# Welcome to the tastytrade Beginner Center!

At tastytrade, we know that building a solid stock option foundation is the key to having a successful trading portfolio.

If you're coming from a stock trading background, Step Up To Options with us and learn about the very basics of options trading. Some of the videos from the series are featured below.

Under each keyword you will find a description, the keyword feature video, as well as additional tastytrade videos & dough blog posts to supplement your knowledge and get you to trading in no time!

Follow along below to learn the why & how of stock option trading, the tastytrade way!

## options: WHAT ARE THEY?

## 1a. CALL OPTION

A call option is a contract that gives the owner the right to buy 100 shares of stock at a certain strike price and expiration.

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## 1B. PUT OPTION

A put option is a contract that gives the owner the right to sell 100 shares of stock at a certain strike price and expiration.

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## WHY WOULD I USE OPTIONS?

## 2A. LEVERAGE

Leverage in the options world refers to the magnification of profit, or magnification of loss, compared to traditional investing. Options offer greater leverage than buying and selling stock outright. There are also leveraged products that aim to replicate movement of a different underlying on a magnified scale.

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## 2B. FLEXIBILITY

Options offer endless flexibility when it comes to strategy and portfolio management. We see futures as our macro position, stock as our micro position, and use options to fine tune our positions to the very last detail. Our style of trading options allows us to "be the house" and collect premium with a high probability of profit.

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## 2C. SPECULATION

Options can be used as a speculation instrument, since they are bound by expiration dates and therefore much cheaper than buying or selling stock outright. If we are speculating on a directional move at tastytrade, we're always sure to lower our cost basis by creating a spread. We do not trade long naked options.

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## 2D. HEDGING

We hedge our futures and stock positions with options. We can also hedge our options positions with options. Anytime we lower our cost basis and cap our maximum profit, we are hedging, and options allow us to do so in many ways.

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## 2E. COST BASIS REDUCTION

Cost basis reduction refers to lowering the initial cost of trade entry. Instead of buying 100 shares of stock outright, we will buy 100 shares of stock and sell a call against it to reduce our cost basis and improve our probability of profit.

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## HOW ARE THESE PRICES GENERATED?

## 3A. STRIKE PRICE

The strike price is the aspect of the option contract that determines the price in which shares can be bought or sold. Strike prices are priced differently depending how far in the money or out of the money they are. A call contract on the 50 strike allows the call owner to purchase 100 shares of stock at $50.00 per share, regardless of where the stock is actually trading.

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## 3B. EXPIRATION

All options have expiration dates. Unlike stock, options have expiration cycles and are either converted to long stock, short stock, or cash at their expiration if they are in the money. If they are out of the money at expiration, they expire worthless.

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## 3C. INTRINSIC VALUE

Intrinsic value is the "real" value in an option's premium. For example, if a stock is trading at $100.00, the 95 strike call will have $5.00 of intrinsic value. Options are priced through the combination of intrinsic & extrinsic value.

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## 3D. EXTRINSIC VALUE

Extrinsic value is the time & volatility value in an option's premium. For example, if a stock is trading at $100.00, and the 95 strike is trading at $6.50, we know that $5.00 of that is intrinsic value. The remaining premium of $1.50 is the extrinsic value that is attributed to implied volatility & time remaining in the option contract. Underlyings with high IV values and/or options with longer dated expirations will have more extrinsic value associated with each option.

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## 3e. premium

Premium is the price paid (debit) for long option positions, or the cash received (credit) for short option positions. Option premium is made up of intrinsic & extrinsic value. When demand for options increase, prices increase. When demand diminishes, prices diminish.

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## HOW DO I ARTICULATE MY DIRECTIONAL ASSUMPTION?

## 4A. LONG

Being "long" means that you own the product or option contract. If you are long stock, you own the stock. If you are long an option, you own the option. With options, being long can mean being bullish or bearish, depending on whether you own a put (bearish) or own a call (bullish).

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## 4B. SHORT

Being "short" means that you sold the product or option contract. If you are short stock, you sold the stock without owning it in the first place. If you are short an option, you sold the option without owning it. With options, being short can mean being bullish or bearish, depending on whether you are short a put (bullish) or short a call (bearish).

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## 4C. BULLISH

Being bullish means that you have a positive directional assumption. If you are bullish on an underlying, you want the underlying price to go up.

