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Stock and Bond trading strategies run the gamut from the simple 'buy and hold forever' to the most advanced use of technical analysis. Options trading has a similar spectrum.
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Options trading can become very complicated very quickly. There are LEAPS (long-term contracts), choosers, barriers, compounds (exotics) and a host of technical parameters to measure volatility and predict price movements.
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Options are contracts on some underlying trading instrument - shares of stock, bonds, a commodity, a mortgage loan, etc. (The list is endless.)
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There are more kinds of risk than there are investments, since every instrument carries several kinds. But risk isn't inherently bad. Without it there'd be fewer opportunities for profit.
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Options price listings vary in appearance from site to site, but most will contain the following basic information. Here's a breakdown of what they list and what it means.
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There are several basic trading strategies, but in order to execute any of them successfully an investor new to options will need to know some elementary concepts.
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Risk isn't inherently bad. Without it, there would be far fewer opportunities for profit. In particular, there would be no options market at all. No one would have to speculate on price direction or other factors, since risk always implies uncertainty about the future.
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The ancient Greeks are justly praised for inventing much of elementary mathematics. But it was left to moderns to create the tools that help options traders quantify risk and calculate prices. Chief among these tools are several quantities known fondly as The Greeks: delta, theta, gamma and vega.
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In Part I, we introduced the concept of the Greeks as trading tools and discussed delta and theta. We continue by examining gamma and vega. (Note: unlike the others, vega is NOT a Greek letter.)
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Unlike stocks, options have an expiration date. Unless a company goes bankrupt or buys back all its stock, the stock investor always has the choice to wait for a price correction. Sometimes that wait represents the triumph of hope over experience, but more on that elsewhere.
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In Part I, we outlined an example. MSFT (Microsoft) stock with a current market price of $27, and a June 30 call option with premium of $2. (I.e. an option whose characteristics are: contract to buy 100 shares of MSFT by June 16 at a strike price of $30. Remember the '30' refers to the strike price, not the expiration date.)
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Because the actual calculation, and sometimes even the discussions, of volatility involve some fearsome mathematics, novice options traders often forgo learning about it. Those traders are at a disadvantage compared to their more intrepid competitors. And unnecessarily so, since the concept is not only useful but simple to understand.
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Why do options offer any advantage over trading stocks? They're riskier, since they expire within a certain amount of time and their values are more complicated to assess.
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A hedge is an investment made to offset the risk incurred by entering another investment. Ironically, the basic idea is to bet against oneself, in a way.
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There exist today an array of charts, patterns and statistical analyses large enough to please even a Medieval numerologist. Though it often looks and reads much like mathematical tea-leaf reading, most of the commonly used tools are based on serious empirical studies of the markets.
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You often see the phrase 'options and futures', as if the two were financial Siamese twins. But, though similar, there are important differences the savvy investor should keep in mind.
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The terms 'options' and 'futures' appear together often enough to confuse even knowledgeable traders into thinking they are the same thing. But, while they have important similarities, options and futures are distinct trading instruments.
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Trading options is risky. While the risk is limited to the cost of the option (the 'premium'), that isn't necessarily small. A Google June 400 call can cost around $2800.
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Glossary
