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Complexities of Options
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Complexities of Options

By: options mentoring

Let’s discuss the complexities of options and how they differ from trading stocks. First of all stocks are simply one-dimensional trading vehicles…the dimension of “price movement.” For example, one can go long a stock if he/she is forecasting a rise in the price of the underlying asset. The stock trader doesn’t need to worry about time or changes in volatility affecting the outcome of his trade. The stock trader only needs to focus on the asset’s price movements. Options, however, involve these other two dimensions just mentioned plus the dimension of price as well. So options are actually three-dimensional trading vehicles based on price, time and volatility. To compare stock and options in a practical sense, let’s consider this scenario:
A stock takes a full year to move up 10%. The stock trader who bought and held on to his stock has just made 10%. However, the option trader might have made nothing at all or even lost money if he just bought an option. The reason the option buyer may have lost money is because of Time Decay. His option just lost a whole year of Time Premium. Also, since the volatility of the underlying asset probably went down, this can also cause the call option to lose value. This is why we need to be correctly educated in order to trade options. Simply buying calls and puts makes option trading very difficult because of the elements of time and volatility. Remember, options are three-dimensional vehicles, and if we don’t understand how to manage these complex assets, we shouldn’t trade them. Options are somewhat similar to stocks, but since there are three dimensions to them, we can’t just learn how to graph a price chart and trade them. Trading options isn’t so simple.
So we can conclude that when trading options we are trading two other dimensions besides the price movement. We are also trading time and the 3rd element known as volatility. So when we construct an option spread, we must always keep these 3 dimensions in mind to create an option trade that will benefit in all 3 directions at once. Trading options can be somewhat complex, but in a nutshell we have to forecast time, price, and volatility and construct each trade accordingly. By combining different options at different strikes, different months, etc, we can create situations that benefit in all three dimensions simultaneously. It’s actually quite interesting to be an options trader.
Anyway, part of becoming a successful options trader is to understand the option Greeks. We must understand how to use the option Greeks to adjust an option spread and how to construct option spreads so they benefit from time, from volatility and also from the changes in price.
For example, let’s say our forecast is for the market to go up. The first thing we have to understand is when the market goes up, the normal direction of volatility will be down (that’s not always the case, but it usually is the case!). So our scenario is the price is going up and the volatility is going down.
What kind of trade can we construct that would benefit from this scenario?
Of course, if you are just trading a stock, you can just buy the stock and if it goes up, you make money. Now, if you’re trading options, you’ll want to construct a trade that is bullish, takes advantage of time passing, and also benefits from a decline in volatility. An example that might work is a Bull-Put Credit spread. This option spread will benefit from a rise in price as well as a drop in volatility. It also benefits from time passing by. This is just one example of trading the three dimensions of options.

Article Source: http://articlenexus.com

For more information about getting educated on option trading please visit our website at www.sjoptions.com A great way to learn the craft of option trading is through a personal mentoring program such as ours.

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