showed you in the last section, is said to have very little risk and unlimited profit potential. And selling an option is said to have unlimited risk and limited profit potential. Which one sounds better? Of course, buying options looks very attractive at first glance. Unlimited profits, very little risk. Sure, sign me up. But in life, does anything really ever pay without taking risk? If something looks too good to be true, then it usually is. And this is why we consider buying options to be a sucker's bet. Now, the reason I point this out to you is because you'll likely hear over and over again that selling options is extremely risky. We don't believe this to be true. We believe that the theoretical risk is much higher than the actual risk. I've built my entire career off of this concept. And also keep in mind that any trading strategy is dangerous if you are overleveraged and are sizing your positions too big. and we're going to talk about position sizing in part two. With that being said, we wouldn't really recommend doing this strategy as your first trade. Since the risk of this strategy is undefined, it's hard to wrap your head around what your real risk is as a beginner. The only way to truly understand your real risk with this strategy is simply by gaining experience and getting familiar with the markets. But we also wouldn't recommend doing the long option strategy as your first trade either because it just simply is not proven to be profitable over time. Our favorite strategy for a first trade is a strategy known as the vertical spread. The vertical spread allows us to sell options like this to achieve a high probability of profit but with limited risk. You're going to learn about this strategy soon in the next chapter. But first, keep watching the rest of this chapter because even though you likely won't be trading the long or short option as your first trade, it's important to fully understand them both before moving on because they are the building block of all other strategies you'll learn about. Now, let's actually make a live trade so you can follow along and learn. And actually, let's make two trades. We're going to trade a short call and a short put. But for the first trade, let's trade a short call in Caterpillar, ticker symbol C A T. Now, if we look at a chart of the stock, you can see that it's trading at just above $95 per share. So, if we sell a call option in Caterpillar, then that would be a bet that the stock will stay below some level, and that level would be determined by whatever strike price we choose. So, let's just look at the option chain and check out the options and their prices. Here at Sky View Trading, we like to trade this strategy with 30 to 60 days to expiration. So, this January expiration with 39 days is perfect. But keep in mind, you can trade whatever expiration you want to trade. And actually, for the purposes of this example, let's choose an expiration with fewer days because I'm going to show you the entire trade cycle of these trades we're about to make, and we don't really want to wait a full 39 days. So, let's just choose the December expiration with 11 days left. Now, we just have to choose which strike price we want to trade. Remember in the Option Greeks chapter when we said delta can help us choose which strike to trade? Well, you can see that we have delta and probability in the money displayed on the option chain. And you can see that for each strike, the delta and probability in the money number are very similar. So delta can actually tell us the probability of our option being in the money at the expiration date. For example, you can see the delta on the 100 strike call option is 12. What this is suggesting is that there is a 12% chance that Caterpillar stock will be above 100 11 days from now. Now, the cool thing is this also tells us the probability of Caterpillar being below 100 in 11 days. If there is a 12% chance of the stock being above 100, then there is an 88% chance of the stock being below 100. And remember, selling a call option is simply just a bet that the stock will be below some level. Now, you're looking at the Thinker Swim platform because that's what we use to trade. But if you are using another platform that doesn't have the probability in the money feature, you can simply use Delta because every option trading platform should have delta. And you can see that the numbers are very similar. But for now, we're going to remove delta and just look at probability in the money. We don't really need to have both because they're essentially the same thing. Remember with buying options, we talked about how choosing a further out of the money strike would result in a lower probability of success. Well, the opposite is true for selling options. If we choose a further out of the money strike price, you can see that it has a lower probability in the money. So therefore, if money, then it would have a higher probability of being out of the money. And when selling an option, we want it to remain out of the money. And actually, we can just go ahead and change the way this is displayed on the option chain. We can change this probability in the money column to probability out of the money. Now, it's up to you if you want to use probability in the money or probability out of the money. They both tell you the same thing really because they are just the inverse of each other. But as a new trader, maybe probability out of the money would make more sense. You just have to decide what works for you. Now you can see that the further out of the money strikes have a higher chance of remaining out of the money and therefore expiring worthless. So choosing a further out of the money strike would give us a higher chance of the trade being profitable. But there's a trade-off. Remember, when selling an option, our maximum potential profit is simply whatever we sell the option for. And you can see that the further out of the money an option is, the cheaper it is. So, to sum it up, going further out of the money when selling an option will result in a higher probability of profit, but at the same time, you'll have a smaller profit potential. So, of course, we have to find a balance, right? If we go really far out of the money, then we're not really going to have much profit potential. For example, if we sold this 101 strike call right now, sure, we'll have a very high probability of making money, but the profit potential is only $15 per contract. So, if we sold one contract, we can only make $15. And on top of that, we have to factor in commissions that we will have to pay as well. Now on the other hand, if we choose a strike price that is much closer to the stock price, then we will have a much higher profit potential but a lower probability of profit. And there really is no magic number when it comes to strike selection. It's more about just finding a good balance. And again, just like when choosing an expiration date, you are free to choose whatever strike you want to trade. For this example, let's just meet somewhere in the middle and trade the 99 strike call that has an 84% chance of remaining out of the money. And then let's go ahead and make this trade. All we have to do is rightclick on the bid or the ask of the option and click sell single. Here we can adjust our price we want to enter the trade at and a few other things like position sizing, type of order, etc. For this trade, we're going to stick to one contract. Now, keep in mind, we are selling an option. So, we want this order to get filled at the highest price possible. Just remember, buy low, sell high. So, let's go ahead and put in this order at 35. Now, when we click confirm and send, you can see the details of the trade. You can see the break even stock price is $9935 which is simply just the strike price plus the entry price and we want the stock to stay below that level. Now the max profit is whatever we sell the option for. In this case it's $35. Max loss says infinite because in theory the stock can go to infinity, right? But again, we like to rephrase this and say that our max loss is undefined. Now, let's skip down to the buying power effect, or in other words, our capital requirement for the trade. When we bought an option, our capital requirement was obvious. Since our max loss was limited and we could only lose whatever we paid for the option, our capital requirement aka the buying power effect was simply just the price we paid for the option. But in this case, we aren't buying the option. We are selling it. And theoretically, our max loss is infinite. So how is the capital requirement determined? Well, it's simply determined by our brokerage firm. Our theoretical risk is infinite. So, the brokerage firm really just has to make their best guess at what our real risk is. And in this case, you can see that the capital required for the trade is just over $1,500. Always check this number before selling an option, as it's important to know how much of your capital the trade will tie up. And actually, we would consider this number to be pretty high. And that's mostly due to the fact that we chose an expiration date with so few days to expiration, which is one of the reasons we usually choose to place our trades with somewhere between 30 and 60 days. But either way, let's go ahead and send this order to hopefully get in the trade. Okay, so we just got filled and we are in the trade at 35. Now, the stock is currently at around 95 per share. The best case scenario for this trade is that the stock stays below our short call strike of 99. If that happens, then we will get to keep the max potential profit of $35. And we're going to see what happens. But now, let's quickly place another short option trade. But this time, let's sell a put option. Let's make a trade in ticker symbol GDX. GDX is the gold miner ETF. Selling a put option is a bet that the stock will stay above some level until the expiration date. And that level is again determined by the strike price we choose. So let's check out the option chain and make a trade. Now all the same rules apply for the short put option as they did with the call. Choosing a further out-of-the-oney strike will result in a higher probability of profit, but at the same time, it will have a smaller profit potential. So, let's just find a happy medium, and we're going to choose the 20 strike put. You can see that this put option has around a 67% chance of being out of the money at the expiration date in 11 days. So, in other words, if we sell this put option, then we will have a 67% chance of keeping the maximum potential profit of whatever we sell the option for. So, let's go ahead and make this trade. We're just going to rightclick, click sell single, and again, we're just going to trade one contract, and we're going to put in the order at 37. Now you can see this trade has a much smaller buying power effect. Or in other words, it has a much smaller capital requirement of just $329. And that's just how it goes. Some underlying stocks have a more favorable capital requirement for selling options and others are just outrageous. And it really all comes down to the price of the underlying stock, the implied volatility, etc. But don't really worry about that. Just make sure you check what it is before making the trade. So, let's go ahead and send this order and get in the trade. Okay, so there we got filled on the trade. Now that we're in both of these trades, let's see how they do as time passes and we near expiration. You can see the GDX position at the top of your screen and also the Caterpillar position just under that. And you can see the profit or loss for each position here. You can also day. And you'll notice that we have a chart of each stock price at the bottom of your screen with GDX on the left and Caterpillar on the right. For GDX, we are simply hoping that the stock will stay above 20, which is a strike price of the put option we sold for 37. And for Caterpillar, it's the exact opposite. We are short the 99 strike call. So, we are hoping that the stock price will stay below 99 over the next 11 days. Now, as each day passes, we'll show you how each position is doing. And we're not going to take profits, cut losses, or anything like that. We are simply going to hold each trade to expiration so you can see how they perform. And actually, we're hoping that at least one of these trades will be a losing trade as you aren't going to learn from only seeing profitable trades. So, let's go ahead and get into it. We have 11 days to expiration. Now, fast forward one day and you can see that both stock prices have risen for GDX. That's a good thing because you can see our delta on the position is a positive 26. 61. So, since this number is positive, that means we are benefiting from the price of GDX going higher. But for Caterpillar, you can see that we have a delta of negative 21. 42. So that means we will lose money if the price of Caterpillar stock goes higher. So you can see the stock went higher today and we are down $10. 