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Some more, INO will be adding dozens of the top experts and might be raising the price, so get a yearly membership and take advantage of the new authors to be added in 2009.

Learn more about INO TV here.

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Limit-On-Open (LOO) Order

Limit-On-Open (LOO) is an order that is automatically submitted as a Limit Order (i.e. to buy/sell at the Limit Price or better) at the opening of the market, and to be executed as soon as possible after the market opening only if the price during the opening period is at or better than the Limit Price. Otherwise, the order will be cancelled.

As with limit order, while Limit-On-Open (LOO) order can be filled at the Limit Price or better, it does not guarantee a fill.

LOO order is useful when traders find that the opening price of a certain security has historically proven to be the best price of the day (i.e. the opening price is the highest for sell order, or lowest for buy order), but still want to have control over the price at which the order will be filled to ensure that the execution price is still within their comfortable / acceptable limit.

For the list of other types of order, go to: Types of Orders in Trading.

Related Topics:
* FREE Trading Educational Videos You Should NOT Miss
* Getting Started Trading
* Options Trading Basic – Part 1
* Options Trading Basic – Part 2

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Merry Christmas & Happy Holidays

Dearest all readers,


MERRY CHRISTMAS & HAPPY HOLIDAYS!


May you have a blessed & wonderful time with family & friends.
GOD bless you all always...

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Market-On-Open (MOO) Order

Market-On-Open (MOO) is an order that is automatically submitted as a Market Order (i.e. to buy/sell at the market price) at the opening of the market, and to be executed as soon as possible after the market opening at a price within the opening range of prices.

Hence, MOO order can only be executed during the exchange-specified opening period at a price within the opening range of prices; otherwise the order will be cancelled.
However, the execution price does not necessarily need to be the opening price (the first price traded), or to be guaranteed as the best price in that range.

As with market order, while Market-On-Open (MOO) order guarantees an execution, it cannot guarantee the price at which your order will be filled.

MOO order is useful when traders find that the opening price of a certain security has historically proven to be the best price of the day (i.e. opening price is the highest for sell order, or lowest for buy order) and then decided to buy/sell at any price available during this opening period.

For the list of other types of order, go to: Types of Orders in Trading.

Related Topics:
* A Chance to Learn from World Class Trading Experts For FREE You Should Not Miss
* Getting Started Trading
* Learning Candlestick Charts
* Learning Charts Patterns

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Short Trading Videos: FIBONACCI RETRACEMENT RULES

In the earlier post, I’ve shared a trading video that shows an example how to use Fibonacci tools to predict / measure market pullback.

If you’re interested to learn more about Fibonacci, there is another trading video (about 8 mins), which explain in much more details about FIBONACCI RETRACEMENT RULES.

Click HERE to watch the video.

Related Topics:
* FREE Trading Educational Videos You Should Not Miss
* Learning Candlestick Charts
* Learning Charts Patterns

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Limit-On-Close (LOC) Order

Limit-On-Close (LOC) is an order to be executed as a Limit Order (i.e. to buy/sell at the Limit Price or better) as close as possible to the market close.
Hence, Limit-On-Close order will be executed at or near the closing price, only if the price is at or better than the Limit Price. Otherwise, the order will be cancelled.

Similar to Market-On-Close (MOC) order, for this order, the broker normally set a time deadline for LOC order submission for that day, which is well before the closing of the trading day. After this submission time deadline, the broker will not accept any more LOC order, and the traders also cannot cancel the submitted LOC order for that day.

As with limit order, while Limit-On-Close order can be filled at the Limit Price or better, it does not guarantee a fill.

LOC order is useful when traders find that the closing price of a certain security has historically proven to be the best price of the day (i.e. the closing price is the highest for sell order, or lowest for buy order), but still want to have control over the price at which the order will be filled to ensure that the execution price is still within their comfortable / acceptable limit.

For the list of other types of order, go to: Types of Orders in Trading.

Related Topics:
* Getting Started Trading
* FREE Trading Educational Videos You Should NOT Miss
* Learning Charts Patterns
* Learning Candlestick Charts

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Short Trading Videos: How To Determine MARKET TREND & How To Use FIBONACCI To Measure Market Retracement

Just wanna share some short trading videos that could be helpful for the readers here, particularly for the beginners, to learn few quick, simple yet practical trading tips.
Here they are & enjoy:

1) HOW TO DETERMINE MARKET TREND

This five minute video shows some techniques on how determine market trend:
* How to determine a downtrend.
* How to determine an uptrend.
* How to determine when a market is making a change of direction.

As you can see in the video, one of the key components to look out for is how a market closes on a Friday or the last trading day of the week. Because this is when traders have to decide what they want to do with their positions, and it can also tell you with a high degree of probability which way the market is headed for the upcoming week.
Watch this video HERE.

2) EXAMPLE ON HOW TO USE FIBONACCI TO MEASURE RETRACEMENT

This short video shows an example how to use Fibonacci tools to predict / measure the upward retracement during this downtrend period in the Dow Jones Index (as at 1 Dec 2008).
In addition, the video also shares some analysis & prediction on what and how you’re going to approach the markets in 2009.
To watch this video, just click HERE.

Related Topics:
* FREE Trading Educational Videos You Should Not Miss
* Learning Candlestick Charts
* Learning Charts Patterns

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Market-On-Close (MOC) Order

Market-On-Close (MOC) is an order to be executed as a Market Order (i.e. to buy/sell at the market price) as close as possible to the market close.
Hence, the order will be executed at the market closing price (which may differ with exchanges), or as near as possible to the closing price.

For this order, the broker normally set a time deadline for MOC order submission for that day, which is well before the closing of the trading day. After this MOC submission time deadline, the broker will not accept any more MOC order, and the traders also cannot cancel the submitted MOC order for that day.

As with market order, while Market-On-Close (MOC) order guarantees an execution, it cannot guarantee the price at which your order will be filled.

MOC order is useful when traders find that the closing price of a certain security has historically proven to be the best price of the day (i.e. the closing price is the highest for sell order, or lowest for buy order) and then decided to buy/sell at or near the closing price, whatever the price is.

In option trading, one possible use of this order is for options sellers who want to close their expiring option positions at the last minute of expiration day in order to maximize profit by letting the remaining last cent of option’s time value to decay before closing the position.

For the list of other types of order, go to: Types of Orders in Trading.

