Welcome to the stock market millionaire, ladies and gentlemen, this is episode four. My name is Robert Roy, and today we’re going to focus on what is a call option. Now, in episode three, we went through what options were, and I told you in there that there are two different types of options.
But, if you want the scientific formula behind the call option, then you’re in the wrong place. You need to be in Mr. Ishmael class, down the hall. Yes. Mr. Ishmael was my high school science teacher, wild gray hair, and everything, looked like a scientist with his lab coat. You’re not going to get that here. I focus very heavily in what I do in my training. In my teaching, I focus very heavily on breaking down the market into manageable chunks where it’s easy, i’s simple for each and every person to grasp and understand.
So, first off, let’s talk about what an option is or more importantly, in this episode, what a call option is. So, back in episode three way back then, since this is four, we talked about what an option is, right? We talked in general, what an option is. We used the house example. If you remember it, if you listened to the show, awesome. If you didn’t go, back and listen, but I’ll give you a quick synopsis of it.
You want to buy a house; you don’t have enough cash, but you get the owner to agree to let you hold the house for the next 30 days. You’re not moving in – the owners are just taking it off the market. You paid them $5000 for that, right to hold that house. You have the right now to buy the house at $400,000 within the next 30 days, and for that, you paid $5,000 to the owner. It wasn’t down payment. If you bought the house, you already gave them $5000. We would give them $400K more or total of $405,000.
So what you did is you control the house. You never owned it. You see, wealthy, wealthy people aren’t about ownership. They’re about control. Can they control an asset without ever having to own it? Bill Gates does not own Microsoft. He owns shares in Microsoft. He doesn’t own Microsoft. He controls it through his stock shares, right?
When you’re buying a call option – if you’re buying a call option, that means you a bullish on the market. What does bullish mean? Well, let’s talk about the animals or the market. There are three, there are bowls. There are bears and there are hogs, right? Bulls make money, bears, make money, hogs or pigs get slaughtered.
Right? True story. If you’re a pig in the market, you’re going to get slaughtered. You’re going to get your head handed to you and blow your account up.
A bull, you need to think of how they attack, take the bulls horns, and they lift up to attack. Yeah. If the bull lifts its horns up for attack, that’s the way that you want the market to go if you buy a call option.
If you buy a put option, you are bearish. Where do you think the market’s going then down? Think of the bear. How do they attack? They raise their claw and they swing down at you, right? They’re bearish. It’s coming down.
So we buy a call option because we believe the market is going up from where it is right now. Right? And what we do is we leverage that position. Let’s say that you take a stock that’s trading for about $100 per share. You can buy an option, the correct option on that position somewhere out in time, about the next 30 days or so, for the cost of about five to 10% of the stock price. So if the stock is trading at a hundred, you should be able to buy the option for some of them between $5 and $10. Now don’t get me wrong. That is a guide only. You have extremely volatile companies that will be much higher. You’ve got companies that are dead flat that will be much lower. There is not a steadfast rule that every stock will be this price or this percentage, but it gives you a guideline, a base, a place to start understanding from of what we’re looking for. So, bulls are going up with their horns. We’re looking for the market or that individual stock to move higher, so we buy it the call option.
So now if I go ahead and look at what would be called an options chain – and you can go into your broker and take a look. If you’re not sure who to use, come to the website and we’ve got an article on our blog about brokers – and go ahead and go to your broker and say, “where do I find the option chain?” And if you look at the option chain, you’ll see the call options are on the left. The put options are on the right. There’s very few columns there, there might be a lot, but there’s very few you need to focus on as a newer trader. As you become more experienced you’ll learn more about them, but right now I’m trying to get you acclimated to what a call option is.