50 on the trade. And that's shown by these parentheses. If your P& L numbers have parentheses around it, that means you are negative on the position. And if it doesn't have parentheses around it, like on GDX, that means we are making a profit. Okay, fast forward one more day. We now have 9 days left to expiration. The price of GDX has fallen quite a bit and is approaching our short strike that we want the stock to stay above. So, you can see we are down around $15 on the day and our total P& L open is $9. And for Caterpillar, you can see the stock has went in our favor quite a bit today and we are up 2650 on the day for a total P& L open of $14. Now, I'm not going to talk you through every single day, but I do want to talk about what happens this next day. If we fast forward just one more day, you can see that our Caterpillar trade is fine still, but the price of GDX has fallen quite a bit and has pierced through our strike price of 20 that we wanted the stock to stay above. Because of this, you can see that the option we sold as an opening trade at 37 is now at 123 because remember put options rise in value when the stock falls. So, we are down around 86 cents on the trade or since we are short one contract, that means we are down $86 on the position. But I also want to point out something else real quick. You can see our delta is now plus70. But a few days ago, it was much smaller than that at around plus 26. And that's just the nature of short options. As the position goes against us, our deltas will grow. This is often talked about in the trading community as gamma risk because if we are short an option, we are exposed to a lot of gamma which again is the rate of change of delta. And this is the trade-off for the fact that we have time decay in our favor which is measured by theta. Any strategy where time decay is in your favor, you will have gamma against you. You don't fully need to understand what I'm talking about right now, but I just want to point this out as this is why it's so important to keep your position sizing in check and also choose an appropriate time frame for your trades by choosing an expiration that has less gamma exposure. Remember, we tend to place our trades in an expiration cycle with around 30 to 60 days to expiration. But for these two trades, we broke that rule and decided to place a trade with 11 days to expiration. And that's why our deltas have grown so fast. Now this delta of plus 70 will actually never increase to higher than 100, right? Because we are only short one contract and one contract equals 100 shares of stock. So this delta can never increase to higher than 100. Now, we actually think of this as a great thing as we tend to be, not always, but we tend to be more bullish on stocks that have recently sold off and bearish been making new highs. So, you can think of this as, you know, as GDX goes lower, we are getting more long the stock, right? Which is nice because if we were bullish when the stock was around 21 per share, then we're going to be even more bullish when the stock is around 19. So, all right. I just wanted to point that out. Now, I'm going to show you the rest of the trade cycle. And you can see Caterpillar is doing just fine right now and GDX is struggling a bit. Best case scenario is that Caterpillar stays right where it's at and the call option that we are short will gradually decay to zero. And for GDX, we'd really like the stock to bounce at this point and rise back above $20 per share. So, let's fast forward and see what happens. So, you can see GDX is trying to bounce, but it's kind of just trading flat. But our P& L is getting a little better because time decay is in our favor. And at the expiration date, this option will only be worth its intrinsic value. And Caterpillar is doing just fine as well. And we could even take the profit on the trade if we wanted to. All right, so it's Friday and we now have zero days left to expiration. These options literally expire this evening after the market closes. So for Caterpillar, the option is pretty far out of the money and it's highly unlikely that the stock will get to 99 before the day is over. So for this one, we can simply leave the position and let it expire out of the money. If we do this, we will simply keep the $35 that we sold the option for. And over the weekend, the position will be removed from our account. And come Monday morning, we will no longer have the position, but we will have made $35 on the trade. This is cool because when the option expires worthless like this, we don't have to pay any commission fees to close the trade. It's like we are out of the position at zero and we didn't have to pay any trade fees to close the position. Now, for GDX, it's a slightly different story. This option is in the money. And if we were to hold this short option through expiration, it would then turn into long stock. Come Monday morning, we'd no longer be short the 20 strike put, but we'd be long the stock at $20 per share. Now, this is fine if you want to own the stock, but let's assume we don't want to own the stock for whatever reason. We definitely want to close the position today before expiration. You can see we are down 4750 on the trade. Let's go ahead and close the position now and get rid of it so it doesn't turn into stock. All we need to do now is rightclick the position and click create closing order and then click to buy back the put. Now you can see the order to close the put option has popped up on the screen and this is a buy order. Remember we sold the option as an opening trade and we are now buying back the option as a closing trade. This terminology may confuse you at first if you are used to referring to positions as buying them to open and selling them to close. But scratch all of that because now you know that we can sell something as an opening trade and we can buy it as a closing trade. So you can see the order to close a position and you can adjust the price or type of order or whatever. But for this trade, we're just going to enter it like this and close the option at the current price of 76. So, we'll click confirm and send. And you can, of course, see the details of the trade, but for closing trades, all of this information doesn't really matter or make any sense anyways. So, we're just going to go ahead and click the send button to send the order. Okay. So, you can see we still haven't filled on the trade. Our order is in to buy this option at 76, but you can see the bid price is 76 and the ask price is 79. So, for us to get filled immediately, we may need to cancel and replace this order and change the price a little bit. So, we're going to go ahead and do that. We'll just click cancel replace and we're going to change the price from 76 to 78 and see if we can get filled at that price. Okay, so there you can see we got filled on the trade. Now, let's recap and see how much money we lost on the position. If we click the monitor tab and go to the account statement, we can actually see our trade history in GDX. All we have to do is change the number of days back to, I don't know, 15 or so. And then we're going to narrow the results to only show trades in ticker symbol GDX. So, you can see we sold this option at 37, and we bought it back to close it at 78. So the amount we lost on the trade is simply the difference between these two numbers, right? So if we take the difference, that means we simply lost $41 on this trade. And on the Caterpillar trade, we opened that one at 35 and it will expire worthless and be removed from our account over the weekend. So we are essentially out of this position at zero. So on that position, we made $35. So not bad. Between both of these trade examples, we lost a few bucks overall. But I actually want to mention that we did a few takes on these trades in hopes that at least one of them would be a losing trade. Besides these two, we actually made three other trades in Apple, QQQ, and DIA. The reason we did this is because we were hoping at least one of these trades would be a losing trade because we wanted to show you what to do in that scenario as well as you're not really going to learn by simply looking at a bunch of profitable trades that all expired worthless. But you can see that these other three trades were also profitable just like the caterpillar trade. The reason I wanted to show you this is to show you how powerful it is to trade a high probability trading strategy. Since these strategies had a very high probability of profit, we were able to make a profit on four of them and only lose money on one of them. That's a pretty high percentage of winning trades versus losing trades. Let's quickly recap. A short call is a bearish to neutral strategy where we want the underlying stock price to go down or at least stay below the strike price of the option. Time decay is in our favor, which is why this strategy provides so much consistency. And we'd also benefit from a decrease in implied volatility. Because remember, selling options is like selling insurance. And implied volatility is a good measure of fear. When fear or implied volatility is high, then insurance or option prices will be more expensive. Now, our max profit is simply the price we sold the option for and the max loss is undefined because there is no limit to how high the stock can go. As the stock goes higher and higher, we will lose more and more money. Our break even is the strike price plus the entry price. If the stock is below our break even, we would have a profit. And if it's above this point at the expiration date, then we will have a loss. When trading this strategy, we would recommend a few things. Number one, trade the strategy when implied volatility is high. The high implied volatility will be reflected into the option prices, thus allowing us to go much further out of the money while still having a pretty decent profit potential. We're going to cover this in depth in part two. Number two, initiate the trade with 30 to 60 days to expiration. We've done a lot of research that suggests that 30 to 60 days is the sweet spot for selling option premium. And lastly, find a good balance with strike selection. We would suggest starting with the strikes around the 65 to 85% probability out of the money if and only if you can collect a decent profit. To put a number on it, maybe make sure you never sell an option cheaper than 75 cents or so. You want to sell the option for a high enough price to a be able to take profits early and b allow the profit you make to not be affected much by the trade fees you will have to pay to the broker. Now, we do break this rule every now and then ourselves, but most of the time we are selling options for no less than 75 and usually even more than that. So, all right guys, that's it for the short call strategy. Now, let's quickly go over the shortput strategy. A short put is the exact same concept as the short call, except it's a bullish to neutral strategy where we want the underlying stock price to go up or at least stay above the strike price of the option. Time decay will still be in our favor and we'd still benefit from a decrease in implied volatility. Now, the break even on a short put is the strike price minus the entry price. If the stock is above our break even, we would have a profit. And if it's below this point, then we will have a loss. Now, your max profit is still just the price we sold the option for. But the max loss on a shortput is technically not undefined. Remember, we would lose money on a short put if the stock pierces through the strike price and keeps going lower and lower. But the stock can only go so low. It can't go below zero. So technically, the max loss on a short put trade is equal to our break even stock price. For example, on the trade we just showed you in GDX where we were short the 20 strike put at 35, our break even stock price was 1965, right? Well, in this example, our max loss would also be $1965. And if we were short one put option, then that would be equal to $1,965. So technically, the max loss on a short put is simply the strike price minus the entry price. And our tips for this strategy would be the same as for the short call. So, all right guys, that's it for the short option strategy. But before we move on to the next chapter, we need to address something about trading a short option. You'll often hear horror stories about someone getting assigned stock on their short option position and not having enough capital to cover the position. This is often referred to as early assignment risk. Let me explain. Let's say you have a $5,000 account and you are short one contract of the 100 strike put option in XYZ and the capital required for that trade is just $500. So, you're all good. You have a full $4,500 left in your account that is available. But then you wake up one morning to an email from your broker. The email will go something like this. It will have a scary subject line that says, "Alert, immediate action required. " And the body of the email will say, "You've been assigned on the following positions. Please be aware that the option assignment may cause insufficient balances or short positions that cannot be maintained. " And so on. If you get this email, you're probably going to start freaking out and you're going to be like, "This strategy sucks. I'm going to lose all my money and they're going to come get my car. " We literally had someone say this to us once. They were scared that someone was going to come and repossess their car. The funny thing is, we all experienced this the first time it happened to us, and then after it happens once, we laugh at how terrified we were. And who could blame you, right? The email you got makes it sound like you've gotten yourself into some big trouble. But I'm telling you right now, if this happens to you, do not freak out. It is not a big deal. Let me show you what this email means, what actions you'll want to take if this happens to you, and also what this means for your account. Will you lose money? will they come and repossess your car, etc. So, first, all this email is telling you is that whoever took the other side of your trade, or in other words, whoever originally bought the option from you has decided to exercise their option. And long story short, the short option position has now turned into a long stock position. So instead of being short one put with the capital requirement of $500, you are now long 100 shares of stock at 100 for a capital requirement of $10,000. And actually the capital requirement would only be 5,000 because you have a margin account, which means you only have to put up 