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## 4D. NEUTRAL

Being neutral means you don't have a directional assumption on an underlying. Many of our neutral strategies create a profit zone, which means the underlying can go up or down, and as long as it stays within our zone we will be profitable.

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## 4E. BEARISH

Being bearish means that you have a negative directional assumption. If you are bearish on an underlying, you want the underlying price to go down.

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## what are some things I should be aware of?

## 5A. getting filled

Getting filled does not always happen right away. After all, this is a market, so there has to be a trader on the other side to accept the opposing contract. Liquidity & price are the biggest factors in getting filled.

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## 5A. NOTIONAL VALUE

Notional value is the contractual obligation for each trade. For example, if I purchase a futures contract and my buying power reduction is reduced by $5000, but the contract controls $100,000 worth of product, my notional value is $100,000. If I buy 100 shares of stock at $50.00, my buying power may only be reduced by $2500 in a margin account, but my notional value is still $5000. We are always aware of notional value when placing trades.

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## 5B. assignment

Assignment is something that can occur when trading short options. If I sell an option, I am selling the right to someone else to exercise that option if they choose to. Assignment before expiration is rare, but it still does happen from time to time. It is important to keep an eye on ITM options, as they are generally the options that can be assigned early.

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## 5c. buying power

Buying power is the amount of capital available to place a trade. Buying power is reduced by different amounts in different accounts. In a margin account, we have more leverage than a cash or IRA account. Whether I'm trading stock or options, the buying power reduction is generally lower in a margin account than a cash or IRA account.

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## 5D. OUT OF THE MONEY (OTM)

An option is out of the money (OTM) if it does not have any exercise value. A call option is OTM when the strike price is above the stock price. A put option is OTM when the strike price is below the stock price. In both examples, the option owner is better off buying or selling shares in the market for a better price, as opposed to exercising their option.

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## 5E. IN THE MONEY (ITM)

An option is in the money (ITM) if it does have exercise value. A call option is ITM if the strike price is below the stock price. A put option is ITM if the strike price is above the stock price. If the options are held through expiration, the option will automatically exercise and turn into shares of long or short stock, depending on what option was purchased.

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## 5f. breakeven

The breakeven price is calculated by adding or subtracting the credit or debit from the strike price for a trade. Whether we add or subtract depends on the strategy itself. Credit trades have breakevens that help us, and debit trades have breakevens that hurt us.

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## WHAT DOES TASTYTRADE LOOK FOR BEFORE PLACING A TRADE?

## 6A. RETURN ON CAPITAL (ROC)

Return on Capital (ROC) is a metric that allows us to see how efficient our trade is in terms of profitability. We calculate return on capital by taking max profit, and dividing that number by the cost or buying power reduction for the trade.

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## 6b. implied volatility (IV)

Implied Volatility (IV) is the implied one standard deviation move of an underlying in a one year timeframe. For example, if a stock trading at $100.00 has an IV of 20%, this implies that the stock price will be within $80-120 in the next year with a probability of 68%.

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## 6c. implied volatility rank

Implied Volatility Rank (IVR) allows us to put context around an underlying's IV. An IV of 20% could mean two very different things for two different underlyings. IVR is a measure of historical implied volatility, and is calculated by taking the low & high 52 week IV of an underlying, and measuring current IV against that number. For example, if an underlying had an IV low of 40% and an IV high of 80% over the past year, if the IV is at 60% currently, then the IV Rank would be 50.

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# LIQUIDITY

## 6d. bid / ask spread (liquidity)

The width of the bid/ask spread is one of our leading liquidity indicators. The bid/ask spread is the difference between the bid price and the ask price of an underlying or option. The bid price is the price at which I can sell a stock or option to the market, and the ask price is the price at which I can buy a stock or option from the market.

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## 6e. open interest (liquidity)

Open Interest is one of our leading liquidity indicators. This measures the number of open option contracts for a specific strike and expiration. Open interest can increase or decrease, as transactions are conducted throughout the trading day and contracts are opened or closed.

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## 6f. volume (LIQUIDITY)

Volume is one of our leading liquidity indicators. Volume measures the number of contracts that traded for a specific strike and expiration. Volume can only increase, as it is a measure of sheer transactions throughout the trading day.

