Options Education

 Basic Trading 

Options educational content provided courtesy of ChartBender.

Basic Trading provides a brief introduction to some very fundamental concepts relevant to trading. If you are brand new to trading and to options, this section is a good place to start.

When you buy first (buy to open) with the intention of selling later (selling to close), you are said to have a "long" position in the asset (e.g., stock). When you have a long position, you make money when the value of the asset increases. You lose money when the value of the asset falls.

The profit and loss (P&L) chart below shows the linear relationship between profit and stock price for a long stock position (assumes 100 XYZ shares purchased.)

You can also sell first (sell to open) and buy later (buy to close). This is called short selling and, when you do this, you are said to be “short” the asset. You still want to buy low and sell high, just in the opposite sequence. When short an asset, you want the asset's value to fall. See the P&L chart below.

The profit and loss (P&L) chart below shows the linear relationship between profit and stock price for a short stock position (assumes 100 XYZ shares sold short.)

The more shares of stock (real or synthetic) in your position, the steeper the line in your P&L chart will be. Looking at the P&L chart below, Long Position 1 has 100 shares of stock and represents a faster rate (steeper slope) of profit and loss as compared to Long Position 2, which has just 30 shares of stock in it. In the second chart below, the blue arrows indicate that we can rotate our P&L line virtually 360°. As shown, this is accomplished by increasing or decreasing the number of shares. (In the chart, a "+20" indicates long 20 shares and a "-20" indicates short 20 shares.)

Why this is important: When you trade options, you are trading contracts that generally represent 100 shares of stock each. Incorporating actual shares of stock into your options positions can be very useful for "fine-tuning" the pitch of your risk curves. Further, there will be times when you want to adjust your risk curve without sacrificing desirable attributes of your options. This, again, can be accomplished by incorporating shares of stock into your option positions. The value of this knowledge will become increasingly apparent as you venture deeper into ChartBender’s educational content, covering such topics as synthetics.

Bend that chart! So, part of the 360° of profitability includes the ability to rotate the line in your P&L chart by manipulating the number of shares. But the ultimate in risk control comes with the ability to BEND the line on your P&L chart. Bending is accomplished by using options. An example of bending a P&L chart is shown to the right. This is one of an unlimited number of ways you can bend your P&L chart.

Why this is important
This type of control over your P&L enables you to create investments that match your market outlook and risk tolerance precisely. More importantly, if you don't know what the market will do next, options can be ideal. At ChartBender, we sometimes place trades in such a way that the more wrong we are, the more right we become.

This educational content is provided by ChartBender.
© 2005 ChartBender, LLC.