50% of your capital for stock positions. But for this example, let's just call it $10,000. The bottom line is you don't have enough capital in your account to cover the stock position. Now, there are two main things you could do at this point to fix the position. Number one, you could deposit more money into your account to bring the balance up to meet the capital requirement of owning the stock. Most likely, you are not going to want to do this because you may not have the ability to deposit more funds. Or maybe you do have the capital available, but you just don't want to put it in your trading account. No problem. You're going to want to go with the second option, which is close the stock position at the current market price and simply reenter the original option position at its current market price. And it's like it never happened, aside from the small commission of $15 you might have had to pay for the assignment. So, that's all that will happen if you are assigned early on a short option position. It's commonly referred to as assignment risk, but I absolutely hate this term because it scares a lot of new traders away from ever selling options, and it's really the least of our worries. To be honest, being assigned early is no big deal. It will not result in you getting your car repossessed, and actually, it won't even result in any trading losses, aside from the small assignment fee you will have to pay. So, actually, let's put our foot down and rename this term assignment risk to assignment nuisance. I couldn't think of anything that had a better ring to it, but that's really all it is, guys. It's just a nuisance because you will have to go in and do a little bit of management and maybe close the stock position and reopen the option position. Now, anytime you are short an option position, you will be exposed to the possibility of early assignment. But here's the thing, it rarely happens. I've made thousands of trades in my time and out of all those trades, I can only remember two or three times I've been assigned early on a position. And when it did happen, it was no big deal. I didn't lose any money from it. I didn't have to add more money to my trading account or anything like that. And actually, guys, if you're still unsure about this and you want guidance about what to do if this happens to you, feel free to email us with a screenshot of your position at info@skytrading. com and we will instruct you on what to do. So, at this point, don't even worry about early assignment. Don't believe the horror stories. Most people spreading rumors like this don't really understand options or trading. So, all right guys, that's it for this chapter. In the next chapter, we're going to get to the good stuff and you'll learn strategies that are great for your first option trade and also strategies that many hedge funds and professional traders use on a daily basis. Hey guys, before we jump into the next chapter, if you're enjoying the course so far, please do us a quick favor and hit that like and subscribe button. It really helps us out. Plus, we've got a ton more content I don't think you're going to want to miss. I also quick want to mention that if you're serious about automating and scaling your trading, we actually work with traders on a case-byase basis as well. There's a link in the description with more details if you want to check it out. Now, back to the video. Enjoy. The covered stock strategy, also commonly referred to as a

covered call, is simple but very powerful, and it's often the very first option strategy for many investors who are venturing into a more active trading style. The covered stock strategy is a great way to improve your probability of profit on your existing stock portfolio and also enhance your returns by collecting option premium against your stock positions. Let me show you how this works. The covered stock strategy is simply just a combination of long stock and a short call. So you'd buy stock and then you would sell a call option against the stock. Let's look at an example to see how this works. The current price of stock XYZ is $75 per share. And you can also see the prices of the options here with let's just call it 30 days to expiration. For this strategy, we're going to buy 100 shares of stock at the current price of 75. And we're also going to sell a call option. We can sell any strike option we want, but for this example, let's say we sold one contract of the 85 strike call for two. So, we are long stock at 75 and short the 85 strike call at two. Now, let's look at a few scenarios to see how this trade works. All right. So, we are long stock at the current price of 75 and we sold the 85 strike call against the stock and that expires in 30 days from now. Okay. Scenario one. Let's say the stock goes from $75 per share up to $85 per share. So, it goes up and ends up right at our short call strike of 85. If the stock is at $85 per share and the strike price of our option is 85, then our option is at the money, but it still isn't in the money, right? It doesn't have any intrinsic value. So, the option we sold is now worthless because for it to have any value, it would have to be in the money and have intrinsic value. So now let's see what our profit or loss would be on the overall trade if we were to exit this position here at expiration. The stock is now 10 points higher than where we bought it. So we made 10 points on the stock and the option that we sold at two is now worthless. So we made two points on the option. So our total net profit is 12 points. or in this case, we kept our position size at 100 shares and one contract. So, we made $1,200. And that's how we look at it. We treat this as one trade. And we are really just concerned with the net prices of the spread as a whole. The combination of long stock and short call is called covered stock. And our net entry price or net cost of the covered stock is 73, right? Because we paid 75 for the stock, but we collected $2 in option premium. So 75 - 2 is 73. And our net exit price is 85 - 0, which equals 85. So rather than monitoring the prices of each individual leg of the trade, we can just monitor the prices of the spread as a whole. So we bought this spread at 73 and sold it at 85. So our net profit is 12 points. Okay, so the stock went to 85 and we made 12 points on this covered stock position. That's great. If we were to have just bought stock, we would have only made 10 points. And by selling the covered call, we added a full two points to our profits. But here's the thing. This profit of 12 points is actually our max profit on this trade. Even if the stock goes to 100 or 150 or any number above the strike price of the call, we will still only make our max profit of 12 points. The reason is because if the stock goes up and goes well past the option strike price, then the losses on the short call will cancel out much of the profits on the long stock. Right? For example, if the stock is at 90, then the call would be at five since it's five points in the money. So, we will have made 15 points on the stock and lost three points on the short call. So, our net profit is still just 12 points. One more example. Let's say the stock doubles in the next 30 days and goes to 150 per share. That's obviously very extreme and isn't going to happen that often, but if it did, the call would be worth 65 since it is 65 points in the money. So, we will have made 75 points on the stock. And on the call, we sold it at two and bought it back to close it at 65. So, we lost 63 points on the call. So a profit of 75 minus the losses of 63 and that means our net profit is still just 12 points. Basically the price of the spread as a whole can never go higher than 85 or in other words it can never go higher than the strike price of the option. So to sum it up, if the stock goes through our short call strike, then it's no harm to us at all, other than the fact that some traders may beat themselves up that selling the call capped their huge gain they would have had. But that's an amateur thing to do because it's all hindsight anyways. Really, we want the stock to go through our short call strike because that means we make the max potential profit. Okay, scenario two. the stock doesn't do much and maybe it even goes down a little bit and ends up at 7350. If we bought stock at 75 and it's now at 7350, then we are down $1. 50 per share on the stock. And since the stock is below our short call strike, our short call is out of the money and is now worthless. We sold the option at two and it's now at zero. So, we made two points on the option. So, the net profit on the entire trade is 50 cents because the profits on the option more than offset the losses on the stock. And that's what's so cool about selling the covered call against the stock. It cuts down our cost on the trade, which therefore improves our break even point. If we were to instead just trade the stock, then our break even point is simply right where we purchased the stock. If it goes up, we make money and if it goes down, we lose money. But selling the call against the stock allows us to have a better break even point. In this case, our break even point is at 73. So even if the stock goes down a little bit, we can still make money. So yes, selling a call against our stock caps our potential profit, but in exchange for that, we are rewarded with a better break even point and therefore a better probability of profit. Okay, scenario three. How do we lose money? Well, we lose money if the stock is anywhere below our break even point, right? Let's say the stock goes down and ends up at 67. If this is the case and we lost eight points on the stock, but again, the call that we sold at two is now worthless. So, we made two points on the call. So, on the overall trade, our net loss is six points. Now, we lost money, but we lost less money than if we were to just buy the stock without selling the covered call. So, that's how the trade works. Basically, in this example, we are always going to be two points better off, unless the stock skyrockets to the upside. In that case, we will just simply have missed out on the big move. Now, let's go over to the ThinkersW platform so I can show you how to trade this strategy. Now, there are two ways you can trade this strategy. The first way is you can sell a single call option against stock that you already own. If you do this, the strike you choose should be based on where you are willing to sell the stock at. And selling the call will not require any additional capital. Your brokerage firm will recognize that you own stock already and it will not require you to put up any additional capital to sell this call against your stock because doing so adds absolutely no risk to your portfolio. And if it doesn't add any risk, then it shouldn't require any additional capital. The second way to trade this strategy is to enter the trade as one position and also close position. I'll show you how to do that now. Let's say we want to buy shares of Apple at the current price of1629 and we will be more than happy to sell the shares of Apple if it goes up to let's say 1119. In this case, we could buy covered stock where we would buy Apple stock at the current market price of 11629 and we'd also simultaneously sell the 119 strike call option. All we have to do is rightclick the bid or the ask of the 119 call, click buy covered stock, and the order will pop up to place the trade. Now, check this out. This is the cool part about trading spreads. The technology is advanced enough for us to trade the stock and the option that make up this spread with one order, which allows us to just trade the net price of the spread and treat it as one trade. So you can see that Apple stock is around 11629 and the 119 strike call is around 1, but the platform automatically calculates the net price of the spread as a whole. And you can see that we are buying this spread for 11528. Now we can change the position sizing to whatever we choose and it will automatically keep the correct ratio of one contract for every 100 shares. And we can also change the price we want to enter the trade at. And remember, we are buying this spread, so we want to get filled at the lowest price possible. And for this example, we're just going to enter the trade at the current prices. Now, it's always good to do one last check before sending the order and make sure that the spread you are trading is correct by looking at the individual legs of the trade. You can see that we are selling the 119 call and buying 100 shares of stock. So this order is correct and we can go ahead and click confirm and send. Now on the pop-up box you can see all the details of the trade including the buying power effect or the capital requirement to make this trade. In this case the capital requirement is a little over $3,000 and the max loss is simply the price we pay. Right? 11528 * 100 shares is $11,528. Because if the stock goes to zero, then we will lose the full amount. But of course, this is highly unlikely. Is a company as large and dominant as Apple really going to go to zero? Okay, moving on. The max profit is the difference between the strike price and the entry price of the covered stock because this spread can't go above the strike price of 119. So if we buy it at 11528 and sell it at 119, then we will make the difference which is 372. Lastly, the break even stock price is simply just the price we paid for the covered stock. As long as the stock price stays above this level until the expiration date, then we will make money on the trade. So that's it. Now we can click send and get in the trade. So all right guys, that's it for the covered stock strategy. Here's a quick overview for you so you can pause the video and review it before moving on to learning the next spread. And I will see you there.

