The BEST Explanation of Options Trading

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What Is a Covered Call?
A covered call refers to a financial transaction in which the investor selling call options owns an equivalent amount of the underlying security. To execute this an investor holding a long position in an asset then writes (sells) call options on that same asset to generate an income stream. The investor’s long position in the asset is the “cover” because it means the seller can deliver the shares if the buyer of the call option chooses to exercise. If the investor simultaneously buys stock and writes call options against that stock position, it is known as a “buy-write” transaction.

Understanding Covered Calls
Covered calls are a neutral strategy, meaning the investor only expects a minor increase or decrease in the underlying stock price for the life of the written call option. This strategy is often employed when an investor has a short-term neutral view on the asset and for this reason holds the asset long and simultaneously has a short position via the option to generate income from the option premium.

Simply put, if an investor intends to hold the underlying stock for a long time but does not expect an appreciable price increase in the near term then they can generate income (premiums) for their account while they wait out the lull.

A covered call serves as a short-term hedge on a long stock position and allows investors to earn income via the premium received for writing the option. However, the investor forfeits stock gains if the price moves above the option’s strike price. They are also obligated to provide 100 shares at the strike price (for each contract written) if the buyer chooses to exercise the option.

A covered call strategy is not useful for a very bullish nor a very bearish investor. If an investor is very bullish, they are typically better off not writing the option and just holding the stock. The option caps the profit on the stock, which could reduce the overall profit of the trade if the stock price spikes. Similarly, if an investor is very bearish, they may be better off simply selling the stock, since the premium received for writing a call option will do little to offset the loss on the stock if the stock plummets.

Call Options vs. Put Options
A quick primer on options may be helpful in understanding how writing (selling) puts can benefit your investment strategy, so let’s examine a typical trading scenario, as well as some potential risks and rewards.

An equity option is a derivative instrument that acquires its value from the underlying security. Buying a call option gives the holder the right to own the security at a predetermined price, known as the option exercise price.

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DISCLAIMER:
This video is for entertainment purposes only. I am not a legal or financial expert or have any authority to give legal or financial advice. While all the information in this video is believed to be accurate at the time of its recording, realize this channel and its author makes no express warranty as to the completeness or accuracy, nor can it accept responsibility for errors appearing in this video.

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Comments

Jake Broe says:

Thanks for watching! If you want to support me and my channel, then consider giving this video a LIKE to help me with the algorithm. Also check out my entire playlist on trading options here: https://www.youtube.com/playlist?list=PLscTZuOqKWIxSZzy4ObKWDznEsCot_1HU

deadleague says:

Very clear and creative video. Thanks Jake.

simba says:

Well done content. Great job Jake

joshd33 says:

Would be interested in a video where you talk about how you determine when to cut your losses on options and sell to close taking a partial loss… not that CLX is making me nervous or anything, lol!

Carnivore Nurse says:

Finally makes perfect sense πŸ‘Œ

Tyler Case says:

In the buying and selling calls portion Do you have to have the $11,000 to execute the contract and realize the profit?

Vic Tobayashi says:

Hello Jake, Nice video and thank you for the overly simplified version of the market.Β 

I wondered: What will happen to a buyer when he bought a put contract at $110 strike price when the market was $100 (contract already in the money), and then market goes up to $125, but later the market goes down to $75 and the price volatility happens before the contract expires?Β 

Q: Does one lose his premium immediately when the market goes up to $125 (because the strike price of the put contract was $110)? or Will he still make money when the market later goes down to $75 before the expiration date?Β 

Q: Is it that one would never purchase a contract when it is in the money to begin with?

Q: what is a good strategy in a market with lots of price volatility in a given month or two?

Hope I'm not confusing with this scenario.

Bangpaulxu says:

Thank you for the breakdown!

Tiger says:

this was the video i was waiting for. this has completely answered all my questions. thank you.

Tony Nguyen says:

Thanks for the video explanation Jake. You teach the topic really well. I look forward to future videos from you!

Yan Voskanov says:

Jake, you should do a tutorial using the Schwab website so we can see how its done on the website.

Thanks for all your videos. From one AF bubba to another.

Ian Rudolph says:

I understand the advantage for the seller in the first scenario you showed, however, I don’t understand what the advantage is for the buyer. The buyer made $1,000 in the first scenario you showed. If they bought 100 shares when the price of one share was $100, it would’ve cost them $10,000. Then they would’ve been able to sell their shares for a total of $12,500 which would be $2,500 in profit. 2,500>1,000

Dave G. says:

I noticed you taught Korean children. I suspect that when American's learn the options language…we'll finally catch on as well. BTW……excellent video !!

Krystian Streit says:

I love how you threw the Catan board in the 1st minute of the video πŸ˜‚ love that game

Great video as well!

Rafael Otero says:

Great job my friend. Your content is spot on.

Steven Bi says:

Hi Jake, Question: For example if I bought a call contract and the price of the stock goes up until a certain price and I think the price will have a dip. Can I sell to close my call position and buy to open a put on the way down and sell to close the put contract before expiration date and take profits both ways? Do I have to have the 100 shares to buy a put?

joshd33 says:

β€œThe markets don’t care what you do” …. Truer words have never been spoken, ha!

Great video!!

Anil KC says:

Hey Jake, awesome work. I got Option in theory. However, when I go to brokerage account I see gap in ask and bid prices. I am not sure if the Option is expensive or I should buy Option with market price (ask). How do I know the value of the option? For example, if the option has ask as $10 and bid as $5. How should I bid to buy this contract?

Josue Sepulveda says:

nice videos bro, keep doing it

David Kang says:

I'm confused, I'm out.

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