Lesson #1: What are Options? / Lesson #2: How options are priced / Lesson #3: Calls and Puts / Lesson #4: How options increase in value / Lesson #5: Time and Options / Lesson #6: Strike Price / Lesson #7: In, At and Out of the Money / Lesson #8: Option Risks / Lesson #9: Writing Options
In this lesson, we want to give a brief overview on how options are priced.
Option contracts:
When you decide to purchase options, the first thing you need to realize is that you can't purchase a single stock option, you can only purchase option contracts. Each option contract consist of 100 options. The price listed on the options page will only provide the price of a single option and you will need to multiply that single price by 100 when you decide to buy a contract.
Option pricing:
As we discussed in the previous section, when you purchase an option you are not buying the actual stock itself, but simply the right to buy or sell the stock. As such options prices are substantially lower than the price of the stock itself.
There are a number of factors that are used to determine the value of the option. This includes the following:
1. The intrinsic value of the underlying stock. Obviously the more in-the-money the option is, the more expensive it is.
2. The volatility of the stock.The more a stock swings up and down in a short period of time the more volatile, "the greater the volatility - the higher the option price."
3. The amount of time purchased before the stock expires. For example, if you purchased an option that expires in two months, it would cost more than an option that expires in one month.
4. The dividend paid by the company is a important factor.
5. The interest rate (3 month T Bond) also plays in the pricing of an option.
Bid and Ask Spreads:
For real short term option plays you must choose options with small spreads between the bid and the ask. When you decide to buy an option you will be given two prices the "Bid" and the "Ask" price. The Bid, which is the lower of the two prices, is the price you will receive per option if you decide to sell your contract at that particular moment. The "Ask" is the price you will have to pay per option if you decide to buy the option on that stock. Note: As mentioned previously this is only the price per option, you will have to multiply that number by 100 when you buy an option contract.
Options Calculator:
Though the price of each stock option is based on rigid calculations. These calculations are based on factors in play at the time, the option price was set. These factors, such as volatility, can change over the life of the option contract. Because of these changes, some options can become good deals and other become bad deals.
VerticalOptions.com has a calculator available to subscribers who can enter the current data and determine which of the option choices available on a particular stock are the best deals.
There are numerous Options plays available to an Option Trader. These include Covered Calls, Covered Puts, Bull-Call Credit , Bear-Put Credit, Straddles, Strangles, Collar, Leaps, etc. Education is essential and understanding the risk factor of Options and their rewards is of most importance.