Buying and selling call options
The buyer pays a fee called a premium for this right. The term "call" comes from the fact that the owner has the right to "call the stock away" from the seller. Option values vary with the value of the underlying instrument over time. The price of the call contract must reflect the "likelihood" or chance of the call finishing in-the-money. The call contract price generally will be higher when the contract has more time to expire except in cases when a significant dividend is present and when the underlying financial instrument shows more volatility.
Determining this value is one of the central functions of financial mathematics. The most common method used is the Black—Scholes formula. Importantly, the Black-Scholes formula provides an estimate of the price of European-style options. Adjustment to Call Option: When a call option is in-the-money i. Some of them are as follows:. Similarly if the buyer is making loss on his position i.
Trading options involves a constant monitoring of the option value, which is affected by the following factors:. Moreover, the dependence of the option value to price, volatility and time is not linear — which makes the analysis even more complex. From Wikipedia, the free encyclopedia. Options offer you flexibility when trading. You can either buy or sell options or a combination of both for that matter , this allows you to have strategies for stocks that are moving up or stocks that are moving down.
Knowing the best strategy to use can mean the difference between a profitable trade and a losing trade. Regardless of how the market is moving, you can select an options trading strategy for your favorite Stock, Index, Futures, or ETF either by buying, or selling an option contract to open the trade. There are some distinct advantages for the options trader that can be had by selecting the appropriate options trading strategy.
In this article I will discuss my favorite strategies and how to use each depending if the stock you want to trade is moving up down or sideways. Implied Volatility is a measure of the fluctuation of price in an underlying instrument like a stock. As an options trader, the implied volatility will affect the price of an option. Increased implied volatility will increase the price of the option. Because of this, to determine high or low volatility we must look at the historical implied volatility of each stock compared to its self.
Implied volatility rank is one measure that gives the trader an indication of how relatively high or low the current implied volatility is. You can easily monitor implied volatility on your brokerage platform or charting software.
As you gather evidence from the charts and the options chain in order to enter a trade, you might think that a stock with high IV and IV rank is going to have a big move and should be bought to capitalize on that potential high volatility. This higher implied volatility will have increased the options price meaning that the market is expecting a big move and that the stock will have to see an even bigger move in order to profit from the trade.
In other words the market has priced in the higher volatility and is expecting the same big move that you are. This is the reason that most options buyers have trouble consistently profiting from buying puts and buying calls. Most times the moves have already been priced in to the cost of the option and even though the stock moves up or down as expected, the move is not large enough to make the trade profitable.
Increased Implied Volatility is a classic indicator of a big move in stocks. This behavior is most pronounced around earnings announcements. It makes sense since earnings announcements typically move the price of a stock more than the average daily move. This is another scenario where traders fall in to the trap of buying puts or buying calls trying to make large profits after the announcements. Theoretically, a news event like earnings can bring opportunity for a stock move beyond what is expected by the market.
However, the reality is not as consistent as you might expect. Increased implied volatility will mean higher amounts of premium that will need to be paid to buy the put or the call option, in order to account for the higher implied volatility of the upcoming event.
Looking at Implied Volatility rank can be a clue to how much premium may be embedded in the cost of an option. You will notice the cost to buy an option will be much higher because of the anticipated move. So, this begs the question, if the cost to buy the option is higher, is the higher price worth it prior to earnings?
An options buyer will often end up over paying for an option only to see the premium decay from their trade and ultimately, the profit from buying the option fades away. Anytime a stock is stuck in a range, I will usually try to sell the option.
I want to take advantage of the rangebound price action to my advantage. I will look at selling an out of the money put or call. Selling the option means that I want price to have a small move in to expiry.
For example if I sell a put option, I want price to stay flat or move up before expiry. If I sell a call option, I want price to stay flat or move down before expiry. When I sell an option I receive money in my brokerage account, I get to keep that money if at expiration price has not moved through my strike. Stocks that are trading in a range with strong levels of support and resistance are great for selling options. As price moves sideways you are able to profit on the option as the premium in the option will slowly disappear.
Rather than trying to guess when a stock will break out of a range, why not sell the option each week until it decides to make its move. CMG has been trading in a range for more than one month.