So you want to focus on, first off, if the stock is trading at $100, would you like to have the right to buy it at 90? Or would you rather have the right to buy it at $110? Think about it. It’s trading at $100 because in the example you have the right but not the obligation to buy the stock. I’m not saying you have to buy it, but that’s what your rights are. And just to clear that up right now, we don’t buy options to ever buy the stock. We buy options with the purpose of selling the option. We bought the option for $5. I sold it for eight. That’s my purpose. The price goes up higher. Well, when you look at that option, what are you focused on? What do you need to see, to say this is the right one?
There’s a few things. And I want you to think of the example of let’s say going to a party, right? I would venture to say most people like going to parties. I do. I love going to parties, life of the party. I love having fun to talk to everybody, right? “Hey, I’m a trader.” They love to hear what I have to say. You want me to tell you, I want to know the best stocks, right? So I love going to parties, but I don’t really like being the only one at the party. Now, for something, they call that a pity party. I definitely don’t want to be there. I worked very hard on mindset. I don’t want to be at the pity party. But when you think about it, the more people at that party, the more fun, right? If you got two or three people, I may have a really good time, but man, there’s 40, 50, 80 people at that party. You go to a wedding, especially the Italian weddings here in New York? Oof! You get two, three, 400 people at those weddings, man. We’re rocking all night long, right? I love having more people at the party. Well, when you look at an option chain, there’s a column called open interest. Write this down: Open interest needs to be greater than 100.
Okay. What does that say? There’s enough people at the party that you’re not going to get your head handed to you, right? I want to make sure there’s at least a hundred people at the party. Okay, great. Got it. Now what, from there, I’m only looking for one other thing on the option chain. Again, this is as a newer trader. We’ll get more into options chains in some of the later episodes. But when you look at the option chain, I want you to find a column called Delta.
“What does it mean?”
“Don’t worry about what it means.”
“Well, Rob, I need to know everything.”
“No, you really don’t know.”
“I really need to know.”
No, You really don’t, and here’s why… Most of you, unless you are a mechanic, know that you take your key. Well, you used to take your key and put it in the ignition and turn. Now, you keep it in your pocket and press a button ‘cause you’ve got the fob in your pocket, but you put the key in the ignition. You turn and you go. Do you know the firing order of the spot or the spot close of your car? Unless you’re a mechanic or an enthusiast, probably not. Bottom line is, do you need to know that information to drive your car? No, you don’t. Right. So what do you do? Stick the key in the ignition turn and go.
Don’t worry about what Delta is for right now. You want to get into the math behind it. You can go on Google and search Delta for an option, and there will be thousands of definitions of it that you can go and see. For our purposes, let’s just say we’ve got a range. I’m looking for the Delta between 65 and 85. And I really want to closest to 65.
So you could write down Rob’s rules, right? 65 to 85 Delta. But I want the closest to 65. That doesn’t mean 64. If it’s 64 and 75 are going with the 75, 64 is lower than 65. Oh, but it’s so close. So close. Got it. So if I tell you 64 is okay, you know what your next question is? How about 63? Come on, Rob. 63 was okay. Can we go to 62? How about 50?
See where I’m going with it. 65 to 85, but closer to 65. We spend less money on the 65 option. The higher the Delta, the more expensive the option is. We also are on a place on the bell curve of the option where we’re in that sweet spot and we’ve got the largest potential gains-ish taking place right from there. So we want a hundred open interest and we want a Delta of 65 to 85 closest to the 65.
Let’s say we find that option on XYZ stock that is trading with a Delta of 70, and it’s a $10 option. So we spend $10 on the call option. Well, is that what it is? Just a whole $10. No. See that’s $10 per share. One contract controls 100 shares. (Okay, got it. Contract controls a hundred shares. Each contract has 100 shares in at times the $10, which means you have to have a thousand dollars in that trade?) Yes.
Now that thousand dollars is also your maximum risk. You can’t lose more than that, that’s it. That’s the most it can cost you in that trade. Or if you bought a hundred shares of stock at a hundred dollars per share, 10 shares would be a thousand dollars, 100 shares would be $10,000. So the stock went to zero, you would lose $10,000. See, so remember I told you somewhere between five and 10% of the stock price? That’s about where we are in this example that I’m making up here, this XYZ stock, okay?
