Option trading can enhance your portfolio returns if used properly. Many traders use options as a speculative gambling adventure. Options are actually used for risk control and hedging. Professional traders use option systems as a risk aversion tactic.
Options are available on equities, exchange traded funds, currencies and commodities. No matter which assets you are trading, options can be used to enhance your position. An investment in time is required to learn how to use options but once you learn the basics the more complex aspects will come easy.
There are two kinds of options, puts and calls. You can buy them or sell them. The novice investor should stick to buying for starters. When buying options the risk is limited to the premium paid for the option.
If you buy a call it gives you the right to purchase the asset for the strike price selected on or before expiration. For example, if you buy a call on XYZ at the $50 strike price, you have the right to buy XYZ for $50 no matter what the actual price may be.
If you buy a put it gives you the right to sell the asset for the strike price selected on or before expiration. For example, if you buy a put on XYZ at the $50 strike price, you have the right to sell XYZ for $50 even if the actual price goes to zero.
The option GREEKS remain a mystery to many traders but they are pretty straightforward. They simply tell you how the option is expected to behave. If you want to be a good option trader then you need to learn the Greeks.
Delta is the ratio of the value of the option compared to the value of the asset. The delta of an ATM (at the money) call should be very close to +.50. This means that if the asset price increases by one dollar the option value will increase by fifty cents.
The delta of an ATM put should be very close to -.50. This means that for each dollar the asset decreases in value, your put option will increase in value by fifty cents. The opposite is true for an adverse price movement. Since DELTA is one of the GREEKS in option trading, I will discuss my view of the Greeks.
Delta is the most important aspect of option trading. An ATM call option may have a delta of +.5 which means for each $1 the price of the asset increases, the value of the option will increase by fifty cents. An ATM put option may have a delta of -.5 which means for each $1 the price of the asset decreases, the value of the option increases fifty cents.
GAMMA is the reason delta neutral trading works. Gamma is the rate of change of delta. Gamma is greatest at or near the money and is lesser deep in or out of the money. It is this increase or decrease in delta that make delta neutral trading work.
When you buy a stock you are making a linear trade. If the price of the stock goes up one dollar then you make one dollar. Option trades are non-linear. You can make more if the trade goes in your favor. You can lose less if the trade goes against you. This is the effect of Gamma.
THETA is the rate of change of the value of an option due to time decay. This tells you how much money you will lose (if buying) or make (if selling) each day due to time decay. VEGA is sensitivity to volatility which is very important. An increase in volatility can increase the value of your option. RHO is rate of change due to interest rates. It is a factor in option pricing.
When I am setting up a trade, DELTA is pretty much the only Greek I am interested in. I don't need the other values because I always GRAPH my trade and count up or down the chain ladder. I also do a quick VOLATILITY study. That's all I need (along with my technical analysis) to make a trade. I'm in the TMI camp. TOO MUCH INFORMATION! There is a lot to be said for keeping it simple.
Once you grasp the fundamental concepts of option trading, the other information can be added if necessary. Complex trades can be developed and simple trades will become second nature.Before trading options please read the publication "Characteristics and risks of standardized options", available from your broker.
Options are available on equities, exchange traded funds, currencies and commodities. No matter which assets you are trading, options can be used to enhance your position. An investment in time is required to learn how to use options but once you learn the basics the more complex aspects will come easy.
There are two kinds of options, puts and calls. You can buy them or sell them. The novice investor should stick to buying for starters. When buying options the risk is limited to the premium paid for the option.
If you buy a call it gives you the right to purchase the asset for the strike price selected on or before expiration. For example, if you buy a call on XYZ at the $50 strike price, you have the right to buy XYZ for $50 no matter what the actual price may be.
If you buy a put it gives you the right to sell the asset for the strike price selected on or before expiration. For example, if you buy a put on XYZ at the $50 strike price, you have the right to sell XYZ for $50 even if the actual price goes to zero.
The option GREEKS remain a mystery to many traders but they are pretty straightforward. They simply tell you how the option is expected to behave. If you want to be a good option trader then you need to learn the Greeks.
Delta is the ratio of the value of the option compared to the value of the asset. The delta of an ATM (at the money) call should be very close to +.50. This means that if the asset price increases by one dollar the option value will increase by fifty cents.
The delta of an ATM put should be very close to -.50. This means that for each dollar the asset decreases in value, your put option will increase in value by fifty cents. The opposite is true for an adverse price movement. Since DELTA is one of the GREEKS in option trading, I will discuss my view of the Greeks.
Delta is the most important aspect of option trading. An ATM call option may have a delta of +.5 which means for each $1 the price of the asset increases, the value of the option will increase by fifty cents. An ATM put option may have a delta of -.5 which means for each $1 the price of the asset decreases, the value of the option increases fifty cents.
GAMMA is the reason delta neutral trading works. Gamma is the rate of change of delta. Gamma is greatest at or near the money and is lesser deep in or out of the money. It is this increase or decrease in delta that make delta neutral trading work.
When you buy a stock you are making a linear trade. If the price of the stock goes up one dollar then you make one dollar. Option trades are non-linear. You can make more if the trade goes in your favor. You can lose less if the trade goes against you. This is the effect of Gamma.
THETA is the rate of change of the value of an option due to time decay. This tells you how much money you will lose (if buying) or make (if selling) each day due to time decay. VEGA is sensitivity to volatility which is very important. An increase in volatility can increase the value of your option. RHO is rate of change due to interest rates. It is a factor in option pricing.
When I am setting up a trade, DELTA is pretty much the only Greek I am interested in. I don't need the other values because I always GRAPH my trade and count up or down the chain ladder. I also do a quick VOLATILITY study. That's all I need (along with my technical analysis) to make a trade. I'm in the TMI camp. TOO MUCH INFORMATION! There is a lot to be said for keeping it simple.
Once you grasp the fundamental concepts of option trading, the other information can be added if necessary. Complex trades can be developed and simple trades will become second nature.Before trading options please read the publication "Characteristics and risks of standardized options", available from your broker.