Related Topics:
* FREE Trading Educational Resources You Should Not Miss
* Getting Started Trading
* Options Trading Basic – Part 1
* Options Trading Basic – Part 2

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Free Trading Educational Videos You Should Not Miss

Previously, I have shared some free trading educational videos from trading experts. Unfortunately, now those videos are no longer available for free.

However, don’t worry! The GOOD NEWS is that there are other 4 new FREE trading educational videos from another trading experts.
One of them is even very valuable particularly for options traders!

Learn from the following 4 new trading educational videos:

1) THE ART OF MORPHING by Ron Ianieri (Duration: 90 Mins)

For option traders, Ron Ianieri is well known as the co-founder & Chief Options Strategist of The Options University.

Every position is the right position when things go exactly as planned. Unfortunately, things do not often go exactly as planned in the market. When all goes right, it is easy to make money but when things go wrong losses follow.
So, when things start to go wrong, what can you do? How can you get out of your bad position that is losing money and into the right position quickly and efficiently and get back to making money? The answer is morphing!

Morphing is the process in which the wrong position is quickly and efficiently changed to the right position by simply adding to or subtracting from the current position based on an understanding of synthetic positions.
Morphing is how the professional floor traders manage their positions to adjust to movements in stock price, time, and volatility.

So, this is the videos that an option trader shouldn’t miss!

2) APPLYING TECHNICALS METHODS TO TODAY’S TRADING by John Murphy (Duration: 90 Mins)

John Murphy is the CNBC-TV’s technical analyst for many years and wrote the book “Technical Analysis of the Futures Markets” (Prentice Hall, 1986), which many technicians consider the core of their technical analysis library.

In this video, John explains how he looks at the markets using non-traditional methods. He also shares his thought process in selecting markets to trade using Sector Rotation. Watch too John's inter-market analysis in action and just how commodities can put a drag or a rocket under a stock. He then further explains the relationship between the U.S. Dollar and Gold prices.

3) FIVE NEW TOOLS FOR WINNERS by Jake Bernstein (Duration: 45 Mins)

Jake Bernstein is probably the most prolific writer and researcher of material for today's individual trader. His titles span subjects from basic technical analysis to trading psychology and seasonal price patterns.

Jake has always been willing to share his research on trading with those students of the market who diligently seek his advice. In the process of working on material for this new audience, Jake has discovered new market relationships which will be of interest to all serious traders. It is these relationships that Jake will discuss in detail in this can't miss videotape recorded at a recent futures conference.

4) MARKET WIZARDS INSIGHTS by Jack Schwager (Duration: 85 Mins)

Jack D. Schwager is well known as the author of The Complete Guide to the Futures Markets, Market Wizards, The New Market Wizards, Fundamental Analysis, and Technical Analysis.

In this video, Jack Schwager explains the traits and behavior patterns that super traders have in common, and tells you how you can develop those same winning characteristics.
This is a video that you'll find as entertaining as it is informative.

So, don’t miss this chance anymore! Watch all these four trading videos HERE.
Just click the “SIGN UP” button in that link and fill up the registration form in order to watch the videos for FREE.

Important Note (as at 9 May 09):
These videos have been available for free for quite some time already, and hence, like what has happened previously, they may not be offered for free anymore anytime soon. So, if you’re interested to learn from then, don’t delay anymore to watch it.

Update as at 22 May 09:
Effective from 18 May 09, the above videos are no longer available for free.
Sorry if you've missed this opportunity. However, I'll update you again when there are new free trading educational videos. Hope you won't miss the chance to learn from trading experts for free anymore next time.

Update as at 30 July 09:
There is a new FREE trading educational video from another trading expert.
For more info about the new trading video, read this post.
Hope you don’t miss this chance anymore! :)

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Limit Order

Limit Order is an order to buy or sell by setting the maximum price (for buy) or minimum price (for sell) at which you are willing to buy or sell.
Hence, when you buy shares/options, you will not pay at any price higher than the limit you set, and it’s even possible for the order to get filled at a price lower than the stated limit.
Similarly, when you sell shares/options, you will not receive at any price lower than the limit you set, and it’s also even possible for the order to get filled at a price higher than the stated limit.

While Limit Order has an advantage that you can be sure the order will be executed / filled at the limit price or better, the disadvantage of this order is that there is no guarantee that the order will be executed / filled.

As a result, in the case when the price has moved up while you are placing a buy order (particularly when the market is moving very fast at that time), the order may not get filled.
Therefore, if an order is not filled on Limit Order within a few seconds, you should check what the prevailing ask price is at that time, and then modify the order accordingly if you’re still interested to buy the shares/options.

Note:
Some brokers may charge different commissions between Market & Limit Orders.
Typically, due to more complexity / additional condition, the commission for Limit Order is more expensive than for Market Order.
Hence, you need to check your broker’s commission before placing a Limit Order.

For the list of other types of order, go to: Types of Orders in Trading.

Related Topics:
* Getting Started Trading
* A Chance to Learn from World Class Trading Experts For FREE You Should Not Miss
* Learning Candlestick Charts
* Learning Charts Patterns

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Market Order

Market Order is an order to buy or sell immediately at the best available price in the market at that time.
The advantage of Market Order is that it will guarantee an execution.
However, the disadvantage of this order is that you cannot control the price at which your order will get executed (or filled), and hence you also won’t know at what price your order will eventually get filled.

Typically, if you are going to buy shares/options, you will pay a price near the Ask Price. If you are going to sell shares/options, you will receive a price near the Bid Price.
However, it is important to note that the last-traded price is not always necessarily the price at which the Market Order will be executed.

When the market is very liquid with very tight bid-ask spreads and not so volatile whereby prices don't change drastically, this kind of order is rather safe.
However, in fast moving & volatile market whereby prices move very fast, or in a less liquid market whereby bid-ask spreads is wide, placing a Market Order can be quite risky, because the price at which the trade got executed (or filled) can deviate significantly from the last-traded price.

When the size of a Market Order is quite big, it is possible that the broker will split the order across a number of participants at the other sides of transaction, resulting in different execution/filling prices for different portion of shares/options.

For the list of other types of order, go to: Types of Orders in Trading.

Related Topics:
* Getting Started Trading
* FREE Trading Educational Videos You Should Not Miss
* Option Greeks
* Understanding Implied Volatility (IV)

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Types of Orders in Trading

Before getting started to trade, a trader needs to get familiar with types and specification of orders in order to prevent from making unnecessary mistakes.