So we go ahead and we buy that option and we buy it for $10 and it has a Delta of 70. Okay. So a lot of numbers floating around now. What does this all mean? We found an option with a hundred open interest, a Delta between 65 and 85 closest to up to the 65, we buy that option for $10 per share, times 100 shares, so we needed a thousand dollars to do this trade, and it has that 70 Delta.
You keep saying that, right? What is this? 70 Delta, me here.
You ready? It tells us for every $1, the stock moves, the option will move approximately 70 cents.
Now there are somethings that could affect it; for our purposes today, we’re just going to say straightforward fact, (it’s not) but for the math purposes, we’re going to say it moves 70 cents per share.
Well, that means if your stock goes up $1, what happened? Well, that means, yeah, if you own this stock, you’d have $1 increase or you’d make $100 on your $10,000 investment. Okay. I got it. Well, what if my option that I was holding increased in value (which you would)? Why? The stock went up a dollar – if the Delta tells us how much does the option increases, how much does my option go up?
70 cents, Because that was the Delta on my option. If it was an 80 Delta, it would go up 80 cents. If it was a 10 Delta, it would go up 10 cents. Right? It tells us, helps us to understand how the position moves based on the Delta.
So now, if you had an option that you bought, and you spent a thousand dollars and you made $70, or you spend $10,000 to make a hundred dollars on the stock, where’s your better deal? You see, here’s a phrase that I need you to write down and there’s no ifs, ands, or buts. If you’ve not heard it don’t even think about skipping it. Write it Down.
When there is a small movement in the stock price, there is a magnified movement in the options price.
When there’s a small movement in the stock price, there’s a magnified movement in the options price
When we talk about the most common trading strategy with options, with a call option, where they call option, it is just buying calls and puts, let’s say, right? Those types of options today, of course, is the option. The call option, not the put option.
We’ll do the next episode or one of the next ones will be on that. Now, are there other call option strategies? Yes.
Are there other ways to trade a call option? Yes.
Are there other ways to use… Yes, there are.
This is the most basic and common way that most traders tend to trade. I was being interviewed the other day by a news organization, big news outlet, and they asked me if I traded more advanced option strategies, because all I kept talking about were very basic option strategies. And I said, you know, “yes, I do have some more advanced ones that I trade…”, but these things that have seven different options in them, they’re called the upside down flint rubble, bubble, cake, whatever name you make up for it, this crazy nutty thing that people do to try to go to a Delta neutral and have no risk in the trade….
And by the time it’s done I need $14,000, and I made 87 cents in total. But hey, I’m guaranteed to win. There are strategies like that, but you know, that’s the equivalent of, I will never cross a street because at some point I might get hit by a car, right. We don’t do that in our lives. And we shouldn’t trade that way either. You are willing to take on some risks. Now, you know, the rules look both ways, and, you know, watch before you cross, cross at the corner, cross on the, you know, with a light in your favor, whatever the rules are, you get the idea, right? It’s no different when you trade options. But just because you do all of that – I was in Manhattan with a girl that I was dating brand new. First time we’re out with her. We were with a bunch of friends. We’re walking in Manhattan and we crossed the street and his taxi comes screaming right at us. We’ve got the light. He didn’t care. Go figure, New York city taxi, right? He didn’t care why. I dunno, why nor do I care, right? But is that what we expect that to happen? No.
Things can happen in your options. Trade. The key is when you buy the call option, you want the stock to go up. And if the stock goes up for every $1, the stock moves, the option will move. What the Delta is, which in this case was about 70 cents.
All right, ladies and gentlemen, there, you have it. You have yourself, a phenomenal rest of your day. Stay focused on the quest to becoming a great trader. Keep crushing it. And remember folks you’re just one trade away, take care, and I will see you all soon.