Most traders have heard something about the importance of the Greeks, but why use option Greeks? What benefit do they actually give you? They give you a lot more then you think.
Most people believe that the price of an option has a 1 to 1 relationship with a stock. If the stock goes up $1 the option also should go up $1. After all, the price of the option is based upon the price of the stock.
While this seems to make sense it is not true. There are many factors that come into the price of an option that you want to understand in order to make targets for your option. These factors are given to us through the Greeks.
This is a list of the most widely used Greeks.
1. Delta measures the amount an option should move for every 1 point move in the price of the stock. For instance if the delta is $.5 then the option will move approximately $.5 for every 1 point move in the stock.
2. Gamma measures the change in delta. Even though delta measures how much an option will move for every $1 move in the stock the delta also changes on a regular bases. The gamma takes care of this. The gamma tells you how much the delta will move for every $1 move in the stock. If the gamma is $.1 then the delta will move up $.1 for every $1 move in the stock.
3. Theta is a very important Greek. It measures the effect of time decay on an option. Because options have an expiration date they are depreciating assets. The theta measures how much value an option will lose for every day that passes. If the theta is $.05 then the option will lose $.05 of time value for every 1 day that passes.
For more information about the Greek options visit http://www.stocks-simplified.com/option-greeks.html
For more information about the stock market visit http://www.stocks-simplified.com
Monday, July 28, 2008
Friday, July 25, 2008
Selling long vs. short term options
It is often a wise idea to sell short term options in the stock market. There are many reasons for this.
Short term gives you more control. No one knows what will happen to a stock 3 months down the road. It is easier to predict which way the stock will be heading in just a few weeks as opposed to a few months.
Selling short term options also allow you to capture the more premium over a longer time frame. For example the stock XYZ has a front month $30 put selling for $2 it also has a $30 put 3 months out selling for $4. At first glance it seems like you would get more money selling the $4 option 3 months out but that is not necessarily true.
If you sold the front month option for $2 and it expired at the end of the month you could sell it again next month or a higher option if the stock moved up. You could sell 3 puts each for $2 totaling $6 before the $4 put would have expired, if you were right.
The longer term option seller does however have some good advantages over the short term seller. First of all you can sell farther out of the money. Because the future is uncertain the farther out you go the higher the options will be selling for. A stock probably will not go from $50 to $70 in two weeks but it might in two months.
The other advantage long term sellers will have is that strong stocks go up on average. If you find a strong stock there is a good chance that over a longer time period the stock could head up which may not be true in a shorter term period.
Every trade has their own opinion on which method is better, which is what makes the stock market what it is.
For more information on the stock market visit http://www.stocks-simplified.com
Short term gives you more control. No one knows what will happen to a stock 3 months down the road. It is easier to predict which way the stock will be heading in just a few weeks as opposed to a few months.
Selling short term options also allow you to capture the more premium over a longer time frame. For example the stock XYZ has a front month $30 put selling for $2 it also has a $30 put 3 months out selling for $4. At first glance it seems like you would get more money selling the $4 option 3 months out but that is not necessarily true.
If you sold the front month option for $2 and it expired at the end of the month you could sell it again next month or a higher option if the stock moved up. You could sell 3 puts each for $2 totaling $6 before the $4 put would have expired, if you were right.
The longer term option seller does however have some good advantages over the short term seller. First of all you can sell farther out of the money. Because the future is uncertain the farther out you go the higher the options will be selling for. A stock probably will not go from $50 to $70 in two weeks but it might in two months.
The other advantage long term sellers will have is that strong stocks go up on average. If you find a strong stock there is a good chance that over a longer time period the stock could head up which may not be true in a shorter term period.
Every trade has their own opinion on which method is better, which is what makes the stock market what it is.
For more information on the stock market visit http://www.stocks-simplified.com
Wednesday, July 23, 2008
Calculating Risk Reward on short term options
It is very important to calculate the risk reward on short term options. This is the amount you would risk if you were wrong and the amount you would make if you were right. If you don’t figure this number out you may find that the stock may go in your favor but the option goes against you.
There are many reasons why the option can lose value if the stock goes in the same direction you are predicting. The market volatility could be heading down causing the option to fall. Volatility makes up a big part of the option. The higher the volatility, the higher the price of the option will be. If it falls the option will be affected.
Time value can also be a reason why you can lose money on options. As time passes the time value of an option will start to erode. This is especially true for short term options which are set to expire in just a few weeks.
If you wanted to calculate the option risk to reward you must first understand that the bare minimum an option would be worth is called the intrinsic value. This is the difference between the stock price and the strike price of the option.