Most option traders start out buying options because it's simplest to understand. If you think Facebook stock will go up, you could buy a call. And if you think Facebook stock will go down, you could buy a put. This sounds great because you can trade the options with much less capital than if you were to simply trade the stock. Let me show you an example. First, let's look at an option chain on stock XYZ, which is currently trading at $75 per share. Let's say you are bullish on the stock and you're looking to buy a call option. So, we're just going to go ahead and ignore the put options for now. If you were to buy the 70 strike call option, for example, this would cost you $750 and you're hoping that the price of XYZ will rise so you can make money. But this is not a very good trading strategy because it puts time decay against you. And not only does the price of XYZ have to move up, it has to move up a significant amount for you to even break even. In this case, your break even is at 7750, a full 2 1/2 points above the current stock price. And if XYZ sits still and trades sideways, you're screwed because your option you just bought will decay each and every day. And that's what options are, guys. They are depreciating assets. And any smart investor is not going to buy a depreciating asset and call it an investment. Let me show you a better way that allows you to make a directional bet on the stock, but without having to buy a naked option or put up tons of capital to trade the stock itself. And we're actually going to eliminate time decay altogether. Instead of just buying the 70 strike call option, we're going to do something a little bit different. We're going to buy this option, but we're also going to simultaneously sell a cheaper out-of-the-oney option to reduce our cost. So, in this case, we're going to buy the 70 strike call for $750, but we're also going to sell the 80 strike call for $250. This knocks our cost down by a full $250, and our net price is now just $500. This is called buying a vertical spread. By trading a vertical spread rather than simply buying a single option, we're able to significantly reduce the cost of our trade, which improves our break even on the trade and our probability of success. The net price we pay for this vertical spread is $5. So, our break even is at $75 per share, which is where the current stock price is. If you're lost, hang with me. I'm going to show you how this works. Let's compare the two strategies in three different scenarios. Scenario number one, XYZ stock price has moved up and at the expiration date, it's at $79. 50 per share. First, let's look at the 7080 vertical spread. The short 80 call that you sold for $ 250 would now be worthless because it's out of the money. So you made $250 on the short 80 call and the long70 call you bought for $7. 50 is now $9. 50 in the money. So it's worth $9. 50. So you made $200 on the long 70 call. So your net profit is $450. Now remember the net price we paid for the vertical spread was $500. So, our return on capital was 90%. Our max risk was simply the net price we bought the spread for, which was $500. Now, let's compare this to if we simply bought the 70 call for $7. 50. With the stock at $7,950, our long call would be at $950, providing us with a profit of $200. So, our return on capital was only 26. 67%. Our max risk was $750 we paid to buy this option. Let's look at scenario two. XYZ has mostly traded sideways and at the expiration date, the price is still at $75 per share. Looking at the vertical spread, our long 70 call will now be worth $5, resulting in a loss of $250 on that leg of the trade. But our short 80 call will again be worthless, resulting in a profit of $250 on that leg. So, the two cancel out and we would actually just be at break even on the trade. Now compare that to if we simply bought the 70 call at $750. We would now be sitting on a $250 loss. So in the case of the vertical spread, time decay was not an issue whatsoever. However, if you just bought the 70 call rather than trading the vertical spread, you're sitting on a 33% loss due to time decay. Okay, scenario three. We are completely wrong about the direction of XYZ and the stock tanks down to $50 per share. Both of the options that make up our vertical spread are out of the money and are worthless. So, we lost 750 on the long 70 call, but we made 250 on the short 80 call. So, our net loss is $500, much less than losing $750 like we would have if we were to simply buy the 70 strike call. Buying the vertical was better than buying the naked option in all three of these scenarios. But there is one scenario where buying the naked call would have worked out better. Let's say the stock rips higher and is now at $85 per share at the expiration date. For the vertical, the 70 call we bought for 750 would now be worth 15, providing us with a profit of $750 on that leg. And the short 80 call we sold at $ 250 would now be worth five, resulting in a loss of $250 on this leg of the trade. So our net profit is only $500 as opposed to $750 if we would have just bought the call. So that's the only downfall with the vertical spread is that it has limited profit potential. Whereas buying the naked option allows us unlimited profit potential. But is the profit potential really unlimited? Of course not. That's just theoretical because theoretically a stock can go to infinity. But look, you still made 100% return on capital on the vertical spread. So, what is there to be upset about? And trust me, these three scenarios are going to happen way more often, and the vertical spread will pay you far more in the long run than the few times you might eventually hit a home run with buying the naked option. Now, let me show you how to pull up an order to buy a vertical spread in the Thinker Swim trading platform. All you're going to do is go to the option chain, rightclick the option you want to buy, then click buy vertical. From there, all you have to do is adjust your strike selection. I personally prefer to buy one strike in the money and sell one strike out of the money when trading this strategy. Now we can click confirm and send and view the pop-up box to see the details of the trade such as max profit, max loss, capital required and break even stock price. And you can also do this on the put side if you want to make a bet that the stock will go down. So all right guys, let's quickly recap the long call vertical. It's a bullish strategy and it's kind of like stock replacement and that it's just simply a directional bet on the stock. So, if you properly choose your strikes, then time decay will not be an issue, but it also won't be in your favor. And the same goes for implied volatility. Now, your max loss or your max risk on this strategy is simply the net entry price. You can only lose the net amount you pay for the spread. And your max profit is simply the strike width minus the entry price. For example, if your long option strike is 70 and your short option strike is 75, then your strike width is five points wide, right? So then you would just take five minus the entry price. So let's say you bought this spread at two, for example. That would mean your max potential profit on the spread is three points, right? Because the spread can never be worth more than the strike width. So if you bought the spread at two and sold it at five, then you made three points. Now, your break even point is simply just the long option strike plus the entry price. So continuing the example I just showed you, you would simply take your entry price of two and add it to your long option strike of 70. So your break even stock price would be 72. If the stock is above 72, then you'll make money and if it's below 72, then you will lose money. And lastly, our tips for this strategy. Well, first choose strikes where you are paying about 50% of the strike width. So, if your strike width is one point wide, then you would want to pay about 50. And if it's five points wide, you'd want to pay around 250 and so on. And the reason we say to do this is because if you pay about 50% of the strike width, then that should put your break even point right at the current stock price. And that's really what it comes down to. Just make sure that your break even point is better than or equal to the current stock price because if you make sure of that then time decay will not be against you. If the stock doesn't move and just trades sideways, you will still break even. And for our second tip, we say trade this strategy with small size because we don't have that much of an edge with this strategy since it's simply just a directional bet similar to if you were to just buy stock outright. It's a cheaper way to make this directional bet, but it's still just a directional bet. Now, the long put vertical is the exact same concept, except instead of being a bullish strategy where you want the stock to go up, it's a bearish strategy where we would want the stock to go down. So, the risk profile would look a little bit different. It would look like this. Now your max profit and max loss are calculated in the exact same way but your break even point is calculated slightly different. Instead of adding your entry price to the long option strike you are going to subtract it from the long option strike. If the stock is below this level then you'll make money and if it's above this level then you will lose money. So all right guys that's it for the long vertical. Now let's talk about the short vertical.

In an earlier video, we talked about how you can sell options to collect time premium because we know that if an option is out of the money at the expiration date, it will be worthless. So, let's look at a real example. Netflix stock is trading at $93 per share, and we don't know where the stock will go, but we would like to bet that it won't go over $100 per share. You could of course sell the 100 strike call option for let's say $3. And if this option remains out of the money until the expiration date, meaning that the stock stays anywhere below 100, then we would get to keep this entire credit received as profit. And you know, it makes a lot of sense. However, there are a few problems with this that keeps the majority of traders away from selling premium. Number one, we don't know our max risk. Netflix could skyrocket and blow right through the 100 strike. Number two, the capital requirement to sell this option could be very large. So, what can we do to combat these two problems? Well, in addition to selling the 100 strike call for $3, we could also simultaneously buy the 105 strike call for, let's say, $1. 20. This is called a short vertical spread. By trading a vertical spread rather than selling just a naked option, we are able to sell time premium but with very little capital and also with defined risk. So how exactly does this trade work? Well, let's think about three different scenarios. Scenario number one, Netflix stays below $100 per share. Now, we already know that if an option is out of the money at the expiration date, it will have no value. And if the stock is below 100, then that means both of our options that make up our vertical spread would be classified as out of the money and are worthless. That means we made $300 on the short 100 strike call, but we lost $120 on the long 105 strike call. So our net profit is $180. And that's how we look at it. We don't really care about each individual leg of the trade. All we care about is our net profit of the vertical spread as a whole. And actually, once you understand vertical spreads and start trading them, you probably won't even look at the prices of each individual option. You'll simply monitor the price of the entire spread itself. And I'll show you how to do that at the end of this video. Now, in this scenario, we don't have to do anything with this trade. We can let these options expire worthless and they will disappear from our account and we won't have to pay any commissions to close it. Or if you'd like, you could also close the trade any time prior to expiration. Now, let's check out another scenario. Even though there's only a 1% chance of it happening. Let's say Netflix stock decides to go nuts and ends up at $130 per share. Let's break it down and see what each individual option price will be. Our short 100 strike call that we sold for $3 is now 30 points in the money. So now it will be worth $30. If we sold this call naked, that sucks big time because that means we lost $2700. But fortunately, we traded a vertical spread instead of selling the naked call. Our 105 strike call that we bought for $120 is now 25 points in the money. So even though we lost $2,700 on the short call, we made $2380 on the long call. So our net loss is just $320. Now again, we aren't really concerned about each individual leg of the trade. The loss of $320 will be the same whether we're at 130 or $190 or any other number above $105 per share. If we are above $15 per share, the net price of the vertical spread will be worth the difference between the strike prices we chose when we open the position. The difference between the strikes on this example is five points. So, in absolutely no situation will this vertical spread ever be worth more than $5. If we sell the spread at 180 and close it at five, then we lost $320. Okay, so last scenario. What if the stock ends up between our short and long strikes of 100 and 105? Well, in this case, the 105 strike call will be out of the money and the 100 strike call will be in the money. So, the 105 call will be worthless and the 100 strike call will be worth the difference between the stock price and the strike price. If the stock is at 101, for example, then the vertical spread as a whole will be worth $1. And of course, if we sold at 180 and closed it at one, then we made $80. But where do we break even? Well, we sold this vertical spread for $180. So, our break even is 180 plus our short strike of 100. So, if the stock is anywhere below 10180, we'll make money. And if it's anywhere above 10180, we're going to lose money. I'm going to show you some real trade examples in my trading platform. But first, let's recap a bit. When selling a vertical spread, our maximum profit is simply the net price that we sell the vertical spread for. In this case, we sold the vertical spread for a net price of 180. So, our maximum potential profit is $180. And by the way, you can also see this on the chart in the bottom of your screen. The x-axis or the horizontal axis represents the stock price and the y-axis represents our profit or loss. So, that's represented by this blue line. Our maximum loss is the width between our strikes of our spread minus the price we entered the trade for which in this case it came out to be $320. And by the way, this is also your capital requirement for the trade. And finally, our break even is our short strike plus our net price we entered the trade, which is 10180 on this example. I know this may sound like a lot to remember, but the cool thing is that all of this information is automatically calculated and given to us by the Thinker Swim platform before we send our order. And you may be wondering why anyone would take a trade where you are risking more than you can potentially make. The reason is because it allows you to achieve a very high probability of success and profit without having to predict stock prices. Risk-to-reward and probability of success are directly tied to each other. Now, let's check out a few real examples in my trading platform. So, here we are in the ThinkersW platform. And the cool thing about trading spreads is that the technology is advanced enough to allow us to enter the multiple options that make up the spread as one order. So, we're looking at the option chain of SPY, which is the S& P 500 ETF. All we have to do is rightclick any out of the money option. And in this case, we're going to do the call side and right click the bid or the ask and then click sell vertical. And you can see it pulls up an order and it defaults to one strike wide. We can now adjust our strikes to whatever strikes we want. And our short strike, the one we are selling, would be our strike that we want the stock to stay below. Now we can select our price. And since we are selling this vertical, we would want to get filled at a higher price. When trading spreads, the default is the mid price between the bid and the ask on both options. So, use the mid price as a guide. The closer to the mid price that you can get in the trade, the better. And this is why we stick to only liquid stocks in our Sky View watch list that you'll find on our website. So, now that we have our price selected and our order pulled up, now we can go ahead and click confirm and send this order. Also, our example involves selling a vertical call spread where we would want the stock to stay below our short call so we can keep the credit we received for the trade. Well, we could also do this with the puts where we would sell a put and then buy a further out of the money put as protection. In this case, we would want the stock to stay above our short put strike. So, a short put vertical would be a bullish to neutral trade and a short call vertical would be a bearish to neutral trade. The key here to remember is that when selling a vertical spread, whether it's calls or puts, we want to make sure that we are selling the closer to the money, more expensive option, and we are buying the further out of the money, cheaper option. If you use the Thinker Swim platform to construct your vertical spread, it will default to this for you. So, all right guys, that's it for the short vertical spread. Here's a quick overview of the short call vertical. Again, it's a bearish to neutral strategy. Time decay is in our favor and we will benefit from a decrease in implied volatility. And our tips for this strategy would be to collect about 20 to 33% of the width of your strikes. What we mean by this is let's say your short and long option strikes are five points away from each other. Well, 20% of five is one and 33% of five is $167. So, if we sold a vertical that is five points wide, then we would want to choose strikes that allowed our entry price to be somewhere between 1 and 167. The reason for this is because it gives us plenty of profit potential while still allowing us to have a decently high probability of profit. And this is just a rule of thumb. Sometimes we break this rule, but in general, we try to stick to it. Now, our second tip is to initiate this trade when implied volatility is high. If implied volatility is high, then the options will be expensive. So that will allow us to go further out of the money while still collecting a nice profit potential. And the short put vertical is the same thing except it's a bullish to neutral strategy where we would want the stock to stay above our short put strike. And to be specific, we actually only need the stock to stay above our break even point. But best case scenario is that the stock stays above our short put strike. That's where we make the max potential profit. So now you've learned all about the vertical spread, but now let's take it one step further and learn the iron condor.