Below is a list of a number of types of orders. I’m trying to organize them for easier understanding. We’ll discuss each of them further in the next posts.

Too many types of orders may cause some confusion and lose of focus. Therefore, I also mark a few of very common types of orders in the list below with “***”.
(Click the LINK in BLUE FONTS below to read the posts on each type of orders).

For beginners, you can start to get familiar with these marked types of orders first, before moving on to more advanced types of orders. Hope this can help you to speed up your learning. :-)

Types of Orders related to How an Order will Get FILLED:

1) Market Order ***
2) Limit Order ***

3) Market-On-Close (MOC) Order
4) Limit-On-Close (LOC) Order

5) Market-On-Open (MOO) Order
6) Limit-On-Open (LOO) Order

7) Market-To-Limit (MTL) Order
8) Iceberg Order

Types of Orders related to the TIMING / DURATION of the Order:
When submitting an order, a trader also needs to specify the timing or duration in which the order will still be active / valid before it gets executed.

1) Day Order ***
2) Good Till Cancelled (GTC) ***
3) Good Till Date/Time (GTD)

CONTIGENCY ORDERS
Contingency Order is an order that is to be executed only if one or more specified conditions are met.
Possible conditions may include quantity, price (of that security or another security), or the completion of another order.

Even though some brokers accept contingency orders, they are actually not obligated to do so. However, if they do accept such orders, they must abide by the terms of the order.

Examples of contingency orders are listed below.

Contingency Orders with Conditions related to QUANTITY / SIZE of Order and TIMING of Execution:
When submitting Market or Limit Orders, it is also possible to attach conditions that are related to the ability of the broker to fulfill the quantity / size of the orders and timing of execution.
Contingency orders with such conditions are as follow:

1) Fill-Or-Kill (FOK)
2) Immediate-Or-Cancel (IOC)
3) All-Or-None (AON)

Contingency Orders with Conditions related to PRICE
Contingency orders with conditions related to price are very useful, particularly when you cannot monitor the market all the time. These orders allow traders to open or close position in the market automatically once certain conditions are met.
Examples of Contingency orders with conditions related to Price are as follow:

For Automatic OPENING of a Position:
The following are some types of orders that allow you to open a position in the market automatically once a certain condition is met, particularly when you cannot monitor the market all the time:

1) Market-If-Touched (MIT) Order
2) Limit-If-Touched (LIT) Order

For Automatic CLOSING of a Position:
The following are some types of orders that allow you to close the position automatically once certain condition/s is/are met, in order to protect your position, particularly when you cannot monitor the market all the time:

1) Stop Order ***
2) Stop Limit Order
3) Trailing Stop Order ***
4) Trailing Stop Limit Order

More COMPLEX Types of Contingency Orders
1) Conditional / Contingent Order
2) Bracketed Order
3) One-Cancels-Other (OCO) & One-Cancels-All (OCA) Orders
4) One-Triggers-Other (OTO) & One-Triggers-All (OTA) Orders


Related Topics:
* Free Trading Educational Video: Learn Technical Tips from Dan Gramza
* Options Trading Basic – Part 1
* Options Trading Basic – Part 2
* Understanding Implied Volatility (IV)
* Option Greek
* Understanding Option’s Time Value
* Learning Candlestick Charts
* Learning Charts Patterns
* Getting Started Trading

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GARTMAN’S RULES OF TRADING – Part 3: Technical Trading System

Go back to Part 2: Trading System & Money Management

TECHNICAL TRADING SYSTEM

16. Keep your technical systems simple.
Complicated systems breed confusion; simplicity breeds elegance.

17. Establish initial positions on strength in bull markets and on weakness in bear markets.
The first "addition" should also be added on strength as the market shows the trend to be working. Henceforth, subsequent additions are to be added on retracements.

18. Respect and embrace the very normal 50-62% retracements that take prices back to major trends.
If a trade is missed, wait patiently for the market to retrace.
Far more often than not, retracements happen... just as we are about to give up hope that they shall not.

19. Bear markets are more violent than are bull markets and so also are their retracements.

20. Try to trade the first day of a gap, for gaps usually indicate violent new action.
We have come to respect "gaps" in our nearly thirty years of watching markets; when they happen (especially in stocks) they are usually very important.

21. Respect "outside reversals" after extended bull or bear runs.
Reversal days on the charts signal the final exhaustion of the bullish or bearish forces that drove the market previously. Respect them, and respect even more "weekly" and "monthly," reversals.

GENERAL

22. All rules are meant to be broken: The trick is knowing when... and how infrequently this rule may be invoked!

Related Topics:
* Learn Technical Analysis from LINDA RASCHKE for FREE
* Learning Candlestick Charts
* Learning Charts Patterns

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GARTMAN’S RULES OF TRADING – Part 2: Trading System & Money Management

Go back to Part 1: Trading Psychology

TRADING SYSTEM & MONEY MANAGEMENT

7. Never, under any circumstance add to a losing position.... ever!
Nothing more need be said; to do otherwise will eventually and absolutely lead to ruin!

8. Trade like a mercenary guerrilla.
We must fight on the winning side and be willing to change sides readily when one side has gained the upper hand.

9. The objective is not to buy low and sell high, but to buy high and to sell higher.
We can never know what price is "low." Nor can we know what price is "high."
Always remember that sugar once fell from $1.25/lb to 2 cent/lb and seemed "cheap" many times along the way.

10. In bull markets we can only be long or neutral, and in bear markets we can only be short or neutral.
That may seem self-evident; it is not, and it is a lesson learned too late by far too many.

11. Sell markets that show the greatest weakness, and buy those that show the greatest strength.
Metaphorically, when bearish, throw your rocks into the wettest paper sack, for they break most readily.
In bull markets, we need to ride upon the strongest winds... they shall carry us higher than shall lesser ones.

12. Do more of that which is working and less of that which is not.
If a market is strong, buy more; if a market is weak, sell more.
New highs are to be bought; new lows sold.

13. Trading runs in cycles: some good; most bad. Trade large and aggressively when trading well; trade small and modestly when trading poorly.
In "good times," even errors are profitable; in "bad times" even the most well researched trades go awry. This is the nature of trading; accept it.

14. Be patient with winning trades; be enormously impatient with losing trades.
Remember it is quite possible to make large sums trading/investing if we are "right" only 30% of the time, as long as our losses are small and our profits are large.

