OPTIONS

Monday, September 29, 2008

Reading Links

* All-Time High Volatility: What’s a Trader or Investor to Do? by IITM.com

* The VIX Stretch by Optionetics:

* VIX Options as Catastrophe Insurance by Vix and More.

* Stock Market Trading Method by Kevin’s Market Blog.

* How to Recognize Market Capitulation by Trading Market.

* Forex Buyers Guide - Forex Guides and Tips.

* Trader’s Blog: This blog provides many trading educational articles. Check out many of great articles under the Categories of Traders Toolbox, Technical Indicators, and Trading Tips & Techniques.
FYI, if you want to get alerts on the latest update of Trader's Blog postings, you can also subscribe to their “Trader’s Blog’s Alerts”.

Tuesday, September 23, 2008

Options Transactions

In stock trading, there are only 2 types of transactions: To buy or to sell.

In option trading, there are 4 different types of Option Transactions:
1) Buy To Open
2) Buy To Close
3) Sell To Open
4) Sell To Close.

The type of transaction that an option trader will make depends on whether he/she is an Option Buyer or Option Seller/Writer.

For an Option Buyer, the following are the types of transaction he/she will make:

1) Buy To Open
When an Option Buyer wants to open / enter a “long” position on a certain option contract, he will need to do a “Buy To Open” transaction.
For example: When an option trader wants to buy a straight Call option to take advantage of current upward trend.

2) Sell To Close
When an Option Buyer wants to close the “long” position he entered previously, he will need to do a “Sell To Close” transaction.
For example: When the option trader wants to sell the Call option he/she owned / bought earlier.

For an Option Seller/Writer, the following are the types of transaction he/she will make:

1) Sell To Open
When an Option Seller/Writer wants to open / enter a “short” position on a certain option contract, he will need to do a “Sell To Open” transaction.
For example: When an option trader wants to sell a Call option to earn premiums.

2) Buy To Close
When an Option Buyer wants to close the “short” position he entered previously, he will need to do a “Buy To Close” transaction.
For example: When the option trader wants to buy back the Call option he sold earlier.

Related Posts:
* Getting Started Trading
* Options Trading Basic – Part 1
* Options Trading Basic – Part 2
* Understanding Implied Volatility (IV)
* Option Greeks
* Trading Educational Videos

Sunday, September 7, 2008

Main Factors that Affect Option’s TIME VALUE

As mentioned in “Option Price Components”, option price or premium consists of:

For ITM Option:
Option Price = Intrinsic Value + Time Value

For ATM and OTM Options:
Option Price = Time Value

Whereas:

Intrinsic Value of ITM CALL Option:
Intrinsic Value = Current Stock Price – Strike Price.

Intrinsic Value of ITM PUT Option:
Intrinsic Value = Strike Price – Current Stock Price.

As you can see from the above formula, Intrinsic Value of an option is very straightforward.
It’s simply the difference between option’s strike price and current stock price.
Time Value component of an option is the one that make an option very complicated to understand.

Time Value of an option would be mainly affected by:

1) Degree of Options Moneyness
As discussed in this post, Options Moneyness describes the relationship between an option’s Strike Price with stock price (i.e. where the Option’s Strike Price is in relation to the current stock price).

The farther the option’s Strike Price to current stock price, the lower the time value will be.
Therefore, since for ATM options, the option’s Strike Price is the same as the current stock price, ATM options would consequently have the highest time value.
The time value will gradually decline as it moves to deeper ITM and deeper OTM options (like inverted-U curve), because the deeper ITM or OTM an option, the farther its Strike Price from the current stock price.

2) Implied Volatility (IV)
The higher the IV, the higher the option’s time value.

3) Time Remaining to Expiration
The longer the time remaining to expiration, the higher the option’s time value.
All other things being equal, an option with more days to expiration will have more time value than an option with fewer days to expiration.

Hence, Implied Volatility (IV) is not the only one that influences an option’s time value. That’s why although, for instance, IV of an option is very much higher than the other options, it does not mean that its premium will be higher in terms of dollar value. There are other factors affecting their overall premium.

Just remember that whether an option is considered “cheap” or “expensive”, it is not based on the absolute dollar value of the option, but instead based on its IV.
When the IV is relatively high, that means the option is considered “expensive”.
On the other hand, when the IV is relatively low, the option is considered “cheap”.
(Please see this post – How To Determine If An Option Is Cheap (Underpriced) Or Expensive (Overpriced) – for further discussion).

However, the overall option price / premium in absolute dollar value will be determined by other factors as discussed above.
Therefore, it’s possible that an option is low in terms of dollar value, but it’s considered “expensive” due to relatively high IV.
On the other hand, an option can be high in terms of dollar value, but it’s considered “cheap” due to relatively low IV.

Related Topics:
* FREE Trading Educational Videos You Should Not Miss
* Options Trading Basic – Part 1
* Options Trading Basic – Part 2
* Understanding Implied Volatility (IV)
* Option Greeks
* Learning Charts Patterns