Lesson 2: Options Fundamentals

Now we build your foundation. This lesson covers everything you must understand before placing your first trade — the vocabulary, the mechanics, and the logic of how options work.

Rule of Thumb: Trade What You See, Not What You Think

Before anything else, internalize this rule. When I first started trading, I made decisions purely on intuition based on news headlines, without looking at charts. That rarely works.

• Good news does not always make a stock go up
• Bad news does not always make a stock go down
• The market has its own logic that news alone cannot predict

You must learn to see opportunities as they appear on the chart, not force trades based on what you think should happen. Look at charts. Identify patterns. Do your research. Then decide.

Glossary of Essential Terms

Memorize these. We will use them constantly.

Option — A contract you buy or sell. Either a call or a put.

Premium — The price you pay for an option. Also the price of the option itself.

Strike Price — The price at which you believe a stock can realistically reach by the expiration date. It’s your “target price.”

Expiration Date — The date the option contract expires. Options have time limits. You must close your position before this date.

Underlying Stock — The stock the option is based on. If you buy an option on Apple, Apple is the underlying.

Bullish — Expecting a stock to go UP. (“I’m bullish on Apple.”)

Bearish — Expecting a stock to go DOWN. (“The market was bearish today.”)

In The Money (ITM) — A call’s strike is BELOW the current stock price. A put’s strike is ABOVE the current price. Safer, more expensive, lower reward.

Out of The Money (OTM) — A call’s strike is ABOVE the current stock price. A put’s strike is BELOW the current price. Riskier, cheaper, higher percentage upside.

Volume — How many contracts of a given option have traded. Higher volume = easier to enter and exit.

Position — A trade you currently have open.

Weekly — A contract that expires on the Friday of the current trading week.

Swing — Buying a contract and holding it into the next trading day or longer.

The Two Types of Options

There are exactly two types of option contracts. That’s it.

Call Options — Betting a Stock Will Go UP

Buy a call option when you anticipate the stock price will RISE.

• Stock goes up → your call goes up in value → you profit
• Stock goes down → your call loses value → you lose

Put Options — Betting a Stock Will Go DOWN

Buy a put option when you anticipate the stock price will FALL.

• Stock goes down → your put goes up in value → you profit
• Stock goes up → your put loses value → you lose

Key insight: Unlike owning stock, you can profit from stocks falling with puts. This is one of the most powerful aspects of options — you have tools for any direction the market moves.

How You Actually Make Money

The most basic scenario:

1. A stock is at $100. You believe it will go up.
2. You buy one (1) call option priced at $0.50 — this costs you $50 (remember, options are sold in contracts of 100 shares).
3. The stock rises to $105.
4. Your call option’s value increases to $1.50 — now worth $150.
5. You sell the call.
6. You just made $100 profit off a $50 investment.

That’s the core mechanic. Buy an option low, sell it higher. The option’s value changes based on the movement of the underlying stock.

Stocks vs. Options — The Difference

• Stocks: Buy at $20, sell at $50 → $30 profit. Slow and steady.
• Options: Buy at $0.20, sell at $0.80 → $60 profit (per contract). Faster, larger percentage moves, but more risk.

Options give you leverage. A small move in the stock creates a much larger percentage move in the option. That’s the appeal — and the danger.

Bid and Ask — The Price You Actually Pay

Every option has two prices in real-time:

• Bid price — What buyers are willing to pay (the price you get when SELLING)
• Ask price — What sellers are willing to accept (the price you pay when BUYING)

The difference between them is called the spread.

Think of it like buying sneakers from a reseller. Buyers want to pay $200. Sellers want $1000. Eventually they settle somewhere in the middle — maybe $600. That middle price is called the Mid.

Rule: Only trade options with a TIGHT bid/ask spread. A spread of $0.01–$0.05 is ideal. A spread of $0.50 or more means the option is illiquid — you will lose money just from entering and exiting. Always check.

Picking a Strike Price

The strike price is where you think the stock can reach by expiration. But here’s something most people get wrong:

The stock does NOT have to reach your strike price for you to profit. You can sell your option at any time for whatever the current premium is. I repeat: the stock does not have to hit your strike.

When I trade, I typically buy options slightly Out Of The Money because:

• They’re cheaper (smaller capital commitment)
• They have room to grow if the stock moves my direction
• Higher percentage upside

Example

Apple is at $100 and typically moves about $15 in a 3-month period. I might buy a $115 call expiring 3 months out. The stock doesn’t need to reach $115 — if it moves even $5 in my favor, my call will gain significant value.

Volume Rule

Pick strikes with at least 200 volume for beginner trades. Round number strikes (multiples of 5 or 10) tend to have the best volume.

Options Misconceptions to Clear Up Now

Myth: “The stock has to reach my strike price.” False. You profit from the change in option premium, not from hitting the strike.

Myth: “The Break Even price is important.” Only if you plan to exercise the contract. Most traders don’t. The break even price is IRRELEVANT for our purposes.

Myth: “Stock Price, Strike Price, and Option Price are the same thing.” They are three different things. Keep them straight:

• Stock Price: Current price of the underlying company’s shares
• Strike Price: The price level you chose for your option contract
• Option Price (Premium): The cost of the option contract itself

Rule: Do not buy options expiring too soon. Give yourself at LEAST 4 days before expiration. Preferably 7+ days. Time is your friend — don’t throw it away by buying near-expiration contracts. A good rule is to double the time based on the time frame you’re entering. For example, if the weekly time frame is the main time frame that has your A+ setup, buy the contract at least 2 weeks out to let the set up play out.