What you are looking at is an option chain of Netflix. And these options have 37 days until they expire. Here are the out of the money calls and puts. And we know that if these options remain out of the money, they will gradually go to zero. And I'll just show you an example here. Let's just reference the 90 strike put. It's trading at 335x 350. Now, let's fast forward to the options that expire in just 2 days. You can see that they are all much cheaper. And if you look at the 90 strike put that expires in 2 days, it's only at 11x 15, whereas the 90 strike put with 37 days to expiration is at 335x 350. So each and every day, time premium is sucked out of these options. Now, if you buy options, you already know that you are constantly fighting this time decay. Instead of fighting it, we prefer to let it work for us and make us money. Let me show you one of our favorite option strategies that you can start utilizing immediately to put time decay in your favor, even with a small account. We can achieve this by trading an iron condor. So, what exactly is an iron condor? Don't let the name intimidate you. It's actually very simple. The first part of an iron condor consists of selling to open an out- of-the- money put and simultaneously selling to open and out-of-the-oney call. We would do this in hopes that between now and expiration, the stock will stay in between the strikes and the options we sold will go to zero. If this is the case, we will keep the entire price we sold these options for. But since short naked options can have a lot of risk and can require a lot of capital, we are also going to buy a further out-of-the-oney put and call for protection. These four option trades are collectively called an iron condor, but we're selling two options and buying two options. So, how does this work? Well, let me show you. Stock XYZ is trading at $75 per share. Let's sell the 85 call for $2. And we're also going to sell the 65 put for $2. And our idea is that the stock will stay in between these strikes and the options we sold will expire worthless. But again, since naked options theoretically have unlimited risk, we are going to buy some protection. So, we're also going to buy the 90 call for a dollar and the 60 put for a dollar. And I know that keeping track with all of these individual option trades seems like a lot to keep up with, but we can actually trade an iron condor with one order and view it as one trade. And I'm going to show you how to do that in the end of the video, but for now, just stick with me. Let's say we initiated this trade with 30 days to expiration. And as time passes and we near expiration, let's say the stock doesn't move much and just kind of bounces around and trades sideways. So, as we near expiration, these options remain out of the money and the price of each option gradually goes to zero. If all of these options are worthless, what does that mean for our trade? Well, we make $200 on the 85 call and also on the 65 put because we are short those options and they are now at zero. So, we collected a credit and since they of no value, we get to keep that credit. Okay. But we also lost some money on the options we bought as protection. We lost $100 on the 90 strike call and also on the 60 strike put because we bought these options and they now have no value. Adding all of these numbers up totals to a net profit of $200 because we made $400 on the short options and lost 200 on the long options. So by trading an iron condor, we are simply betting that the stock will stay within a certain range. And we treat it as one trade. We lost money on the long call and put, but that's exactly what we want to happen because we simply bought these options as protection. It's kind of like we pay for car insurance, but we don't actually want to crash our car. So, now that you know how we make money on the trade, let me show you how we can lose money and also how much we can lose. Let's say the stock goes crazy and although it was completely unexpected, it goes well outside of our range we wanted it to stay in and ends up at $96 per share. Well, we already know that both the long put and the short put are out of the money and are worthless. So, we made $200 on the short put and lost 100 on the long put. So, this totals to a net profit of $100 on the puts. But what about the calls? The 85 call is 11 points in the money, so it's worth 11. And the 90 call is six points in the money, so it's worth six. We are short the 85 call at 2 and it's at 11. So, this means we lost nine points or $900 on that leg of the trade. So, that sucks. But fortunately, we bought the 90 call for protection. We paid $1 for the 90 call and it's now trading at six. So, we made $500 on that leg of the trade. This $500 and the $100 we made on the put side cancels out much of the $900 we lost on the short call. Adding up all of these numbers totals to a net loss of $300 on the entire trade. Now, this is the cool part. We lost 300 on the entire trade, but that's the maximum amount we can lose on this trade. No matter where the stock is, it doesn't matter if the stock goes to 104, 25, 0, infinity, whatever the case may be, we can't lose more than $300 on this trade. And the way we end up with this max loss is if the stock is outside of our long option strikes at the expiration date. Now I keep mentioning how we treat this trade as one trade. When we trade an iron condor, we are usually just monitoring the price of the iron condor as a whole. Check out this iron condor we just opened in Facebook. You can see that when we trade an iron condor, the platform automatically calculates everything for us. We are able to see the individual legs of the trade, but we are also able to see the total net prices. In this example, you can see we sold this iron condor at $112. It's currently trading at 82, and we have a profit of just $30 on the trade. When trading an iron condor, our maximum potential profit is simply the price we sold the iron condor for. In this example, for a net price of two. So, our maximum profit is $200. Our maximum loss is simply the width between our short and long strikes minus our net entry price. So in this case, our strikes are five points wide on both the call and put side. And if we subtract our entry price from that, we get a max loss of three points or $300. This $300 is also our capital requirement for the trade. This is the reason the iron condor is so powerful because we can sell option premium with very little risk and also without the large capital requirement. Now our break even prices that we need the stock to stay between is just our entry price plus the short call strike. And on the downside it's our short put strike minus our entry price. And at the expiration date if the stock stays within this range then we make money. And if the stock is outside of this range then we lose money. And I know this seems like a lot to keep up with, but check this out. Before entering the trade, the Thinker Swim platform will calculate all of this information for you. On this pop-up box, you can see your max profit on the trade is $200. Your max loss is $300. And the range you need the stock to stay between for you to at least break even is 63 and 87. So before you trade an Iron Condor, just be sure to check this popup box before sending the order. Now, let me show you how to pull up an order to trade an iron condor. Let's say that we want to collect time decay in Tesla options, but we aren't necessarily bullish or bearish on the stock. To do this, we're going to trade an iron condor, and the strikes we choose are going to give us a neutral stance on the stock. First, before we build the iron condor, we need to add the probability in the money column to our option chain. If you are using a platform that doesn't have this feature, then you can use Delta instead. For this example, we're going to trade an iron condor with 30 days to expiration. You're free to choose whatever expiration you want to trade in, but we prefer to initiate our trades with 30 to 60 days to expiration. Now, for starters, let's find a call with a probability in the money of 13%. That brings us to the 260 call. We're going to right click on the bid, click sell iron condor. In this case, it defaulted to five points wide, which is what we're going to stick with in this example. So, you see we're selling the 260 call and buying the 265 call for protection. Now, we just have to select our put strikes. Since we want to place a trade that is directionally neutral, we will find a put that has the same probability in the money as our call did. Scrolling up, we can find the put that has a probability in the money of around 13. And that brings us to the strike of 18750. So, we're just going to adjust the short put strike on our order to 18750. And then adjust the long put to five points further out of the money to 18250. Now, if we click confirm and send, we can see our max profit is $11. Our max loss is $399. And the range we need Tesla to stay between is 18649 and 26101. This gives us a nice wide range for us to make a profit. So the trade has a very high probability of success, but it has a poor risk-to-reward because our max profit is only 101 and our max loss is 399. What we could do is just simply move in our strikes a bit. This will lower our probability of success because it will narrow the range we need Tesla to stay within. But in exchange for this, we will collect a bigger credit for the trade, which improves our risk-to-reward. So, let's move the strikes in 10 points on both sides. You can see our credit is now 170 rather than just 101. Now, let's see what this iron condor will be trading at in the future if the stock price and implied volatility doesn't move. To do this, we can just look at the same trade, but with only 2 days to expiration rather than 30. So, we're just going to change the expiration of our order to the July weekly options that expire in two days. You can see the net price of the iron condor is just at 1 cent. We could do one of two things. We could close this position at 1 cent for a profit. Or we could try and let the options expire worthless as long as the stock stays still and the options remain out of the money. The choice is yours. So, all right guys, that's it for the iron condor. Here's a quick overview for you so you can recap everything you've learned about this strategy.

