Traders Toolbox: Learning Options Part 2 of 4

Many people like options because they believe them to be less risky than futures. Options sometimes offer reduced risk, but usually at the cost of reduced profit potential.

One drawback of options is that a trader must consider market speed (volatility) as well as direction. Traders who buy or sell options outright to profit from up or down moves in the underlying market can find themselves fighting an uphill battle against volatility and time decay. With futures, if you're right about market direction, you'll win. With options, you can be right about the market and still lose.

If a market is trading at 200 and you buy a 210 call expecting a rally, you'll still lose on the trade if the market only rallies to 205 by expiration; your 210 call will be worthless. The same thing would happen even if the market rises as high as 220, but does so one week after expiration. In each case you would be right about market direction but would not profit.

The advantage of options is their flexibility. Because of the variety of strike prices and expiration dates a trader can choose, options naturally lend themselves to spreading strategies (simultaneously buying an selling different options), accommodating varying views of market direction and risk levels. Traders can design option strategies that will profit if the underlying market goes up or down, moves in either direction by a certain degree or remains unchanged.

Options also allow you to profit without predicting market direction because of time decay and fluctuation in volatility that increase and decrease premium. For example, a trader might sell as out-of-the-money call on a relatively volatile futures contract he thinks will fall. Over then next two months, however, the market does not fall, but gradually moves higher, trading in a narrow range (but still below his strike price). The trader was wrong about market direction, but finds the combination of decreased volatility and time decay has eroded the value of his option to the point that he can buy it back at a profit (or perhaps hold it until expiration).

Part 3 will be posted on Thursday (5/12/11). Do you like this short lesson series? Let us know in our comments section.

The MarketClub Team

13 thoughts on “Traders Toolbox: Learning Options Part 2 of 4

  1. OH YES . This short Lessons are GREAT.I like simple facts like you are doing it. Thank you . Up you !

  2. Yes, I do like the short lessons. I can rad them over quicly, and againif I am not sure if I understand. Thanks.
    Evan Jungbluth

  3. William
    One way is to go to where you have a set of services you can take, some of them are free.

  4. One statement above is quite inaccurate. Generally speaking, if you buy a 210 call option when a stock is at 200 and the stock rallies to 205 that 210 option would gain in value prior to expiration. It would not be a losing trade nor would it expire worthless.

  5. Very informative for the new comers like me. Thanks for making this available

  6. I attempted to print Part 2 but got a message that there is an error in the
    text that won't permit a printout. Could you resend Part 2 or perhaps redo it
    since its only a few paragraphs?

    Thank you.

    1. Hi Paul,

      You might be having issues because of the hyper links in the the heading and tags. Just copy and paste the text into a word document and print it that way to avoid any problems. If you are unable to do this I can send you the word document via email. Let me know.


  7. Thank you for the basic information on options. Although I have been trading for a while, it is good to review the information that got me started.

  8. Are there charts of an options volatility over a period of time, via Market Club? If not, where could I find charts of volatility?

    1. William,

      We do not offer Volatility Charts within MarketClub at the present time. We are looking to add them in the future.


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