Winning Advice On Stock Option Trading

There is a lot of advice for trading in options on the internet

. This is because options are such an interesting topic, and you can make a lot of money with this type of asset class investing. Several things that potential investors are asking themselves are what are the risks of investing in options, how do you determine a good investment and how is the pricing of options determined.

Purchasing options enables you to purchase or sell at a later date a set amount of an underlying asset. The asset class is known as the underlying asset, because of the fact that options can be purchased for any type of asset including, commodities, land, equities, and many other types of assets. If it can be bought or sold, there is probably an option market for that asset.

Option trading is a fascinating arena due to the fact that you do not need to invest a large amount of money to invest in this field. Options are generally sold at a very minimal price, and represent the right to purchase a stated quantity of the asset. For example, you could pay 1.50 per share for the right to purchase stock trading for 50.00 per share. This is only an example. The option price and the share price could be any other price.

Option trading allows you to leverage your investment strategy. This is because you can commit only an amount that might equal 1,000 and have the right to purchase an underlying asset value of 100,000. In this example you are 99 percent leveraged. What a deal.

An important thing to know when investing in options is that there is a set methodology to the pricing of the options. This pricing takes into consideration the implied volatility of the stock, the amount of time until the option expires, the risk free interest rate and the amount of risk associated with the stock or underlying asset.

This really makes sense since all of these factors play a part in determining the amount of money an investor would be willing to pay for the option. If there was a shorter time period to the expiration date, then the investor would expect to pay a different amount than if there was a longer period of time. Conversely, the closer the current option strike price is to the actual stock price, the option price would be different than if there was a larger difference. The same would apply to the risk, interest rate and volatility.

There are five different option Greeks which are used to determine the pricing methodology. These are the Delta, Vega, Theo, Gamma and Rho. Each of these Greeks have a different level of sensitivity. The disclaimer is that the pricing is determined with all other factors remaining stable. If there are other changes occurring either in the stock price or the other Greeks, then the option pricing will be affected by those changes.

The Delta Greek reflects the options sensitivity to changes in the stock price. The Gamma is a measure of the Deltas sensitivity to the stock price. Vega measures the volatility of the stock price. Theta is a measure of the effect of time decay while Rho measures the effect of changes in the risk free interest rate.

Having a good knowledge of how these Greeks work and the effect they have on the stock option pricing will help the option trader to know when to go long or short, and when to sell out of the option. In order to make money with your investment in options, you need to know how to play the game. If you merely purchase a stock option and hold it to the expiration date, you will probably lose your investment. Using option strategies and watching the information that the Greeks give you will give you a better chance of succeeding with your investment strategy.

by: Garth Wheeler

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