Let's talk about the butterfly. This one is really cool. It's an extremely versatile strategy because you can trade it in so many different ways. But the overall premise of the butterfly strategy is that you want the stock to pin at a certain strike. What I mean by this is that instead of making a trade where you'll make your max profit if the stock stays within a certain range like with the iron condor that you just learned about, you're actually going to be pinpointing an exact price. And if the stock finishes right at or very close to this price at the expiration date, then you're going to hit a home run and you can make a lot of money. Let me show you how this works. XYZ stock is currently at $75 per share. And let's say we want to place a bet where we will make a lot of money if XYZ stock moves up to 80 per share and finishes right there at the expiration date. We can achieve this by buying a butterfly. To construct a butterfly, we're just going to buy one contract of the 75 strike call at 450, sell two contracts of the 80 strike call at 3:15, and also buy one contract of the 85 strike call at two. And the combination of these three option legs make up our butterfly. Now, there's actually an easy way to remember how the butterfly spread is constructed. We refer to the middle strike as the body of the butterfly and then the two other strikes are kind of like the wings of the butterfly. So just remember sell the body and buy the wings. Now let's actually look at a few scenarios to see how this trade works. Again, the butterfly is a strategy where we will benefit from the stock pinning right at a certain price. In this case, we want the stock to finish right at $80 per share at the expiration date. So, for the first scenario, let's say that this happens. The stock goes up and ends up right at the body of our butterfly at expiration. This is the best case scenario. And here's why. If the stock is at 80, then the 75 call that we are long will be worth five because it's five points in the money. The 80 strike call that we are short will be at zero. And the 85 strike call that we are long will also be at zero. Now let's total everything up to see what our profit will be on the entire trade. For the 75 call, we bought this option at 450 and it's now at five. So we made 50 on that leg of the trade. Now, for the 80 strike call that we are short, we made 315 on that leg of the trade because we sold it at 3:15 and it's now at zero. But remember, we are short two contracts of this option. So, to keep it as simple as possible, we're just going to go ahead and multiply our profit by two. And this means we actually made 630 on this leg of the trade. And lastly for the 85 strike call, we bought this option at two and it's now worthless. So we lost two points on this leg of the trade. And if we total all of these numbers up, you can see that we made a net profit of 480 on the entire trade. I know this seems like a lot to keep up with, but the cool thing is you don't have to. Just like with every other option spread, we are simply just concerned with the net price of the spread as a whole. In this case, we bought the butterfly spread for 20 and we sold it for $5. And this is all that matters. All you care about is that you bought the butterfly for a certain price and then you're trying to sell that butterfly at a higher price. And the difference between your buy and sell price is your total net profit. The only reason I show you the profits and losses of each individual leg of the trade is just to show you how the trade actually works. But technically, all you really need to know is that you're buying a butterfly for a certain price and you're trying to sell it at a higher price. And you will be able to sell it at a higher price if the stock moves towards the body of your butterfly as time passes. Now, the only way you're going to make this max profit is if the stock is exactly at 80 at the expiration. And yes, this is a long shot. There's a very low probability that this would actually happen. But that's also the reason that this trade, if it plays out, would pay you $480 for every $20 you have invested. And I'm actually going to show you how you could modify this trade to make it have a higher probability of profit. But before I do that, you need to fully understand the strategy. So, first let me show you a few more hypothetical scenarios for this trade. Okay. Now, let's say the stock doesn't exactly go to our short strike. It trades sideways mostly and still goes up a little bit. Maybe it ends up at 76 at expiration. If the stock is at 76, then the 85 strike call and also the 80 strike call are again worthless. So, we lost two points on the long 85 call and we made 630 on the short 80 strike call. But the only difference is the long 75 call is now only one point in the money. So, it's worth one point. If we bought this call at 450 and sold it at 1, then we lost 350 on this leg of the trade. So on the trade as a whole, we bought the butterfly at 20 cents and it's now at one. So we made a profit of 80 cents on the trade. And this is really where the butterfly is powerful. Obviously, we're very rarely, if ever, going to be able to pinpoint the exact location of the stock at expiration. But you see, in this scenario, we were still able to turn a tiny $20 investment into $100. And the stock was a full four points away from the body of our butterfly. Okay. Now, how do we lose money? And also, how much can we lose? Well, we lose money if the stock is anywhere outside of our long strikes. If the stock goes down to 70, for example, all of the options will be worthless. So we will have simply lost the 20 cents that we paid for the butterfly. So that's our maximum loss. We can only lose the amount we pay for the butterfly because it can't go below zero. Now, whenever I say that the butterfly spread can't go below zero and you can't lose more than the amount you pay for the butterfly, this is assuming that your long strikes or the wings of the butterfly are the same distance away from your short strike or the body of the butterfly, right? So, for example, if you were to change this 85 strike to the 90 strike, then it would just throw everything off and you could actually lose more than the amount you pay for the butterfly. Now, skewing the strikes like this is actually another strategy, and we call it the broken wing butterfly. It's a great strategy as well, but it's completely different than the regular butterfly. So, make sure you learn this regular butterfly first before trying to learn the broken wing butterfly. And just keep in mind that your max risk is the price you pay for the butterfly, assuming that your strikes are symmetrical. I just wanted to quickly mention that because I don't want anyone getting fancy with the strike selection thinking that the trade will work in the exact same way and end up losing a lot of money because they heard me say that they can't lose more than the entry price that they paid for the spread. So, just keep that in mind. Everything I'm saying in this lesson is true, assuming the wings of the butterfly are equidistant away from the body of the butterfly. Okay, now back to what we were talking about before I went on that little rant. In all of these scenarios that I showed you, the stock was either at or below our short strike of 80. So, what happens if the stock goes higher and I don't know is above 85, for example. Well, here's the thing. This strategy is symmetrical. You'll see what I mean by this. If we look at the risk profile, you can see that we make our max profit if the stock is at 80. And if the stock is anywhere above 85 or below 75, then we make our max loss. And between there, it's symmetrical and basically just depends on how close the stock is to 80. Now, I'm not going to go through any more scenarios because it would be a bit redundant. But let's do a little exercise. Let's say the stock goes up and is at 90 at expiration. Now, get out a piece of paper and fill in all the blanks that you see and see if you can figure out what your total net profit or loss is. Then, I'll reveal the answer for you at the end of this video so you can check to see if your answers were correct. Okay, moving on. Remember how I said that we are able to modify this butterfly to improve the probability of profit on the trade? Well, let me show you how to do that. Now, when we are constructing the trade, we would just want to widen out the width between the strikes a little bit. So, instead of just five points between them, like in the example we showed you, let's say we decided to widen them out to 10 points between each strike. So, we'd be along the 70 strike call at 8:15. And again, we'd be short the 80 call at 3:15 because that one didn't change. And lastly, we'd be long the 90 call at one. Totaling up all of these buy and sell prices would bring our net cost of the butterfly as a whole to 285. And since the strikes are 10 points wide, the maximum amount we could sell the butterfly for would be 10. So if we buy the butterfly at 285 and sell it at 10, then that means our max profit is 715. So, for the fivepoint wide butterfly, we had the potential to make $480 with only $20 at risk. But with the 10point wide butterfly, our risk-to-reward ratio isn't even close to being this good. If you risk 20 to make $480, then your risk-to-reward ratio is 1 to 24. And you don't have to know how that's calculated. This is just for demonstration purposes. But basically what I'm saying is that on this trade, for every dollar you have at risk, you have the potential to make $24. But with the 10point wide butterfly, our risk-to-reward ratio is more like one to two and a half. So you're risking $1 to make $2. 50. Still a great risk-to-reward, no doubt, but not even close to as good as the five point wide butterfly. But in exchange for this worse risk-to-reward ratio, you are rewarded with a higher probability of profit because the stock has a much wider range that it needs to be in for the trade to be profitable. Okay. Now, I know this is a lot to take in, but let me go ahead and show you how to trade the butterfly in the Thinkorswim platform, and then after that, we'll do a final recap, which should clear up any questions that you may have. So, let's go ahead over to the Thinkorswim platform. All you have to do to trade a butterfly is rightclick the option that you want to be the body of the butterfly, then click buy butterfly. Once you do this, the order will pop up for you to make this trade. You can then adjust your strikes of the butterfly. You can adjust the price and anything else. And that's really all there is to it. You would just click confirm and send the order. But I just want to mention one more thing about the butterfly. You can actually trade the butterfly on the calls or the puts. And what's even crazier is that there's actually no difference between either one. You might be thinking, well, how is there no difference? Calls and puts are the exact opposite of each other. Well, let me just show you a demonstration. Let's pull up an order to buy a butterfly on the put side with, I don't know, let's say 115 as the body of the butterfly. So, we're just going to rightclick the 115 put, click buy butterfly. Now, let's click confirm and send to view the details of the trade. Okay. Now, you see the max loss, the max profit, and the break even stock prices for this trade. Let's compare this to if we were to buy a call butterfly with the corresponding strikes. So, we're just going to go to the 115 call, rightclick, then click buy butterfly. Now we'll click confirm and send on this trade and compare the two. You can see the details of the trade are exactly the same on both of these trades. Same break even stock prices, same max loss, same max profit, etc. Now, I understand that this probably just adds more confusion, but here's what we suggest. Although you can achieve the same thing by buying a call butterfly as you can with a put butterfly, we suggest that you always choose whichever will allow the body of your butterfly to be out of the money when you initiate the trade. For example, if you are looking for Apple to go higher and end up at 125, then you would buy a call butterfly because the 125 call is currently out of the money. But if you are looking for Apple to move down and end up at 115 for example, then you'd buy a put butterfly. The reason we suggest this is simply because out of the money options tend to be a bit more liquid than deep in the money options. So we simply choose to go wherever the liquidity is. Okay. Now let's quickly recap the butterfly strategy. First, to construct a butterfly, you're going to sell two calls or puts. Again, it doesn't matter which one you choose. It's really the same thing, and we just went over that. But we refer to this as the body of the butterfly. Now, in addition to selling these two options, we're also going to buy the wings of the butterfly. So, we're going to buy one call or put at a lower strike, and we're also higher strike. And we're going to make sure that all of these strikes are equidistant away from each other. And there you go. There's our butterfly. Now, let's talk about our max loss, our max profit, and our break even points. Well, our max loss is simply the price we purchase the butterfly for. If the stock ends up being outside of our long strikes at the expiration date, then we will assume our max loss on the trade. And for our max profit, we're going to make our max profit if the stock finishes right at the body of our butterfly at expiration. And how much we can make is calculated by taking our strike width and subtracting our entry price from that. So for a quick example, let's say our strikes are 70, 75, and 80. So this would mean that we have a strike width of five points. And let's say we bought this butterfly at 20 cents. In this case, our max loss would be 20 cents and our max profit would be 5 minus 20 cents, which equals $480. Okay. Now, for our break even points, well, after you find out what your max profit is, you're simply going to add that to the short option strike or the body of the butterfly. And that's one of our break evens. Now, you're going to have two break evens because you need the stock to end up within a certain range. So, for the other break even, that one will be calculated by subtracting your max profit from the short option strike. And you need the stock to be within this range for you to make money. Okay. Now, for market direction, the butterfly really can be bullish, bearish, or neutral because it really just depends on our strike selection because we basically need the stock to move towards the body of our butterfly. So, where we place our strikes in relation to the current stock price will dictate whether the trade is bullish, bearish, or neutral. Now, what about time decay? Well, this also depends on strike selection. If you buy a butterfly that is far out of the money, for example, then time decay will be against you. And if you buy a butterfly that is right at the current stock price, then time decay will be in your favor. Now, try not to get confused by this, but a general rule of thumb is that if the stock is in between your break even points when you initiate the trade, then time decay will typically be in your favor. But if the stock is outside of your break even points when you initiate the trade, then time decay will be against you. Again, try not to let that confuse you. It's just a general rule of thumb in case you are curious. Okay. Now, how about implied volatility with the butterfly? We want implied volatility to decrease because if implied volatility decreases after we enter the trade, then the price of the butterfly we bought will go higher. The reason for this is because, well, just think about it. If you want the stock to pin at a certain strike, then it's going to have a better chance of doing so if implied volatility is low. high, on the other hand, then good luck trying to get the stock to pin out a certain strike because the stock is going to be all over the place. So, therefore, butterflies will be very cheap when implied volatility is high. Hopefully that didn't confuse you. To sum it up, we tend to buy butterflies when implied volatility is high because we can get them for very cheap prices. And then if implied volatility decreases, then the price of our butterfly should go higher and we can sell it for a higher price than we bought it for. And that leads us to our first tip for this strategy. Initiate the trade when implied volatility is high. If implied volatility is high, then we will be able to buy a butterfly for a very cheap price. And lastly, widen your strikes to improve your probability of profit. Doing so will cause you to have a less favorable risk-to-reward ratio, but again, you will be rewarded with a higher probability of profit because the range you need the stock to stay within for you to make money will be much larger. So, all right, guys. That's it for the butterfly spread. Now, earlier in the video, I promised that I would reveal the answers to you from the little exercise that I gave you. So, here are those answers. So, go ahead and check your answers, and I will see you in the next lesson.