15. To trade successfully, think like a fundamentalist; trade like a technician.
It is imperative that we understand the fundamentals driving a trade, but also that we understand the market's technicals. When we do, then, and only then, can we or should we, trade.

To be continued to Part 3: Technical Trading System

Related Articles:
* FREE Trading Educational Resources You Should Not Miss
* Trading System: What Is It and Is It Important?
* Why Being Right In Your Trading Does Not Necessarily Mean Making Money
* The Psychological Need To Be Right vs. Making Money
* The Fear Of Losing Money

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GARTMAN’S RULES OF TRADING – Part 1: Trading Psychology

22 Trading Rules by Dennis Gartman, Editor/Publisher of The Gartman Letter:
(I was just trying to group the rules based on their topics)

TRADING PSYCHOLOGY

1. Capital comes in two varieties: Mental and that which is in your pocket or account.
Of the two types of capital, the mental is the more important and expensive of the two. Holding to losing positions costs measurable sums of actual capital, but it costs immeasurable sums of mental capital.

2. "Markets can remain illogical longer than you or I can remain solvent", according to our good friend, Dr. A. Gary Shilling.
Illogic often reigns and markets are enormously inefficient despite what the academics believe.

3. An understanding of mass psychology is often more important than an understanding of economics.
Markets are driven by human beings making human errors and also making super-human insights.

4. The market is the sum total of the wisdom ... and the ignorance...of all of those who deal in it; and we dare not argue with the market's wisdom.
If we learn nothing more than this we've learned much indeed.

5. The hard trade is the right trade: If it is easy to sell, don't; and if it is easy to buy, don't.
Do the trade that is hard to do and that which the crowd finds objectionable.
Peter Steidelmeyer taught us this twenty five years ago and it holds truer now than then.

6. There is never one cockroach: Bad news begets bad news, which begets even worse news.

Continue to Part 2: Trading System & Money Management

Related Articles:
* A Chance to Learn from World Class Trading Experts For FREE You Should Not Miss
* Why Trading Psychology Is Very Important
* Reverse Psychology For Success

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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”.

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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

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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

Read More

Free Trading Educational Videos from Trading Gurus

Do you want to learn some trading tips & techniques from famous trading experts/gurus? Some more, it’s absolutely FREE….. Just want to share with you few wonderful trading educational resources to grab that opportunity.

There are 4 trading educational videos from trading experts/gurus' seminar/conference, which you can watch for free:

1) A New Look at Exit Strategies by Charles Le Beau
Charles Le Beau co-authored a book on futures trading, Computer Analysis of the Futures Market. He is registered Commodity Trading Advisor (CTA) and a noted developer of trading systems.

Many new traders - the majority, in fact - suffer big losses because of a lack of planning and understanding in setting up a sound exit strategy.
In this 90-minutes video, Chuck Le Beau reveals the secrets to gaining bigger profits for trading stocks, futures or options, i.e. the methods he has used for years as a successful institutional trader, particularly in the area of exit strategies.

2) Classic Indicators - Back to the Future by Linda Raschke
Linda Raschke has been a full-time professional trader for over 20 years. She was featured in Jack Schwager's book, The New Market Wizards. In 1995, she co-authored the best selling book, Street Smarts, High Probability Short Term Trading Strategies.

In this 75-minute video of a first-rate keynote address given at a recent international trading conference, Linda shares her favourite trading techniques that you'll watch over and over again! Here, you can definitely learn some valuable trading techniques using classic indicators, how to stay disciplined and what it takes to keep you running at full speed.

3) I Am a Turtle by Russell Sands
A famous trading guru Richard Dennis reportedly made a bet with his long-time friend, William Eckhardt, nearly 25 years ago. Dennis believed that successful trading was an activity that could be learned rather than an innate ability, whereas Eckhardt believed otherwise.
To settle this dispute, in 1983, Dennis recruited and trained 13 people who became known as the "Turtles." The program with the Turtles ended in 1988 and became a legendary trading experiment. Many turtles have gone on to successful careers as commodity trading advisors.

Russell Sands was one of the students trained by Richard Dennis and William Eckhardt, who achieved fame as the "Turtles”.

In this video of his seminar (93 minutes), Russell shows the exact criteria that the Turtles were taught to use in order to get a handle on which breakouts or types of breakouts have a higher probability of succeeding, which have the potential to become the kind of monster trend the Turtles are famous for riding to enormous profits.
He also itemizes a list of approximately 20 different criteria and/or conditions that the Turtles examine every time they look to initiate a trade. He then explains each item carefully and demonstrates the effectiveness of each by looking at current charts of various markets.

4) Avoiding Common Trading Pitfalls by Mark Cook
Mark Cook, with more than 20 years trading experiences, is well-known for his Cook Cumulative Tick™ Indicator, which gained acclaim by winning the 1992 U.S. Investment Championship with an astounding 563.8% return.
His own early trading years were difficult, but as he struggled for success, he gained valuable experience and learned what makes - and breaks - a trader.

In this video (86 minutes), Mark reveals how he uses common sense and hard work in just the right proportions to dramatically improve his trading success. After viewing this video, you'll come away with a realistic perspective on how much money you can expect to earn with your trading and how much time you'll need to spend to achieve your goals.

As mentioned above, the good news is that all the above 4 trading educational videos are FREE.
You can watch these trading videos by following this link.

All you need to do to watch the videos FOR FREE is simply by clicking the “SIGN UP” button on that page in the provided link, and fill up a simple form to register. That’s it!

So, enjoy...! I’d suggest that you grab this opportunity as soon as possible…. while it’s still free! ;)

Update as per 22 Nov 2008:
The 4 videos mentioned above are no longer available for free.
However, don’t worry!
There are 4 new free trading educational videos from other trading experts you can learn from. Don’t miss this chance anymore! :)
Just click the “Sign Up” button in that page and fill up the registration form in order to watch the videos for FREE.
For more info about the new trading videos, read this post: Free Trading Educational Videos You Should Not Miss.

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Trading Quotes from “The Logical Trader” by Mark B. Fisher – Part 2

Go back to Part 1.

There are some more good trading quotes from the book, The Logical Trader.

Hope these can give you some insights for trading psychology.
Why do I like this kind of trading quotes? Because in my opinion, trading psychology plays very important part in trading success.
So, enjoy!

I Have No Clue
If a market is making a substantial move and traders seem to understand why, this market trend is not going to last very long.
However, if the market is moving in one direction and nobody has no clue as to why, then the trend is going to be prolonged.