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## 6g. Probability Of Profit (POP)

Probability of profit (POP) is the probability of our trade reaching at least $0.01 in profit by the expiration date. In the dough platform, we measure POP from our breakeven prices to obtain the most accurate measure.

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## I'm a math person... are there any deeper insights?

## 7a. correlation

Correlation is a measure of two underlyings and how often they are on the same side or opposite side of their mean over a period of time. Underlyings with a strong positive correlation will be on the same side of their mean price most of the time, and underlyings with a strong negative correlation will be on the opposite sides of their mean price most of the time. Underlyings with positive correlations will tend to move together, while underlyings with negative correlations will tend to move in opposite directions.

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## 7b. beta

Beta weighting allows you to take two highly correlated underlyings and measure the magnitude of their relationship. We beta weight to market indicating underlyings such as SPY, to show us how long or short we really are in any given position.

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## 7c. delta (d - direction)

Delta is a greek metric that allows us to see the rate of change of an option's price given a $1.00 move in the underlying. Delta can be positive or negative, and changes as the stock price changes.

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## 7d. gamma

Gamma is a greek metric that measures the rate of change of delta. Gamma increases as expiration nears, and it's something that we're especially aware of when trading options.

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## 7e. theta (T - time)

Theta is a greek metric that measures the decay of an option's price, all else equal. One of the reasons we like to sell options is so that we have theta on our side, as a decaying option can only help the original option seller.

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## 7f. vega (v - volatility)

Vega is a greek metric that measures the rate of change of an option's price given a 1% move in the underlying's implied volatility. The more short option positions we have on, the greater our vega risk will be.

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## 7g. standard deviation (SD)

Standard Deviation allows us to put context around probabilities in terms of stock price movement. If we are looking at a one standard deviation range, we know that the stock price shoud stay within that range about 68% of the time. A two standard deviation range will yield a probability of about 95%.

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## 7h. mean reversion

At tastytrade, we have found that implied volatility has shown mean reverting properties. That is to say that if implied volatility spikes up, we have reason to believe that it will eventually come down. If implied volatility crushes, we have reason to believe it will eventually go back up.

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## 7i. probability of touch (POT)

Probability of touch is the probability of a strike price being breached by the stock price. We calculate probability of touch by doubling the prob. ITM of the strike. For example, if a call option has a prob. ITM of 20%, the probability of the stock price touching that strike is 40%.

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## what can i do if my position goes against me?

## 8a. rolling

Rolling is where a trader closes their current position and opens a new one at the same time. At tastytrade, we roll for a credit or even. This allows us to keep the dream alive, and lower our cost basis further.

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## 8b. defensive hedging

Hedging is the act of reducing max profit and/or max loss, usually by adding a trade in the same underlying or a different one. For example, if I have 100 shares of stock, I may hedge the max loss & max profit by selling a call against it.

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## 8c. scaling

As traders, we can scale our posititions up/down based on our account size. If my account size doubles over time, I may increase my contract size or product size. I can also scale down in the same way. We can also scale into our positions. If my normal contract size is five, I may trade two initially and then add a few more at a later time to reach my normal contract size. That is an example of scaling into a trade.

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## 8d. managing losers

We have shown that managing losers can be an effective strategy when compared to letting losers ride. Our studies show that closing a trade when it reaches a loss of 2x credit received is optimal if we are going to manage losers.

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## what are some best practices?

## 9a. MANAGING winners

The practice of managing winners refers to closing winning trades when they reach a certain percentage of profit. Managing our winning trades has proven to increase our probability of profit, as it takes unneccesary risk off the table and allows us to realize our gains sooner.

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## 9b. number of occurrences

When we talk about number of occurrences when trading options, we are talking about increasing our number of high probability trades. When dealing with probabilities, the only way to realize our expected probability is to have a large number of occurrences, so that our occurrences can average out closer and closer to the expected probability.

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## the learning doesn't have to stop here!

Get certified trading options in the doughjo, and submit your certificate to TD Ameritrade to assist with obtaining tier two options approval!

## Read ARTICLES & watch videos about TRADING CONCEPTS

The tastytrade learn page organizes tastytrade videos and concepts to find the best content on trading terms for all levels.

Have any questions about the content above? Shoot us an email at support@tastytrade.com!