Traders Toolbox: Learning Options Part 4 of 4 Revisited...

Trader's Toolbox

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"In real estate, they say that the three most important things are location, location, and location. In options, the three most important things are volatility, volatility, and volatility. Often neglected by option rookies, volatility is the cornerstone of an option professional’s trading strategy.In its simplest form, expressed as the annualized percentage of the standard deviation, volatility measures how far a contract can be expected to swing from a mean price. A contract trading at 50 would have a volatility of 10% if it traded between 45 and 55 over a given period of time.

Historical volatility is just that: the volatility calculated (using closing prices) over a given period – 20 days, 20 weeks, one year, etc. Implied volatility is the volatility using current market prices. For example, using four primary option pricing inputs – futures price, settlement price, time until expiration and volatility – would result in a theoretical price.

By plugging in the current option price in place of the theoretical price and working backward, it would be possible to determine the volatility the current market is implying. (It is not mathematically possible to work backward and solve for implied volatility using an equation like the Black-Scholes model, but an approximation can be derived.)..."

Revisit the Trader's Toolbox Post: "Learning Options Part 4 of 4 " here.

5 thoughts on “Traders Toolbox: Learning Options Part 4 of 4 Revisited...

  1. I am searching for strategies that the home trader can use, and the views on your site help with this. We can read about various simple and complex options strategies, but is it realistic for the home trader to attempt these? Do the available trading platforms allow complex multi-part trades for this kind of investor?

  2. Suman,

    Thank you for your feedback.

    We have always stressed on this blog that you need to understand what you're investing in and trading in. If you don't understand it, don't do it is the best rule of all.

    All the best,
    Adam

  3. I have lost Rs15,000 last week for trading in S&P NIFTY 4600(PUT) options, thru my brokeraging house of Rel Money.I opened new account with 1 Lac. I didnt understand what is PUT,but they took my agreements on phone to invest in it.I agreed thinking it, as a Delivery. I lost full amount.I do not understand when we entrust the money to any Brokeraging Firm, why do they need our agreementto invest? If I knew I wd do myself. Also they gain in brokerage whether we loose or Profit!!! No compensation either. I didnt know the implications of investing in Derivatives, why did they do it ? I was even not aware of how PUT moves or that it expires in one month.V sorry. Dont want to venture to derivatives any more.

    Can you pl enlighten me , what it means if a scrip has a lower and higher CIRCUIT defined with it ?
    Regards,
    Suman

  4. This was an interesting beginning primer article on volitility. However, I find that some of the language used in your articles is difficult to understand. You lost me in the impossibility of figuring out the theoretical value of an option using the Black-Scholes equation working backwards. I mean really, who cares. And the following two sentences should have been cleaned up to say "buy options with low volitility, sell options when volitility is high" instead of your confusing sentences... "If a market is trading at historically low volatility levels, options premiums could be expected to rise as market volatility increases, presenting a buy opportunity. The reverse is true for high volatility situations." If you want to present basic information please do it in a basic way.

  5. hello;
    i just trade as the situation fits.some times i get stuck on a stock .but have learnt, not to get sentlementall on a stock. i dont understand chess,or options.
    what i don,t understand i look to learn
    regards
    Richard

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