When a market goes up or down for no apparent reason, it tends to go a lot further in that direction than people can imagine.

Be The House
The more time you spend at the table, the more bets you are going to place, and the greater the probability that you will eventually walk out of the casino as a loser. The casino would rather not have someone make a single large wager and, win or lose, immediately walk away.
What the house wants is for you to keep playing. The passage of time is the casino’s best friend and the player’s worst enemy.

Money Management
If the odds are in your favor of making a profit with your trading system, then keep your trade size consistent, cut your losses short, and know that, over time, you’ll be successful.

Fear and Greed
The two key ingredients that every trader needs to posses in the right combination in order to be successful – namely, fear and greed.

You need to have enough fear in you, meaning a healthy amount of respect for the market that you are participating in.
Allowing yourself that you are always right, especially when the market is clearly dictating that you are dead wrong, is a sure path toward trading disaster.

However, fear is not enough.
A trader must also have a healthy amount of greed.
You must be willing and able to press winning trades and allow these once-in-a-blue-moon occurrences to develop into large scale winners.
Sometimes it takes an iron will and a great deal of patience to be able to max out on these particular trades.

Staying Out Of The Penalty Box
The key to the whole puzzle is discipline, the more you have, the better you’ll trade.
The best traders have incredible amounts of discipline when they have a trading position on. They cut their losses and run. That’s the hardest thing on the world for a lot of other traders.
Maybe you’re bullish on the market, but your indicators say to get out. After you do, the market goes up this one time. Then you question your system. But if you stick with the system, you’ll be a lot better off.

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Trading Quotes from “The Logical Trader” by Mark B. Fisher - Part 1

Recently, I just read a book authored by Mark B. Fisher, The Logical Trader.
Although this book is not really one of my favourites, there are some good trading quotes that I like from that book. So, I think it may be good to share them here too.

Here are the trading quotes:

Have A Plan
In trading, as in life, you need a plan. This plan includes not only the micro – a strategy for each and every trade you make – but also the macro – meaning why you trade, how you intend to reach that goal (your means to the desired end), and what you’ll do as an alternative if that doesn’t work out.

Know what you want to accomplish, how you intend to get there, and what you will do if it does – or does not – work out. Have a plan and stick with it. That works in trading, as well as in life.

I Know Who I Am
Coming to term with who I am as a trading, knowing my limitations, and doing what I do well – and not doing those things that I have no clue about – has brought me continued success.
Too many people want to be who they are not, and professionally – whether in trading or in another field of business – that’s where they run into trouble.

Discipline and Comfortable With Yourself
You don’t need complicated Einstein formulas to make money in the markets.
You do need to be disciplined and comfortable with yourself.
No matter how good of a trader you think you are, the markets are always going to screw with your head and test your mental fortitude.
Remember, the survivors are also the ones who make up the market’s success stories.

Time Stop
An important rule of trading is that time is much more important than price.
Successful trading is a matter of seeking out immediate gratification. If the market doesn’t move your way within a short time of putting on a trade, just get out.
Most people trade just with Price Stops and not with Time Stops. They think they have to endure some initial pain. You, however, should not.

Get Out When You’re Wrong
Successful traders know that discipline is what allows them to enter their trades when the odds are in their favor and, more importantly, to get out when they’re wrong.
Being right is not the problem. What you do when you’re wrong is the crucial issue.

There are a lot of traders who buy then pray while the market goes against them, because they think that it will eventually go their way.
Most traders average down and wait for the market to turn their way.
Trading my way, I always have defined amount of money that I am willing to lose.
I let the market decide how much money I’m going to make.

Good News/Bad Action
When the news is good but the market just does not rise correspondingly, sell.

Continue to Part 2.

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The Impact of IMPLIED VOLATILITY (IV) on OPTIONS GREEKS: Summary

The Impact of Implied Volatility (IV) on DELTA
Assuming all other factors constant, when Implied Volatility increases, the time value portion of an option will increase.
As a result, the delta of OTM (Out-of-The-Money) options will go up, whereas the delta of ITM (In-The-Money) options will go down.
Nevertheless, the delta of ATM (At-The-Money) options will always remain at around 0.5.

Why is it so?
As discussed previously, IV has a very big impact on the option price. However, IV would affect only the time value component of an option's price, not on the Intrinsic Value.
Therefore, when there is significant movement in Implied Volatility, ATM and OTM options will be greatly affected as compared to ITM options.

However, although ATM will be significantly affected by IV movement, the delta of ATM options will always be around 0.5.

The Effect of Implied Volatility (IV) on THETA
When Implied Volatility (IV) decreases, Theta will be lower, especially when it is approaching expiration.
On the other hand, when IV increases, Theta would be higher.

Why is it so?
As discussed earlier in this post, Time Value as the price that people are willing to pay for the chance / uncertainty as to whether or not an option will finish ITM.
The more uncertain, the higher the time value will be.
An option that is far OTM has almost no chance of finishing ITM. As such, it will not command a high time value.
An option that is already deep ITM is almost certain that it will finish ITM, hence time value is smaller.
But ATM or near ATM options have more uncertainty as to whether or not the options will finish ITM, and therefore these options have a higher time value.

When IV decreases, such uncertainty will be lower, particularly when the option is nearing to expiration. This lower uncertainty will then be reflected in lower time value. Since Theta is the decrease of time value due to the passage of time, Theta will naturally be lower because it has less time value to lose over the remaining time to expiration.

For more detailed discussion, go to: Options Greek.

Related Topics:
* Options Trading Basic – Part 1
* Options Trading Basic – Part 2
* Understanding Implied Volatility (IV)
* Understanding Candlestick Charts
* Learning Charts Patterns
* Trading Videos from Trading Experts You Should Not Miss

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The Impacts of TIME REMAINING TO EXPIRATION on OPTIONS GREEKS: Summary

The Effect of Time Remaining To Expiration on DELTA
Delta is a measure of the change in the option price resulting from a change in the underlying stock price.

An option’s Delta does change as one trading day passes. This is often called as “Delta Decay”.
As the expiration is nearing (time to expiration gets shorter), the time value portion of an option is declining (time decay effect).
This causes the delta of ITM (In-The-Money) options to increase (i.e. ITM option’s delta gets closer to 1 for Calls or to -1 for Puts) and the delta of OTM (Out-of-The-Money) options to decrease (i.e. OTM option’s delta gets closer to 0).