For instance, if a stock is trading at $40 the intrinsic value or the bare minimum that the $35 call would be worth is $5. Knowing this can be extremely helpful. Here is how you can use it.
We will say the $35 option is worth $8 for the same stock. We are expecting the stock to run up from $40 to $51. $51-$35 is $16 making the option at least worth $16 if we are right. In this case the reward for this trade would be at least $16-$8 or $8.
Now say we wanted to set the option with a $4 stop. This means if the option goes down to $4 we would exit the trade. That would give you a 2/1 risk reward ratio on the stock. Which means you would make $2 if you are right and only lose $1 if you are wrong.
For more information on options visit http://www.stocks-simplified.com/options.html
For more information about the stock market visit http://www.stocks-simplified.com
There are many reasons why the option can lose value if the stock goes in the same direction you are predicting. The market volatility could be heading down causing the option to fall. Volatility makes up a big part of the option. The higher the volatility, the higher the price of the option will be. If it falls the option will be affected.
Time value can also be a reason why you can lose money on options. As time passes the time value of an option will start to erode. This is especially true for short term options which are set to expire in just a few weeks.
If you wanted to calculate the option risk to reward you must first understand that the bare minimum an option would be worth is called the intrinsic value. This is the difference between the stock price and the strike price of the option.
For instance, if a stock is trading at $40 the intrinsic value or the bare minimum that the $35 call would be worth is $5. Knowing this can be extremely helpful. Here is how you can use it.
We will say the $35 option is worth $8 for the same stock. We are expecting the stock to run up from $40 to $51. $51-$35 is $16 making the option at least worth $16 if we are right. In this case the reward for this trade would be at least $16-$8 or $8.
Now say we wanted to set the option with a $4 stop. This means if the option goes down to $4 we would exit the trade. That would give you a 2/1 risk reward ratio on the stock. Which means you would make $2 if you are right and only lose $1 if you are wrong.
For more information on options visit http://www.stocks-simplified.com/options.html
For more information about the stock market visit http://www.stocks-simplified.com
Monday, July 21, 2008
Playing the Downside vs. upside
The stock market is a constant struggle between bulls and bears. Most people prefer to play the upside of a stock rather than the downside. That strategy may work well in rising bull markets but often gets crumbled when stocks crash.
There are advantages to shorting just like there are advantages of buying every trader needs to figure out which strategy works best for them.
The advantages of being a bear
1. Stocks often go down faster then they go up. This means it is possible for you to make faster and bigger gains by playing the downside of the market.
2. Playing the downside can help you make money when there is a bears market. This could be a good alternative to watching your bullish positions lose money. Remember bear markets make millionaires too.
3. Jessie Livermore who was considered the best trader of all times was considered a bear. He made fortunes when the markets were heading down and would be a billionaire by today’s standards.
The advantages of being a bull
1. The market is bullish much more then it is bearish. Buying strong stocks can help you to take advantage of this type of market.
2. Bulls do not have to sell. If you have a stock that you are bullish on you can buy it and hold it forever. This is different from shorting in which at some point you have to buy the stock back and return it.
3. The majority of traders and investors are bullish. If the majority of the people are playing the upside it is more likely that over a longer term timeframe the market should go up.
4. Warren Buffets made Billions by being a long term bull in the stock market. If you have plenty of time to let your money grow it could be a good thing to become a bull.
For more information on the stock market visit http://www.stocks-simplified.com
There are advantages to shorting just like there are advantages of buying every trader needs to figure out which strategy works best for them.
The advantages of being a bear
1. Stocks often go down faster then they go up. This means it is possible for you to make faster and bigger gains by playing the downside of the market.
2. Playing the downside can help you make money when there is a bears market. This could be a good alternative to watching your bullish positions lose money. Remember bear markets make millionaires too.
3. Jessie Livermore who was considered the best trader of all times was considered a bear. He made fortunes when the markets were heading down and would be a billionaire by today’s standards.
The advantages of being a bull
1. The market is bullish much more then it is bearish. Buying strong stocks can help you to take advantage of this type of market.
2. Bulls do not have to sell. If you have a stock that you are bullish on you can buy it and hold it forever. This is different from shorting in which at some point you have to buy the stock back and return it.
3. The majority of traders and investors are bullish. If the majority of the people are playing the upside it is more likely that over a longer term timeframe the market should go up.
4. Warren Buffets made Billions by being a long term bull in the stock market. If you have plenty of time to let your money grow it could be a good thing to become a bull.
