How options are priced – Premium / Credit / Debit

When you’re looking at  options prices you’ll see most of them in cents and a few in dollars.

Amazon example below:

put examaple - price

You can see a price of $8.60. The actual buying power reduced would be $88,500. This is because the contract controls 100 shares at the strike price of $885. The beak even would be the strike price of $885 – the credit of $8.60 leaving the break even floor at $876.40

The current price is $894.88. This means there is a $18.48 distance between the current price and the beak even, about a 2% move – the option above is for 13 days.

The same option 41 days out pays $25.45 or a credit of $2,545 – you can see how theta has changed the price.

Most people including my self don’t have $88,500 buying power to be reduced in a single trade. In this case you can employ verticals

Here is an example of a set of 41 day options with a 5 strike width.

vertical example to explain option prices and defining risk

You can see we’re now collecting $1.45 or $145 in credit and our buying power is reduced by our max risk which calculated by taking the width of the strikes $5 minus the credit received $1.45 – Total max risk would be $3.55 or $355

Now you can see how you can trade higher priced stocks and not have to put up $88k. The break even on this trade is the strike on the put you sold minus the premium collected. In this case $860 – $1.45 = $858.55

That is a $36.33 difference from the current price of $894.88 and it would require a 4% down in price to breach the break even. If the price remains above the break even of $858.55 or rises even more this trade is a winner.

I prefer to manage winners at 50% so I would manage this trade around $75.