As a result:
For ITM options, for the same strike price, the longer days to expiration, the lower the delta. Hence, a next month ITM option will have a lower delta than the current month option.
On the other hand, for OTM options, for the same strike price, the longer days to expiration, the higher the delta. So, a next month OTM option will have higher delta than the current month option.

The Impact of Time Remaining to Expiration on THETA
As mentioned earlier, as the expiration is nearing (fewer days to expiration), the time value portion of an option will be declining due to “time decay” effect.
And Theta is a measure of the Time Decay, i.e. the rate of decline of option’s time-value resulting from the passage of time.

Theta (time decay) increases as an option gets closer to expiration.
Theta would increase sharply (resulting in time value decrease at an accelerating rate) in the last few weeks before expiration (particularly in the last 30 days before expiration). Therefore, this can severely undermine a long option holder's position.

However, please note here that Theta increase sharply (Time Value decreases at accelerating rate) as expiration nears is true only for ATM option.

For both ITM & OTM options, on the other hand, Theta decreases as an option is approaching expiration.
As a result, for both ITM & OTM options, Time Value actually decreases at a decelerating rate as expiration nears.


Please refer to “More Understanding about Options Time Value” for further discussion about this.

The Effect of Time Remaining to Expiration on VEGA
Vega is a measure the sensitivity of an option’s price to changes in Implied Volatility (IV).
Assuming all other things unchanged, Vega decrease as an option gets closer to expiration.

Vega is higher when there is more time remaining to expiration. This makes sense because options with more time remaining to expiration have larger portion of time value, and it is the time value that is affected by changes in volatility.

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

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Reading Links

Another few good readings:

* Stock Bandit: Trading With Objectivity

* Trader Psychology: Who Should Not Be A Trader?

* Chris Perruna: 10 Steps to Profitable Trading

* Stock Trading To Go: Timeline of 17 Recessions and World Crises Since Great Depression

* Afraid To Trade: Confirmed Bear Market Rally Underway

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Options Greeks and Position in the Market (Long vs. Short): Summary

DELTA and the position in the market:
* Long calls have positive delta; short calls have negative delta.
* Long puts have negative delta; short puts have positive delta.
* Long stock has positive delta; short stock has negative delta.

Positive delta means that the option’s value will increase when the underlying stock price increases, and will decrease when the stock price decreases (positive relationship).
Negative delta means that the option’s value will increase when the underlying stock price drop, and will decrease when the stock price rises (negative relationship).

For Calls, the value of delta ranges from 0 to 1, whereas for Puts from -1 to 0.
Calls have a positive delta because Call premiums increases when the underlying stock price increases, and vice versa, assuming all other factors remain the same.
In contrast, Puts have a negative delta because the Put option price drops when the stock price goes up, and vice versa.

GAMMA and the position in the market:
* Both long calls and long puts always have positive gamma.
* Both short calls and short puts always have negative gamma.
* Stock has zero gamma because its delta is always 1.00 – it never changes.

Positive Gamma means the delta will increase when the underlying stock price increases, and will decrease when the stock price decrease (positive relationship).
Negative Gamma means the delta will decrease when the underlying stock price rises, and will increase when the stock price drops (negative relationship).

What does “long calls and long puts have positive gamma” mean?
What does “short calls and short puts have negative gamma” mean?
Please refer to the following post for further discussion about this:
Option Greek: GAMMA

THETA and the position in the market:
* Long calls and long puts always have negative theta.
* Short calls and short puts always have positive theta.
* Stock has zero theta – its value is not eroded by time.

Positive theta means that the option value will increase as the time passes, while negative theta means the option value will fall as the time passes.
Therefore, it makes sense that long options have negative theta and short options have positive theta.
If options are continuously losing their time value as days pass, a long option position will lose money because of theta, whereas a short option position will make money because of theta.

VEGA and the position in the market:
* Long calls and long puts both always have positive vega.
* Short calls and short puts both always have negative vega.
* Stock has zero vega – it’s value is not affected by volatility.

Positive vega means the option price increases when volatility increases, and decreases when volatility decreases.
Negative vega means the option price decreases when volatility increases, and increases when volatility decreases.

RHO and the position in the market:
Long calls and short puts have positive rho.
Short calls and long puts have negative rho.

Positive rho means the option price increases when the interest rate increases, and decreases when the interest rate decreases.
Negative rho means the option price decreases when the interest rate increases, and increases when the interest rate decreases.

For more detailed discussion, go to: Option Greeks.

Related Posts:
* Options Trading Basic – Part 1
* Options Trading Basic – Part 2
* Understanding Implied Volatility (IV)
* FREE Trading Videos from Famous Trading Gurus

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Options Greeks vs. OTM, ATM & ITM Options: Summary

1) Option Greeks: DELTA
Delta is a measure of the change in the option price resulting from a change in the underlying stock price.

The delta values will be positive for Calls & negative for Puts.

At-the-money (ATM) options have (absolute) deltas around 0.5.
Out-of-the-money (OTM) options have (absolute) deltas between 0 to 0.5.
In-the-money (OTM) options have (absolute) deltas between 0.5 to 1.




2) Option Greeks: GAMMA
Gamma is a measure the rate of change of delta due to a one-point change in the price of the underlying stock.

Unlike delta, gamma is always positive for both Calls and Puts.

Gamma is the highest for the ATM options, and gradually gets lower as it moves furthers towards ITM and OTM.
That means that the delta of ATM options changes the most when the stock price moves up or down, as compared to ITM & OTM options.

3) Option Greeks: THETA
Theta is a measure of the rate of decline of option’s time-value resulting from the passage of time (TIME DECAY).

Theta is typically highest for ATM options, and is progressively lower as options are ITM and OTM.
This makes sense because ATM options have the highest time value component, so they have more time value to lose over time than an ITM or OTM option.

4) Option Greeks: VEGA
Vega is a measure the sensitivity of an option’s price to changes in Implied Volatility (IV).

Vega is highest for ATM options, and is gradually lower as options are ITM and OTM.This means that the when there is a change in volatility, the value of ATM options will change the most. This makes sense because ATM options have the highest time value component, and changes in Implied Volatility would only affect the time value portion of an option’s price.




For more detailed discussion, please refer to the following post:
Option Greeks

Related Posts:
* Options Trading Basic – Part 1
* Options Trading Basic – Part 2
* Understanding Implied Volatility (IV)
* FREE Trading Videos from Famous Trading Gurus

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“Deeper OTM Puts are considered as ‘most expensive’ options”: What Does This Really Mean?