In a previous chapter, you learned about the shortput and the short call strategy. For the short put, you would want the stock to stay above the strike price of the option. And for the short call, you would want the stock to stay below the strike price of the option. Well, in this chapter, we're going to talk about the strangle, which is simply just a combination of a short put and a short call. And the idea of this strategy is that you are hoping the stock will stay below the short call strike, but also above the short put strike. So, you are looking for the stock to trade sideways and stay within a certain range. If this happens, we will profit on both the call and the put. Let's look at an example to see how this works. The current price of stock XYZ is $75 per share. And you can also see the prices of the options here with let's just call it 30 days to expiration. To construct a stringle, we're going to sell an out-ofthe- money call and also put. We can choose whatever strike prices we want for each option, but for this example, let's just go 10 points away from the current stock price on each side. So, we're going to sell the 85 strike call option at two and also sell the 65 strike put option at two. Now, let's look at a few scenarios to see how this trade works. All right. So, we are short the 85 strike call and we are also short the 65 strike put and both of these options expire in 30 days from now. Now, with this trade, we want the stock to stay within this range. If it does, we will make money and if it goes outside of this range, we can lose money. So, let's just look at an example. Let's say the stock doesn't move much and maybe it even goes up a little bit and ends up at let's say $82 per share. If the stock is at $82 per share, then both the call and the put that we are short are still considered to be out of the money. And what do we know about outofthe money options that are about to expire, right? They are worthless. If both of these options are worthless, then we made two points on the short put and we also call. So if we add these together, then we made a total net profit of four points or $400. And just like with all the other option spreads, we treat this trade as one trade. And we are really just concerned with the net prices of the spread as a whole. The combination of the short call and short put is called a short strangle. Our net entry price for the strangle is four because we collected two points on the call and two points on the put. And our net exit price is zero because both of these options are worthless. So rather than monitoring the prices of each individual leg of the trade, we can just monitor the price of the spread as a whole. We sold the stringle as an opening trade at four. It's now at zero. So, we are up four points on the trade. Okay. Scenario two. This time, let's say the stock doesn't cooperate and goes well outside of our range that we wanted it to stay in. And let's say the stock goes up and ends up at, let's just call it $94 per share. If the stock is at 94, then the 65 put we sold at two will again be worthless because it's still out of the money. So, we made a profit of $200 on this option. But the 85 strike call option is 9 points in the money. So, it's now worth its intrinsic value of 9. If we sold this option at two and it's now worth nine, then we are negative seven points on the short call. So if we made two points on the put and lost 7 points on the call, our net loss on the trade as a whole is five points or since we traded one contract, we are down $500. Now, you'll notice that we lost money on the call side and we made money on the put side. And that's what's cool about neutral strategies like this strangle or even the iron condor you learned about in the last chapter. Yes, we have risk on both sides. We can lose money if the stock goes up too much and we can also lose money if the stock goes down too much. But we can't lose money on both sides, right? Because the stock can't be in two places at once. If we lose money on the call, then we will have made money on the put. And if we lose money on the put, then we will have made money on the call. I just wanted to throw that out there because it's often misunderstood and people sometimes think, well, if you're selling a put and a call, then don't you have double the risk? Well, the answer is no. You don't have double the risk because you can't lose money on both sides of the trade. So, hopefully that made sense and clears up any confusion that might have occurred otherwise. Now, let's go over to the Thinker Swim platform so I can show you how to trade this strategy. You're looking at the option chain for Netflix. Netflix stock is currently at 129. 89 and the options displayed on your screen have 38 days to expiration. Let's make a bet that Netflix stock will stay within a certain range. And that range will be determined by whatever strikes we choose for our short call and short put. Now, we can choose whatever strikes we want. And the further out of the money we place our strikes, the wider our range will be that we need the stock to stay within and therefore the better our probability of profit will be. But at the same time, going really far out of the money will mean that we don't collect as much option premium. And again, there's no magic number when choosing your strikes. It's really more just about finding a balance between having a high probability of profit but also achieving a decent return. Now, you can choose whatever works best for you, but as a starting point for this example, let's just choose the strikes that have a probability in the money of around 16%. You can see this brings us to around the 150 strike on the call side, and on the put side, it brings us to around the 110 strike at 18% probability in the money. Close enough. All we have to do to bring up the order is rightclick the bid or the ask of the 150 call, click sell strangle, and the order will pop up on your screen. But now we have to adjust the put strike selection. We're just going to change this from 145 to 110. Now we can change the position sizing to whatever we choose. And it will automatically keep the correct ratio of one put to one call. And we can also change the price we want to enter the trade at. And remember, we are selling this spread. So we would want to get filled at the highest price possible. And for this example, we're just going to enter this trade at the current prices. Now, with trading spreads, it's always a good idea to do one last check before sending the order and make sure the spread you are trading is correct by looking at the individual legs of the trade. You can see that we are selling the 150 call and also selling the 110 put. So, this order is correct and we can go ahead and click confirm and send. Now on the pop-up box you can see all the details of the trade including buying power effect or the capital requirement to make this trade. In this case the capital requirement is about $1,300 and the max loss is infinite or as we like to say it's undefined. We just feel that that's a more accurate term to use. Moving on, the max profit is simply the price we sell the strangle for. So in this case we are selling the stringle for $369 but of course we are selling one contract. So that equals $369. And of course we achieve this max profit if the stock stays between our short call and short put strike. Lastly the break even stock prices are the short call strike plus the entry price and the short put strike minus the entry price. As long as the stock stays within this range, then we will make money. And if it's outside of this range, then we will lose money. So, all right guys, that's it for the strangle strategy. Here's a quick overview for you so you can review it before moving on to learning the next spread, and I will see you there.

You just learned about the strangle. Now, let's talk about the Straddle, which is kind of like the Strangle's more aggressive twin brother. Okay, so they're basically the exact same thing, except the straddle is just a lot more aggressive. Let me show you what I mean. When we sell a strangle, we are selling an outofthe-oney call and put, right? This, of course, creates for a very high probability trade because we simply need the stock to stay within a certain range. But with the straddle, instead of selling an outofthe-oney call and put, you would be selling an at the money call and put. And the idea is you are hoping the stock will stay as close to the strike price of your straddle as possible. The closer the stock is to this level at expiration, the better. So, let's check out an example. Let's compare selling a straddle to selling a strangle. You already learned about the strangle and we're going to use the same example as we did in the strangle video. The example we used in that section was selling the 85 call for two and also selling the 65 put for two. And these two options make up what we call a strangle. And of course, if we sold the put for two points and a call for two points, then the net price of this strangle is four points. And again, we are selling this strangle. So that means we are collecting four points. Now let's compare this trade to the straddle. To construct our straddle, we're simply going to sell the at the money call and put. So we're going to sell the 75 strike call at 450. And we're also going to sell the 75 strike put option at 450. The combination of these short options are what we call a straddle. And the total net price of this straddle is nine points. And again, the only thing that makes this a straddle versus a strangle is that the short call and short put have the same strike price. Now, let's look at the risk profile of each strategy and compare the two. First for the strangle, our put strike is at 65 and our call strike is at 85. And we know that if the stock finishes anywhere in between these two levels at the expiration date, then we will make our maximum profit potential of four points. And actually, let's just assume that we sold one contract on these trades. So that means our maximum profit potential on this strangle is $400. And again, we make this profit if the stock is anywhere between our strike price of 65 and 85. Now, where do we break even on this trade? You learned that with the strangle, our break even price on the upside is the short call strike plus the entry price. So, for this example, our break even stock price would be 89. And on the downside, our break even is the short put strike minus the entry price. So in this case, that would be 65 minus 4, which is 61. So with this trade, the 8565 strangle, we're going to make money if the stock finishes anywhere between 61 and 89 at expiration. And we're going to lose money if the stock is outside of that range. But now let's compare this to the straddle. With the straddle, our maximum potential profit is also the entry price. So our max profit is nine points. Or since we are assuming that we are trading one contract positions, then that means our max profit on this trade is $900. But we don't make this max profit if the stock stays within a range, right? Because our strike prices are at the same price. We make this max profit if the stock pins at the strike price of our straddle at expiration. So for this trade, we would need the stock to be exactly at 75 for us to make the max profit of $900. And the further and further away the stock ends up from your strike price, the less and less money you'll make. And eventually you would actually lose money if the stock is far enough away from your strike price. Now the break even price is calculated in the exact same way as the strangle. So we would simply add the entry price to the strike price. So 75 + 9 that puts one of our break even points at 84. And then on the downside it would be 75 - 9 which is 66. And we would make money anywhere within this range. But the closer the stock is to our strike price the better off we will be. So to sum it up, we basically just want the stock to stick to our strike price like a magnet. If it does, then we will have a very nice winner on our hands. But at a bare minimum, we want the stock to at least not deviate in either direction by more than our entry price. So for this example, we don't want the stock to go more than nine points away from our strike price of 75 in either direction because that's where our break even points are. Okay. Now comparing the two strategies. With both strategies, we need the stock to stay within a certain range. But with the straddle, we need the stock to stay within a much tighter range. Right? So since it has to stay within a tighter range for us to make money, then it's going to have a much lower probability of profit than the strangle. So basically, that's the trade-off between the two strategies. The strangle will have a higher probability of profit because the range you need the stock to stay within is much bigger, and the straddle will have a lower probability of profit because the range you need the stock to stay within is smaller. But because you are willing to accept a lower probability of profit, you're going to be rewarded with a higher potential payout. Now, we actually trade both of these strategies on a regular basis. And it really all just comes down to what type of market environment we are in, and we're going to cover this in part two. But let's not get ahead of ourselves. Let's continue to talk about the straddle so you can fully understand how this strategy works. Okay, so we are short the 75 straddle at 9. Let's look at some scenarios. Scenario one, after we enter the straddle, let's say the stock price trades sideways for the most part and maybe it ends up at 77. If the stock is at 77, then the 75 put will be worthless because it's out of the money. But the 75 call will be worth its intrinsic value of two. So, the straddle as a whole will be worth two points. If we sold the straddle at nine and closed it at two, then that means we made seven points on the trade or $700. Now, scenario two. This time, the stock price is highly volatile and goes outside of our range. And let's say it ends up at 61 per share. If the stock is at 61, then the 75 call is worthless. But the 75 put is 14 points in the money. So it's worth 14. So this means the straddle as a whole is worth 14 points. And since we sold it at 9, then that means we are down five points on the trade or $500. To put it simply, the price of the straddle at expiration will be however far away the stock price is from your strike price. So in the first scenario, the stock ended up being two points away from our strike price at expiration. So that means the straddle was at two, which of course resulted in us having a profit because we sold it at 9. And in the second scenario, the stock ended up being 14 points away from our strike price at expiration. So the price of the straddle ended up being 14, which of course resulted in us having a loss. Okay, simple enough. Now, let's quickly go over to the ThinkersW platform so we can look at how to place a straddle trade. You're simply going to rightclick the bid or the ask of the at the money call, then click sell straddle. This will bring up the order to trade the straddle. You can, of course, adjust your price and your position sizing and everything like that, but let's just go ahead and click confirm and send and review this trade. On the pop-up box, you can see all the details of the trade. You can see your buying power effect, your max loss, max profit, break even points, etc. And it's really all the exact same as the strangle, except of course our break even points are going to be a little bit tighter. And also to make this max profit, the stock would have to be exactly at our strike price. So, all right guys, that's it for the straddle. Here's a quick overview for you to review, and I will see you in the next section.

