Abcs option volatility trading strategies and risks
High volatility can hurt traders because the market can move quickly. Here are the defined risk option trading strategies we use. The trader still has a directional bias in mind, either up or down, but by combining an option he bought with one he has sold, time decay is now working for him, adding value to his position with each passing day.
You would simply write an option further out from the one you bought and theta is now your asset. This is a trade which results in a credit money given to you at the beginning of the trade.
It consists of two different options legs. You buy an out of the money option at a certain strike price and then you sell an out of the money option at a different strike price of the same month. In this way you created a defined risk strategy. You get a credit of 50 cents. As time goes on the options will decay in value. Difference in strikes minus the credit: Calendar Spreads involves buying a longer dated option, and simultaneously selling a shorter dated one.
The one closer to expiration will always lose its time decay faster. This trade can be put on with a directional bias. This is a great strategy.
Company Filings More Search Options. Options trading may occur in a variety of securities marketplaces and may involve a wide range of financial products, from stocks to foreign currencies. This bulletin focuses on the basics of trading listed stock options.
Options trading uses terminology that an investor should understand before attempting to buy or sell options. The following example of a basic stock option contract quote will help explain some of this terminology:.
This date indicates the day that the option contract expires. Generally, the expiration date for an option contract is the Saturday after the third Friday of each month.
However, certain option contracts may have an expiration date that occurs after only a week, a calendar quarter, or at other some other specified time. Two of the most common types of option contracts are calls and puts.
A call option is a contract that gives the buyer the right to buy shares of an underlying stock at the strike price discussed below for a specified period of time. Conversely, the seller of the call option is obligated to sell those shares to the buyer of the call option who exercises his or her option to buy on or before the expiration date. A put option is a contract that gives the buyer the right to sell shares of an underlying stock at the strike price for a specified period of time.
Conversely, the seller of the put option is obligated to buy those shares from the buyer of the put option who exercises his or her option to sell on or before the expiration date. This is the price at which the buyer of the option contract may buy the underlying stock, if the option contract is a call, or sell the underlying stock, if the option contract is a put. Example in-the-money call option: Example out-of-the-money call option: An option contract generally represents shares of the underlying stock.
The premium is paid up front to the seller of the option contract and is non-refundable. The amount of the premium is determined by several factors including: In addition to the terms above, investors should also be familiar with the following options terminology:.
Assignment — When a buyer exercises his or her right under an option contract, the seller of the option contract receives a notice called an assignment notifying the seller that he or she must fulfill the obligation to buy or sell the underlying stock at the strike price. Market Participants — There are generally four types of market participants in options trading: Opening a Position — When you buy or write a new options contract, you are establishing an open position. That means that you have established one side of an options contract and will be matched with a buyer or seller on the other side of the contract.
Closing a Position — If you already hold an options contract or have written one, but want to get out of the contract, you can close your position, which means either selling the same option you bought if you are a holder , or buying the same option contract you sold if you are a writer. Now that we have discussed some of the basics of options trading, the following are examples of basic call and put option transactions:.
These two examples provide you with a basic idea of how options transactions may operate. Investors should note that these examples are some of the most basic forms of options.