In my post “Volatility Smile and Volatility Skew – Part 1”, it is mentioned as follows:

For Put options, the Implied Volatility is typically the highest for deep OTM options and then is decreasing as it moves towards ITM options.

In other words, generally the “most expensive” options are deep ITM Calls and deep OTM Puts.

For Put options, the possible reason why people are willing to buy an “expensive” deep OTM Puts are that they are viewed as a form of “insurance” against market crash. The lower cost in terms of dollar might also offer another reason for deep OTM Puts to serve as an insurance / protection tool of one’s portfolio.

As discussed earlier in this link, an option is deemed cheap or expensive 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 expensive, whereas when the IV is relatively low, the option is considered cheap.

For deep ITM Calls, even without understanding the above concepts, people won’t really question why they are deemed “most expensive”, as the options premiums are also higher in terms of dollar.
However, for deep OTM Puts, those who are not aware the above concepts will be wondering why deep OTM Puts is considered “most expensive”, as the options premiums are actually low in terms of dollar value.

In this post, we’ll focus on discussing OTM Puts, by comparing less-deeper and deeper OTM Puts.

As deeper OTM Puts normally have higher IV than less-deeper OTM Puts, deeper OTM Puts are therefore considered as "more expensive".
However, this does not mean that the premium of deeper OTM Puts will be higher in terms of dollar.

This is because an option's premium is affected by 6 factors, not only IV.
As discussed in the previous post (i.e. Options Pricing), other important factors that determine option’s price are option’s strike price & current stock price.

Although deeper OTM Puts is higher in IV (and hence it's considered "more expensive"), their option premium will be lower in terms of dollar than less-deeper OTM Put options.This is because deeper OTM Put options' strike prices will be much farther from the current stock price, as compared to less-deeper OTM Puts would.
As a result, deeper OTM Put options will have much lesser chance / probability (almost no chance) of becoming “In-The-Money (ITM)” before expiration. Or in other words, it is almost certain that the deep OTM options will not finish ITM.

Remember that for OTM options, option premium will only consist of Time Value component.
(Please see this post – Option Price Components – in case you need more clarification).

As previously mentioned in this post (More Understanding about Options Time Value):

Time value can be viewed as “the price that people are willing to pay for the chance / uncertainty as to whether or not an option will finish In-The-Money (ITM)”.
The more uncertain, the higher the time value will be.

An option that is far OTM has almost no chance of finishing ITM. As such, it will not command a high time value.
An option that is already deep ITM is almost certain that it will finish ITM, hence time value is smaller.
But ATM or near ATM options have more uncertainty as to whether or not the options will finish ITM, and therefore these options have a higher time value.

Hence, in this case, higher IV increases the time value of deeper OTM Puts. However their overall premium will be lower than less-deeper OTM Put options in terms of dollar, particularly because of lower uncertainty (almost no chance) of the deeper OTM Puts to finish ITM before expiration, as they have farther option’s strike price from current stock price.

To understand more about other aspects of Implied Volatility, go to: Understanding Implied Volatility (IV).

Related Topics:
* Options Trading Basic – Part 1
* Options Trading Basic – Part 2
* Option Greeks

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Volatility Smile and Volatility Skew – Part 5: Strike Skew vs. Time Skew

Go Back to Part 4: Volatility Smile and Skew Implications

Strike Skew vs. Time Skew
Actually, there are 2 types of volatility skews: Strike Skew and Time Skew.

1) Strike Skew, or sometimes called Vertical Skew, is obtained by plotting Implied Volatility of an option with the same expiration month across various strike prices.
This is the most common type of Volatility Skew.
The volatility skew that has been discussed so far in the previous posts is Strike Skew.

2) Time Skew, or sometimes called Horizontal Skew, is obtained by plotting Implied Volatility of an option with the same strike price across various expiration months.
This kind of volatility skew might be seen as an indicative of market’s future expectations on a stock.

Generally speaking, it is possible for options with any expiration month to have higher IV levels than options with the other expiration months.
Because this volatility skew is mainly driven by expected price movement surrounding an impending news event that may significantly affect the stock price.
These skews can arise and disappear as the news event approaches and then passes.

Nevertheless, the typical time skew pattern observed is higher IV for options with shorter time to expiration than for longer-time-to-expiration options.
One possible reason is that most speculators are probably more interested in betting on “surprises” that are expected to occur in shorter term than those in longer term.
As such, they would also prefer options with shorter time to expiration, as these options are lower in terms of dollar value (as it carries less time value than longer-time-to-expiration options), and hence can potentially provide higher % returns when the extreme price movement does take place as expected.
This would consequently increase demand for shorter time options, and hence push the options’ price up through higher IV.

To understand more about other aspects of Implied Volatility, go to: Understanding Implied Volatility (IV).

Related Topics:
* FREE Trading Educational Videos You Should Not Miss
* Options Trading Basic – Part 1
* Options Trading Basic – Part 2
* Option Greeks

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Volatility Smile and Volatility Skew – Part 4: Implications

Go Back to Part 3: Why Volatility Smile and Skew Happen.

Implications of Volatility Smiles
In some cases, volatility charts of an option may shift over time from Volatility Skew to Volatility Smile, or vice versa.
When volatility charts of a particular stock’s options show a shift from Volatility Skew to Volatility Smile, this may signal an increased speculators’ interest into that stock, implying a possibility of volatile price movements for that stock due to certain reasons. (Please refer to Part 3 for more explanation).
For an options trader, this might offer some trading opportunities in order to take advantage of the potential volatile price movement. For instance, by buying straddle or strangle.

In addition, with the same logic, when an option of a stock displays Volatility Smiles, this stock is expected to be more volatile than a stock that displays a Volatility Skew pattern.
This might also provide some useful information/insight for the traders/investors in their investment decision.

Volatility Smiles and Time Remaining To Expiration
Volatility Smiles seem to be more likely to occur for options with shorter time to expiration.

When extreme price movements are expected to happen for a stock in the near term (which leads to huge interests in speculative trading for that stock), most speculators would more likely choose options with shorter time to expiration.
This makes sense as options with shorter time to expiration are lower in dollar term (as it carries less time value than longer-time-to-expiration options), and hence could potentially provide higher % returns when the extreme price movement does take place as expected.

Therefore, Volatility Smiles may particularly be observed in options nearing to expiration of a stock that is expecting big moves from pending news in the near term, due to heavy speculative trades during that period.