For more information on the stock market visit http://www.stocks-simplified.com
Sunday, July 20, 2008
Keeping a good risk to reward ratio
Keeping a good risk to reward ratio is critical to the success of a stock market trader. This is something that most new traders will ignore.
In fact there are people who will take a trade that offers them a $2 risk in order to make a $1 reward. The main reason for this is that new traders do not expect to be wrong. They believe that it is possible to be right all if not most of the time when trading.
This thinking is more of a daydreaming philosophy. Anyone who is serious about stock market trading should remember that no matter how much homework you do on a stock you will always have trades that make you money, and trades that lose you money.
The way someone becomes good in the stock market is by managing their risk and only taking trades in which they can control the amount they can lose.
So what is a good risk to reward ratio? Well, that depends on what system you trade. Many swing traders who make big speculations will only take trades with a $2 reward for a $1 risk.
This philosophy is definitely common but it is not the only one. Options sellers who have a larger risk to reward but a greater probability of success feel different. It is impossible to find a trade that offers a 2/1 risk reward if you are an option seller.
But options sellers also have to manage their risk. It is generally a good rule for an option seller to exit there trade if they lose any more than $1.5 of the premium they make.
Trend traders also have a differently philosophy about risk to reward ratios. They may take trades in which you have an infinite reward for a given risk. That is simply because there is no target when trend trading.
To find out more about trading in the stock market visit http://www.stocks-simplified.com
In fact there are people who will take a trade that offers them a $2 risk in order to make a $1 reward. The main reason for this is that new traders do not expect to be wrong. They believe that it is possible to be right all if not most of the time when trading.
This thinking is more of a daydreaming philosophy. Anyone who is serious about stock market trading should remember that no matter how much homework you do on a stock you will always have trades that make you money, and trades that lose you money.
The way someone becomes good in the stock market is by managing their risk and only taking trades in which they can control the amount they can lose.
So what is a good risk to reward ratio? Well, that depends on what system you trade. Many swing traders who make big speculations will only take trades with a $2 reward for a $1 risk.
This philosophy is definitely common but it is not the only one. Options sellers who have a larger risk to reward but a greater probability of success feel different. It is impossible to find a trade that offers a 2/1 risk reward if you are an option seller.
But options sellers also have to manage their risk. It is generally a good rule for an option seller to exit there trade if they lose any more than $1.5 of the premium they make.
Trend traders also have a differently philosophy about risk to reward ratios. They may take trades in which you have an infinite reward for a given risk. That is simply because there is no target when trend trading.
To find out more about trading in the stock market visit http://www.stocks-simplified.com
Saturday, July 19, 2008
When the VIX is high so is the premium
When the vix is high the premium of stock options tends to be much higher as well. It is important to understand this concept.
What does that really mean? When you buy a call you pay the difference between the stock price and the strike price of the option you bought. You also pay an added fee made up of factors like time decay and volatility. All these factors are figured into the price of a given option.
When the VIX goes up it signals volatility is rising. This means so is the premium of the options that you are paying for. Which also means that if volatility goes down so will the price of your option.
So, what can you do when volatility is high in the market? There are a couple different answers to this question. The first and most obvious is selling options to collect the premium. If you sell options using the covered calls or a spreads you can take advantage of the higher prices of options.
But selling options can only give you a limited return on your money. If you like buying options because they give you an unlimited reward potential you may want to simply buy stocks. Stocks will not move as fast as the options will but they will give you a potential return that has no cap on it.
Still, you can buy basic calls and puts during this time. Many traders don’t care too much about rising volatility. Just remember if you are buying options during highly volatile times you are taking a bigger risk then during regular times.
Every trader should make their own decisions on what to do in a situation like this one. Not all traders agree but that is how the market is set up after all.
For more information about the VIX visit http://www.stocks-simplified.com/volatility_indexes.html
For more information about the stock market visit http://www.stocks-simplified.com
What does that really mean? When you buy a call you pay the difference between the stock price and the strike price of the option you bought. You also pay an added fee made up of factors like time decay and volatility. All these factors are figured into the price of a given option.
When the VIX goes up it signals volatility is rising. This means so is the premium of the options that you are paying for. Which also means that if volatility goes down so will the price of your option.
So, what can you do when volatility is high in the market? There are a couple different answers to this question. The first and most obvious is selling options to collect the premium. If you sell options using the covered calls or a spreads you can take advantage of the higher prices of options.
But selling options can only give you a limited return on your money. If you like buying options because they give you an unlimited reward potential you may want to simply buy stocks. Stocks will not move as fast as the options will but they will give you a potential return that has no cap on it.
Still, you can buy basic calls and puts during this time. Many traders don’t care too much about rising volatility. Just remember if you are buying options during highly volatile times you are taking a bigger risk then during regular times.
