Contracts

• Options are traded in contracts, not as individual derivative units.  Each contract represents a certain number units of the underlying asset.  This number is different for different types of asset worldwide.
• Therefore, when you see a US Equity call option price of, say, $1.45, you will have to pay $1.45 * 100 for just 1 contract.  1 contract is the minimum amount you can trade and for US Equity Options 1 contract represents 100 individual shares.

The following table outlines the amount of underlying securities that represent 1 contract for a few different markets where options are traded on an exchange:

Therefore, when you trade a Covered Call you are only "covered" if you are trading the same number of units on each leg of the trade.

For Example:

If you are wanting to sell 3 contracts of MSFT $80 strike calls at $3.50, you will receive a premium (before commissions) of $1,050.  But you will need to buy 300 MSFT shares in order to be "covered".  This will be at a cost of 300 * the MSFT share price.

Margin

• Margin is the mechanism by which you can borrow funds from your broker account but you are required to cover your potential risk liability with liquid assets in your account.  This is particularly relevant to those traders who sell short, sell naked or trade net credit spreads.
• When you sell short, sell naked or trade a net credit spread, whilst money is deposited into your account, there is still (in most cases) a contingent liability risk which must be covered by sufficient funds in your account.
• These funds can either be represented in cash or "marginable securities".  A marginable security is defined as an asset which is deemed by the brokerage to be secure enough to stand as collateral against your risk on the trade.  A stock like MSFT may well be considered as a marginable security, whilst low priced stocks (under $10) with little trading history, low trading volumes, poor liquidity and high volatility may not be considered as acceptable collateral.
• Remember that in many cases of selling short and selling naked, your potential risk liability may be unlimited (or at least substantial).  Using the Strategy Analyzers to determine your risk profile will help you to identify those situations where your risk potential is unacceptably high, depending on your own personal appetite for risk.

Placing your Order

• Trades can be placed either online of offline, depending on your broker account.
• Use the Strategy Guides to assist you in placing your spread orders over the telephone quickly, efficiently and accurately.  By knowing what to say and how to say it clearly, concisely and correctly you will help save both your time, the broker's time and ensure that there are no misunderstandings.
• Make sure you fill in the right figures and have them in writing before picking up the phone to place your order.  Then simply read out the order to the broker with your limit order prices.
• Because options prices are not always "clean", it is preferable to place a Limit Order, particularly on spreads.  This will ensure that you will be filled at your specified price or not at all.  By using the Limit Order function you can overwrite the market prices in order to base your calculations on your preferred limit order on any strategy and then see the results of your limit order risk profile.

Trading Tips

The most important things you need to know about any trade you ever do are:

• Your maximum risk on the trade
• Your maximum reward on the trade
• Your breakeven point(s)

The Strategy Analyzers give you these crucial figures in both nominal and actual formats for over 60 different strategies.

In addition, you also should know in advance:

• The maximum loss you will accept and when to get out of a loss making trade
• When to take your profits

These are crucial money management criteria, which you must determine in your own mind before you start trading.  There are wide parameters concerning money management techniques and much depends on your own appetite and respect for risk.  Just keep in mind that it is generally a good thing to cut your losses short and to let your profits run.

Expiration

Figures courtesy of CBOE (www.cboe.com)

• Many people believe that 90% of options expire worthless (ie no Intrinsic Value at expiration).  Figures from the CBOE indicate that in fact only 30% of actively options expire worthless in each monthly cycle.
• Only 10% of options are exercised during each monthly cycle.  Usually this happens in the final week before the expiration date.  (CBOE)
• Over 60% of all options positions are closed out in the market before expiration.  In other words option buyers sell to close their positions and option writers (sellers) buy back to close their positions.  (CBOE)

Exercise and Assignment

The process for exercising your options is as follows:

1. notify your broker
2. your broker notifies the Options Clearing Corporation (OCC)
3. the OCC randomly chooses a brokerage firm with the appropriate short options in the same class and series
4. the brokerage firm randomly calls one of its customers with the relevant short options position and delivers an Assignment Notice informing them that the option owner has exercised their right to buy (call) or sell (put)
5. the stock transaction is processed

Understanding Option Symbols

Option Symbols

Options have ticker symbols just like stocks do.  The symbol accurately identifies the underlying, the expiration month, the strike price, and the type of option. 

A series of letters identify the option.  They appear in the order of Root, Expiration month, and Strike price.  The letter that is used for expiration month is also used to identify whether the option is a call or a put. 

The first letter or group of letters (up to 3) identify the underlying and is called the root.  It is not the same as the stock symbol, although it can be.  Microsoft has the stock symbol of MSFT.  But since that's more than 3 letters, a root symbol is devised by the standardizing authority and a group of 3 letters is used.  MSQ is the primary root for Microsoft.  There can be others under certain conditions, but for now let's keep it simple.  The root for Microsoft is MSQ. 

The next to the last letter in an option symbol indicates the expiration month.  If the option is a call then the first half of the alphabet is used.  If the option is a put then the last half of the alphabet is used.  The table below illustrates the codes. 

Expiration Month Codes

The last letter of the option symbol indicates the strike price. Again there are codes to decipher the strike price. 

Strike Price Codes

By using the above information we can decipher the option symbol MSQLM:

• The MSQ is the Root identifying Microsoft, the "L" is for the month of December and it also let's us know that the option is a call option.
• The last letter "M" tells us the option is for the 65 strike price.

Don't worry about remembering or memorizing all the codes.  They are readily available and easily obtained when you need them.

One more example, let's examine the option symbol CAH:

• The last letter tells us the strike.  You have an idea where a stock trades to know the strike.  For instance, the letter "B" could be for the strike price of 40, 140, 240, 340, etc.  In this case the letter "H" is for the strike price of 40.
• The letter "A" is for the month of January and indicates a call;
• And the letter "C" is the root symbol for the stock of Citicorp as well as the stock symbol.