Calculating Estimated Option’s Price Using Options Calculator / Pricer
Since Implied Volatilities vary across different strike prices, it is therefore important to use the respective IV values for a particular strike price when we are calculating an estimated option’s price using options calculator / pricer (e.g. for calculating estimated options price for a stop or price target).
Otherwise, the accuracy of the estimated option’s price will be greatly affected.

Continue to Part 5: Strike Skew vs. Time Skew

To understand more about Implied Volatility, go to: Understanding Implied Volatility (IV).

Related Posts:
* Options Trading Basic – Part 1
* Options Trading Basic – Part 2
* Option Greeks
* FREE Trading Videos from Famous Trading Gurus

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Educational Reading Links

Good readings for trading education:

Van K. Tharp in IITM.com: Understanding Market Type

Libby Adams in IITM.com: YOU are the Holy Grail

Afraid To Trade: Revisiting Stop-Loss and Profit Target Affect on Win Rate

The Stock Bandit: Patient Progress

Swing Trade Stocks: How to Get More Winners by Combining Chart Patterns

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Volatility Smile and Volatility Skew – Part 3: Why Volatility Smile and Skew Happen

Go Back to Part 2: Understanding Volatility Smile & Volatility Skew

Why Do Volatility Smile & Volatility Skew Happen?

As mentioned in Part 1, in more recent years, Volatility Skew pattern are more commonly observed than Volatility Smile pattern.

For Call options, the Implied Volatility (IV) typically displays a Volatility Skew pattern, whereby IV is the highest for deep ITM options and then is decreasing as it moves towards OTM options.

As discussed earlier, traders/investors are willing to buy an “expensive” deep ITM Calls because they can be used as a leverage tool to gain higher % return with lower capital, as compared to invest in the stock itself. Since deep ITM Calls have delta close to 1, they works like stocks, moving almost dollar for dollar with the stock price, but with much lower capital.
In addition, when extreme price movements are expected, this may also mean that stocks can move sharply to the opposite direction. When the stock prices do not move as expected, ITM options would have lower risk of losing all the money than would ATM and OTM options, due to their inherent intrinsic value.

In contrast, for Put options, the IVs also display a Volatility Skew pattern, whereby IV is the highest for deep OTM options and then is decreasing as it moves towards ITM options.
As mentioned previously, the possible reason why people are willing to buy an “expensive” deep OTM Puts are that probably they are viewed as a form of “insurance” against market crash.
In addition, deep OTM Puts are also considered low cost in terms of dollar; hence this might offer another reason why the deep OTM Puts are quite widely used as an insurance / protection tool of one’s portfolio.


Although Volatility Skew is the typical volatility pattern observed most of the time, sometimes Volatility Smile may appear due to some reasons. And the appearance of Volatility Smile might carry some signals to the market.

Volatility Smiles might indicate that the market is expecting a high possibility of extreme stock price movements as result of either increased volatility in the overall market or in a particular stock.
This might arise in anticipation of corporate news announcements or any pending news that will potentially result in a volatile movement in the stock price.

When big movement in stock price is highly possible, OTM options are more likely to become the ITM options. When this really happens, OTM options will produce higher % return than ATM and ITM would. Moreover, OTM options are lower in terms of dollar. This kind of situations may attract speculators to rush and bet into the market by buying OTM options in order to take advantage of the potential extreme movement in stock price.

Under these circumstances, the speculators would be willing to pay a “higher” price for OTM options as well. This would then drive the price of OTM options upwards through increased IV.
As a result, when plotted into the chart, the IV would show a Volatility Smile pattern, whereby the IVs of both ITM and OTM options are higher (more “expensive”) than the IV of ATM options.

Continue to Part 4: Implications of Volatility Smile & Volatility Skew

To understand more about Implied Volatility, go to: Understanding Implied Volatility (IV).

Related Posts:
* FREE Trading Educational Resources You Should Not Miss
* Option Greeks
* Learning Candlestick Charts
* Learning Charts Patterns
* Getting Started Trading

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Volatility Smile and Volatility Skew – Part 2: More Understanding

Go Back to Part 1: Description

What Do Volatility Smile and Volatility Skew Mean?
As you know, an option’s price comprises of Intrinsic Value and Time Value.
In options pricing, there are 6 factors that affect an option’s price: option’s strike price, underlying stock price, implied volatility, time to expiration, interest rate, and dividend.
An Intrinsic Value of an option is determined by the option’s strike price and the underlying stock price.
And the major determinant of option’s Time Value is Implied Volatility and time remaining to expiration.

Since Implied Volatility (IV) represents an estimate of future volatility, this factor is the most subjective. Therefore, Implied Volatility has been used by the market makers to “manipulate” the option’s price in order to balance the demand vs. supply of an option.
For instance, when the demand of a particular option is relatively higher than its supply, traders/investors will be willing to pay a “higher” price for that option. This high demand would in turn push the price of that option upwards (through increased IV), resulting in higher profit for the market makers from higher time value as a compensation for higher risks that they have to bear.

Hence, a Volatility Smile chart suggests that both ITM and OTM options are in higher demand (relative to their supply) than ATM options. Traders/investors are willing to pay a “higher” price to buy OTM and ITM options (through higher IV) than to buy ATM options.

It is important to note that “higher” price here does not mean higher in terms of dollar value.
ITM options will always be higher in terms of dollar value than ATM and OTM options, due to its Intrinsic Value.
However, OTM options could be “more expensive” than ATM and ITM in relation to their Implied Volatility.
In other words, the measure of an option’s expensiveness is its Implied Volatility.

As discussed earlier, the option is considered “expensive” when the IV is relatively high.
On the other hand, the option is considered cheap when the IV is relatively low.

Likewise, a Volatility Skew chart whereby IV values are higher for ITM options and then is declining as it moves towards OTM (i.e. for Call options), for instance, suggests that the demand for ITM options is relatively high and traders/investors are willing to pay a “higher” price to buy ITM options.

On the contrary, a Volatility Skew chart whereby IV values are higher for OTM options and then is decreasing as it moves towards ITM (i.e. for Put options) suggests that the demand for OTM options is relatively high and traders/investors are willing to pay a “higher” price to buy OTM options.

Continue to Part 3: Why Volatility Smile & Volatility Skew Happen

To understand more about Implied Volatility, go to: Understanding Implied Volatility (IV).

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