The back ratio spread is kind of like a long vertical spread where you would buy an option and then sell a further out of the money option against it except you're going to finance this long vertical by selling an extra outofthe-oney option. So instead of buying one option and selling one option, you're going to buy one option and sell two options. So for this example, we're just going to buy one contract of the 80 strike call at 315 and then also sell two contracts of the 85 strike call at two. And this is our 1x two back ratio spread. Now, you could even get creative and do a ratio of 1:3, 1:4, 1:5, and so on. But we usually just stick to the 1:2 ratio to keep it simple. And that's what we're going to use for this example. Okay. So, how does this trade work? Well, let's actually break this up and think of it as a long call vertical plus a short naked call. So we are long one contract of the 80 strike call and short one contract of the 85 strike call. And the combination of those two options make up our long vertical spread. And our net cost of this vertical is 315 minus 2 which equals 115. Right? So we are paying a debit of 115 for this vertical call spread. But in addition to this long vertical spread, we're also selling one contract of the 85 strike call to finance this spread. And our net sale price of this call is two points. Now, the reason I say that we are financing this long vertical by selling this additional call is because if the long vertical ends up at its max loss of 115, then that will be more than offset by the profits that selling the additional call provided. Let me show you an example. Let's say the stock trades sideways and maybe goes down a little bit and ends up at, let's say, $73 per share. If this is the case, then these options are out of the money and will all be worthless, which means that we will have max loss on the vertical spread of 115. But our short call will also be at its max profit of two points. So, of course, the profit of two points will more than offset the loss of 115 on the vertical. So our overall net profit on the spread is 85. Now of course we typically just monitor the net prices of our spreads. So in this case we sold this back ratio spread at 85 and closed it at zero and our net profit was 85. Now let me show you another scenario where this trade really shines. On the long call vertical, we will of course make our max profit if the stock is anywhere above 85. And for our short call, we will of course make our max profit on that leg of the trade if the stock is below 85. So let's just meet in the middle and say the stock goes right to 85 and finishes there at the expiration date. If the stock is at 85, then the vertical that we bought at 115 will now be at five. So we will have made 385 on the vertical spread. But the short call will also have a profit because if the stock is at 85 then this option that we sold at two is now worthless because it doesn't have any intrinsic value. So we made two points on this leg of the trade. Totaling up all of these numbers means we made a net profit of 5. 85 on this back ratio spread. Now here's the thing. We sold this back ratio spread as an opening trade at 85 and we bought the spread back to close it at a debit of -5. So this seems kind of confusing, I know, but this is actually how the trade will show up in the platform. You are selling the spread for a certain price and the goal is to buy it back at a lower price just like with any other spread that we sell as an opening trade. And in this case, neg5 is definitely lower than 85 cents, right? Because it's negative. And that's the cool part about the back ratio is that it doesn't stop when it goes to zero. It can go negative, which means you can actually make more than the credit received. So hopefully that made sense. If it didn't, just rewind and rewatch a couple times and it should be clear. Now, in this scenario, we actually made our max profit here. The stock went right to our short strike and finished there at the expiration which resulted in our max profit. And the way our max profit is calculated on a back ratio spread is by simply taking the strike width and adding our total net credit to it. So in this example, our strike width was five points and our net credit that we entered the trade for was8. So $5 plus85 means our max potential profit on this trade is $5. 85. Or in other words, since we traded the smallest position sizing of one spread here, that means we made $585. And that's the cool thing about the back ratio spread. In this example, we are looking to hit a home run if the stock goes higher and ends up at our short strike. But if it doesn't and just kind of trades sideways or even goes down, then no harm, no foul. We still get to keep the credit that we entered the trade for. So, we make big money if the stock goes up a little bit and we make little money if the stock goes down or trades sideways. But by this point, you know that there's no such thing as free money in the markets. So, let me show you how you can lose money on this trade. Well, remember we are long one vertical spread which has a limited max profit. We can only make up to $385 on that part of the trade. But we are also short an additional call that theoretically has unlimited max loss. So that's where our risk is. If the stock goes quite a bit higher, then we will lose more money on the short call than we will make on the long vertical. So theoretically our max loss is unlimited on the back ratio spread. But as we've said numerous times in this course, we feel that the term undefined is much more accurate. So let me show you one more scenario. Let's say the stock goes up quite a bit and finishes at 9085 at expiration. If this happens, then our long vertical spread is fully in the money and is at five. So, we again made our max profit on the vertical of $3. 85, but the 85 call is $5. 85 in the money. So, it's now worth 5. 85. If we sold this call as an opening trade at two, and it's now at 5. 85, then we lost 3. 85 on this leg of the trade. And if we total up all of these numbers, then that means we broke even on the trade. We didn't make or lose any money. So this is our break even point. If the stock is anywhere below here at expiration then we will make money and if the stock is anywhere above this level at expiration then we will lose money. And the way this break even point is calculated is by simply taking our max profit and adding it to our short strike. So in this example our break even stock price is our strike price of 85 plus our max profit that we already determined of 5. 85. 85 which equals 9085. And here's what this trade looks like on the risk profile. You can see that we will make a little bit of money if the stock is below 80. But if the stock is really anywhere between 80 and 90, then we're going to make more money than the credit received. And then of course our risk is if the stock goes above 9085 and we can lose theoretically an unlimited amount of money. But if you haven't already figured out by now taking theoretical risk is how we make big money in the markets because theoretical risk is not always indicative of actual risk. Okay. Now this is the risk profile for this example on the calls. But you can also trade the back ratio spread on the put side and it would be the same thing except just reversed. Now let me show you how to enter this trade on the Thinker Swim platform. Let's say we wanted to trade a back ratio spread on the call side. All you have to do is rightclick on the bid or the ask of one of the call options, then click sell back ratio. You can now adjust your position sizing, strike selection, your price, etc. And whenever we trade back ratio spreads here at Sky View Trading, we tend to widen out the distance between our strikes as much as possible while still collecting a net credit on the trade. Let me show you what I mean by this. You can see the distance between our strikes on this order has defaulted to one point and the net price is showing a credit of 257. Now let's widen out our strikes as much as possible and see what happens. So let's just change this short strike by one point. So we'll change this from 228 to 229. And you can see that the net credit got a little smaller for the trade. So let's keep going. Let's change this 229 out to 230. Now you can see that our strikes have a distance of three points between them and the net credit for this trade is 41. Okay, let's go one strike further and see what happens. If we move this short strike out to 231, you can see that the price is now showing a debit. We don't want this because that would mean that our long vertical is not completely financed by the short naked call. So that's where we draw the line and we're going to change this back to 230 because that's as wide as we could make this spread while still collecting a credit. The reason we do this is because although we are collecting a smaller credit, we are widening our range where we can potentially hit a home run and make more than the credit we collected on the trade because the stock will have a better chance at being within this range at expiration if it's wider than if it's only one point wide, right? But of course, we still want to collect at least a small credit because we don't want to lose money if the stock goes down from here. So that's how we trade the back ratio. But we like to widen it out as much as possible, but always make sure we collect a credit. Okay. Now, on this trade, can you figure out what your max profit and break even stock price is? We're about to click confirm and send, and that will of course tell us the answers. But if you'd like to test your knowledge and see if you can recall how to calculate these numbers, then pause the video and give it a shot. I'll give you a hint. The width between our strikes is three points wide. And the net price of this spread is a 41 cent credit. Okay. Now, let's click confirm and send and view the details of the trade. First, you can see the capital requirement for this trade is quite high. But that's because selling naked calls in spy just doesn't have that favorable of margin requirements. But the capital requirement will be similar to selling a naked call because remember even though we are short two calls on this trade, one of them is protected by the long call. So this trade has a similar capital requirement to if we were to just sell one naked call. Now again, there's no way to really calculate this. This is just something you'll want to check before trading this strategy. You'll just have to check what the capital requirement is by clicking confirm and send and viewing this popup box. Okay, now let's move on. Our max profit is calculated by taking our strike width and adding our net credit to that. So in this case, our max profit would be our strike width of three points plus our net credit of 41, which equals 341. Or since we are trading the minimum position size of one spread, then that would equal $341. Now our max loss is infinite or undefined because we are short a naked call. Pretty straightforward. Lastly, our break even is calculated by adding our max profit to our short strike. So for this example, our short strike is 230. And we would just add our max profit of 341 to that. And that means our overall break even stock price is 23341. If the stock is below this level, then we will make money on this trade. And if it's above this level, then we will lose money on this trade. Okay, now we can click send and enter into this trade. So, all right guys, that's it for the back ratio spread. Here's a quick recap for you of the call back ratio. This is a bearish to neutral trade, but of course, we hit a home run if the stock goes up a little bit and ends up at our short call strike. And the putback ratio is the exact same concept except it's a bullish to neutral trade. But if the stock goes down a little bit and ends up at our short put strike, then we will hit a home run. So that's it for now and I will see you in the next lesson.