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Avoid common pitfalls review

Lesson in Course: Ambition reviews (beginner, 5min)

Part 4 of Prepare for options trading

Options and margin

The clearinghouse requires margin to be posted for all options traders. Margin is used as insurance to make sure that everyone gets paid at the end of the day.

 

The decay of time

We can think of the extrinsic value as the chance for a radical outcome happening before our option contract expires. This chance diminishes as the window of time shortens.

As a result, extrinsic value decays over time and a -0.04 theta means the option loses $0.04 in premium every day even if the stock price holds steady. So theta works as a transfer of time value from the buyer of the option to the seller of the option until maturity.

 

Naked strategies

In the world of options, a naked position describes an outcome when we write options without owning or short-selling any of the underlying stock. The goal for writing naked options is to receive the premium from the option buyer and hope the option is never exercised.

Payoff diagram: Naked Call
Payoff diagram: Naked Put
 

Covered strategies

A covered option strategy is when we write an options contract in addition to either owning or short-selling the underlying stock, depending on if we're writing a call or put. Similar to naked strategies, the goal is to receive the premium from the buyer of the option and hope it is never exercised.