Every trader should make their own decisions on what to do in a situation like this one. Not all traders agree but that is how the market is set up after all.
For more information about the VIX visit http://www.stocks-simplified.com/volatility_indexes.html
For more information about the stock market visit http://www.stocks-simplified.com
Friday, July 18, 2008
Top 4 challenges facing option buyers
There are 4 top challenges facing option buyers in the stock market. Anyone looking to gain long term success with options should have these questions answered before they use them.
1. Time decay. When you buy an option there is both time value and intrinsic value in that option price. Intrinsic value moves the option based on the price of the stock. Time value goes down slowly as the option price gets closer to expiration. Because of this an option buyer needs to have the intrinsic value go up faster than the time value to make any money.
If they intrinsic value doesn’t go up fast enough have this the stock could do what they wanted it to do and they still lose money. The best way to combat this problem is to buy more time value. If you have an option 3 months out the time value will decay at a much slower rate than an option that is 1 month away from expiration.
2. The Bid and ask price also pose a problem for option buyers. When buying options there are two prices the bid and ask. The ask price is the price that you can buy it for and the bid price is the price that you can sell it for. The difference between these numbers is called the spread.
The price you can buy an option for is always higher than the price you can sell an option for. You need the option to go up above this gap in order to make money. This problem is lessened by not trading options with stocks that have a high spread. Obviously if you find a stock that has an ask price of $8 and a bid price of $6 that might not be a good buy regardless of the stock.
3. The implied volatility. This is very important to understand. The IV measures how volatile the stock is at a given time. It is also used to measure the volatility of an option. This can affect the price because if you buy a call with high volatility the stock can go up but if volatility drops your option’s price will be affected. Now on the same note if you buy a call when volatility is low and the stock price goes down you might still be able to make money if the volatility goes up.
Generally volatility goes down when stocks goes up and it goes up when stock prices fall. You may also want to check the VIX which shows the volatility of the SPY. In addition if you can go to a website like ivolatility.com which will give you the volatility of individual stocks.
4. Delta. Many option traders believe that if a stock moves $1 the option should also move $1. Nope. This is one of the biggest misconceptions new traders have about options. They will not move up exactly the same amount as the stock. In fact there is an option greek called the Delta that is designed to determine how fast an option should move. If the Delta is $.5 then it will move $.5 for every $1 the stock moves.
The farther in the money you buy a stock option at the higher the delta will be. But it will also result in a higher option price as well.
For more information about the stock market visit http://www.stocks-simplified.com
1. Time decay. When you buy an option there is both time value and intrinsic value in that option price. Intrinsic value moves the option based on the price of the stock. Time value goes down slowly as the option price gets closer to expiration. Because of this an option buyer needs to have the intrinsic value go up faster than the time value to make any money.
If they intrinsic value doesn’t go up fast enough have this the stock could do what they wanted it to do and they still lose money. The best way to combat this problem is to buy more time value. If you have an option 3 months out the time value will decay at a much slower rate than an option that is 1 month away from expiration.
2. The Bid and ask price also pose a problem for option buyers. When buying options there are two prices the bid and ask. The ask price is the price that you can buy it for and the bid price is the price that you can sell it for. The difference between these numbers is called the spread.
The price you can buy an option for is always higher than the price you can sell an option for. You need the option to go up above this gap in order to make money. This problem is lessened by not trading options with stocks that have a high spread. Obviously if you find a stock that has an ask price of $8 and a bid price of $6 that might not be a good buy regardless of the stock.
3. The implied volatility. This is very important to understand. The IV measures how volatile the stock is at a given time. It is also used to measure the volatility of an option. This can affect the price because if you buy a call with high volatility the stock can go up but if volatility drops your option’s price will be affected. Now on the same note if you buy a call when volatility is low and the stock price goes down you might still be able to make money if the volatility goes up.
Generally volatility goes down when stocks goes up and it goes up when stock prices fall. You may also want to check the VIX which shows the volatility of the SPY. In addition if you can go to a website like ivolatility.com which will give you the volatility of individual stocks.
4. Delta. Many option traders believe that if a stock moves $1 the option should also move $1. Nope. This is one of the biggest misconceptions new traders have about options. They will not move up exactly the same amount as the stock. In fact there is an option greek called the Delta that is designed to determine how fast an option should move. If the Delta is $.5 then it will move $.5 for every $1 the stock moves.
The farther in the money you buy a stock option at the higher the delta will be. But it will also result in a higher option price as well.
For more information about the stock market visit http://www.stocks-simplified.com
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