Options valuation is a topic of ongoing research in academic and practical finance. Combining any of the four basic kinds of option trades possibly with different exercise prices and maturities and the two basic kinds of stock trades long and short allows a variety of options strategies. This is a FREE webinar rebroadcast that you can watch Mortgage borrowers have long had the option to repay the loan early, which corresponds to a callable bond option.
Here is how I define Option: It is basically an agreement between two parties to sell or purchase the right to an underlying stock. The buyer of an Option pays a premium to the seller with a hope or speculation that the stock price may move up before the expiration of the agreement or vice versa.
How are Options different from Stocks? The Option contract has an expiration date unlike stocks. The expiration can vary from weeks, months to years depending upon the regulations and the type of Option that you are practicing.
Stocks on the other hand do not have an expiration date. In this part I will take you through some of the most important aspects of Option trading. Type of Options In true sense there are only two type of Options i. A Call Option is an option to buy an underlying Stock on or before its expiration date. At the time of buying a Call Option you pay a certain amount of premium to the seller which grants you the right to but the underlying stock at a specified price strike price.
Whereas, a Put Option is an option to sell an underlying Stock on or before its expiration date. Purchasing a Put Option means that you are bearish about the market and hoping that the price of the underlying stock may go down.
In order for you to make profit the price of the stock should go down from the strike price of the Put Option that you have purchased before or at the time of its expiration. What is Strike Price in Options Trading? The Strike Price is the price at which the underlying stocks can be bought or sold as per the contract. It is often referred as exercise. Underlying Asset Underlying asset can be stocks, futures, index, commodity or currency. The price of Option is derived from its underlying asset and since we are specifically talking about Stock Options, we will consider the underlying asset as the stock.
To lock in a selling price for a product to be sold in the future, a short hedge is used. Speculators assume the price risk that hedgers try to avoid in return for a possibility of profits. They have no commercial interest in the underlying commodities and are motivated purely by the potential for profits. Although this makes them appear to be mere gamblers, speculators do play an important role in the futures market. Without speculators bridging the gap between buyers and sellers with a commercial interest, the market will be less fluid, less efficient and more volatile.
Futures speculators take up a long futures position when they believe that the price of the underlying will rise. They take up a short futures position when they believe that the price of the underlying will fall. Buying straddles is a great way to play earnings.
Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time Cash dividends issued by stocks have big impact on their option prices.
This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement.
In place of holding the underlying stock in the covered call strategy, the alternative Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk.
A most common way to do that is to buy stocks on margin Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions.