Advanced Options Trading Concepts & Knowledge to Enhance Your Understanding of Options
Advanced Options Trading - Introduction
Now that you have all the Options Trading Basics to start placing a few options trading positions for practise, it is now time to explore
options trading further.
Next thing to understand is why
behave the way they do. How to measure its sensitivity
to movements in
the underlying stock? What options pricing models are? How does volatility in the overall market affect your options positions?
All these and more in this Advanced Options Trading guide.
Why are these technical knowledge classified as Advanced Options Trading knowledge?
It's because these knowledge gives you better understanding of why options behave the way they do so that you might be able to exploit additional
trading opportunities. There are many successful options traders out there who never explored this far and still made money all the same.
Readers are highly advised to complete the
Options Trading Basics
guide, take a couple of practise trades with a very small amount of money and
really have a feel of what options trading is all about before delving further into the topics discussed here.
How Are Stock Options Priced
Calculating Reward Risk Ratio
Options Expiration Cycles
Level 2 Quotes
Options Trading Styles
Advanced Options Trading - Options Strategies
After understanding how call and put options work from the options trading basics guide, you are now ready to unlock the real power behind
the versatility and flexibility of options trading through the use of options strategies. Options strategies are ways to combine different
options in order to produce positions that profit from more than just one direction. There are 4 main class of options strategies;
allows you to profit when the underlying stock goes up,
Bearish options strategies
allows you to profit when the underlying
stock goes down,
Neutral options strategies
profit when the underlying stock remains stagnant or within a tight trading range and Volatile
profit when the underlying stock breaks out either way or when implied volatility
Advanced Options Trading - Options Spreads
All of the above options strategies work based on what is known as "Spreading". Options spreads are options positions made up of simultaneously
buying and selling multiple options contracts that work as a whole in order to create specific payoff profiles or "risk graphs
". It is these specific payoff profiles that create all the different kinds of options strategies. Understanding what options spreads are makes it easier to understand the working mechanics behind these options strategies.
Study the tutorial on Options Spreads
Advanced Options Trading - How Are Stock Options Priced?
The price stock options consists of intrinsic value as well as extrinsic value. You also know by now through the
Options Trading Basics guide that the intrinsic value depends on where the strike price is in relation to the price of the underlying stock
or what is known as
. However, what you do not know is how extrinsic value is priced. How does the market come up with a
justification for the risk taken by the writer of an option which is determined by the extrinsic value?
Indeed, if you are to grant someone
an option to buy or sell a stock, you would certainly consider many factors in order to justify the risk you are undertaking and such justifications
might include how much of your own money is being locked up in order to fulfill the obligations of the options contract, how much the
stock is expected to move, when the options contract expires
and more, right? The academic community has spent decades trying to come up with
an acceptable, fair and comprehensive mathematical model for the pricing of stock options in order to take all these factors into consideration.
These mathematical models have came to be known as options pricing models and the most popular of them all is known as the
Black-Scholes Model. The Black-Scholes Model is truly the grandfather of all options pricing models and has gave birth to many other more
complex variants over the past few decades, including the now equally popular Binomial Model.
The Black-Scholes Model takes 5 main factors into consideration, representing them using greek alphabets in the equation. These 5 main factors
are; Sensitivity to the change in price of the underlying stock (Delta), the change in the rate of sensitivity (gamma), interest rates (rho),
Volatility (vega) as well as time to expiration (theta).
Using the Black-Scholes Model, the theoretical value of every stock options contracts can be easily arrived at so that options traders can
compare that value against the actual price that is traded in the market to determine of an options contract is over or underpriced.
Most online broker interfaces comes with a Black-Scholes model calculator for free.
Study the tutorial on Black-Scholes Model
Advanced Options Trading - Calculating Reward Risk Ratio
Calculating reward risk ratio is one exercise all serious and professional options traders do before placing an options order. Calculating reward risk ratio allows you to clearly see if a trade fulfills your investment objectives or makes any sense with regards to the amount of money at risk for the potential reward.
Study the tutorial on Calculating Reward Risk Ratio
Advanced Options Trading - Options Expiration Cycles
Have you ever wondered why certain stocks have options of certain expiration months while some other stocks have lesser or more expiration months?
In fact, have you ever wondered why certain stocks have 2 sets of the same expiration month options? The reason for all these is that options of
different expiration cycles are assigned to each individual stock. Having a combination of options of different expiration cycles accounts for
different stocks having options of different expiration months.
Study the tutorial on Options Distinguished By Expiration Cycles
Advanced Options Trading - Options Greeks
You now know that the Black-Scholes Model using 5 main factors in determining the price of a stock option. These 5 factors are known passionately
to the options trading community as the Options Greeks, or simply, the Greeks. Even though the accuracy of the Black-Scholes Model continues to
come under fire from the options trading community, there seems no question at all as to the usefulness and accuracy of the Greeks used by the
model. Options Greeks made it possible for a myriad of interesting options trading strategies to be precisely calculated in order to reap
rewards from even more precise moves and to even better
Study the tutorial on Options Greeks
Advanced Options Trading - Delta Neutral Trading
You already know how to profit from an up, down and neutral market in the Options Trading Basics guide using various options trading strategies.
Do you know that you can actually create positions which are not affected by how the underlying stock or the market moves at all? Such
options trading positions are known as Delta Neutral positions. Market makers simply love delta neutral positions. By delta neutral trading,
you are creating a precisely calculated position which offsets any up or down movement in the underlying stock to profit when the implied
volatility of the underlying stock rises or to profit from the overall time decay of the position. What does this sound like? Yes, almost
a 100% winning position! However, delta neutral trading does have its pros and cons which you will learn about in the tutorial.
Study the tutorial on Delta Neutral Trading
Advanced Options Trading - Implied Volatility
Nothing affects the price of stock options more than the price of the underlying stock and implied volatility. The price of the underlying
stock affects Intrinsic Value while implied volatility determines the extrinsic value. The higher the implied volatility, the higher the
price of an option due to higher extrinsic value. Implied volatility is affected largely by demand. When demand for the underlying stock
or its options increase, implied volatility increases as well. Implied volatility opens the door to another interesting money making
opportunity with stock options, which is the speculation on future volatility instead of specific movements in the underlying stock. If
you buy options when implied volatility is low, you stand to profit when implied volatility increases quickly even if the underlying stock
remains stagnant. Conversely, writing options when implied volatility is high and then closing the position when the implied volatility
reduces is another popular way to make money in
Study the tutorial on Implied Volatility
Advanced Options Trading - Calculating Options Leverage
If you are using options for leverage, then it is instrumental for you to be able to calculate exactly how much leverage you are using. Yes,
you could actually "Over-Leverage" and consequently suffer a much bigger loss than you were initially prepared for! Knowing exactly the
amount of options leverage to use avoids nasty surprises and gives you much more control over the volatility in your portfolio.
Study the tutorial on Options Leverage
Advanced Options Trading - Market Makers
Have you ever wondered who is selling you the options that you bought? Have you ever wondered who is "losing money" on the other side when you
made money? Who are you really dealing with? Unlike in a typical market place where you deal directly with another options trader who is interested
in trading with you, a group of specialists from huge financial institutions known as Market Makers are actually dealing with you. Market
Makers are responsible for maintaining a liquid market for options and makes sure that you will definitely be able to buy as well as sell options
in the marketplace. Market makers do that by placing their individual bid and ask quotes for every options contract in the market place at all times. Therefore, it will never come to a point where nobody sells you options that you want to buy or that nobody buys the options
that you want to sell.
Study the tutorial on Market Makers
Advanced Options Trading - Level II Quotes
Now that you know that options traders actually deals with market makers and that market makers provide a liquid market through providing their
individual quotes, would you like to know how to choose which market makers to deal with directly? Yes, for some options traders where even a
$0.10 difference in price makes a big difference, leaving the filling to the broker may not be the optimal solution. In this case, you can
actually choose to deal directly with market makers who are providing you the quote that you want through what we call Level II Quotes or
Level 2 Quotes. Level 2 Quotes displays all the quotes provided by each individual market makers in every options exchange so that you can
choose which specific market maker to deal with! Level 2 Quotes are essential for Options traders utilizing daytrading strategies aiming to make $0.10 or $0.20 quickly within the day.
Study the tutorial on Level 2 Quotes
Advanced Options Trading - Synthetic Positions
One of the greatest advantage of options trading is its flexibility. It is possible to transform a call option into the equivalent of a
put options instantly without even closing the orginial call option position! This flexibility to transform a long position into a short
position and vice versa cuts down commissions and enhances the option trader's ability to take advantage of volatile, fast changing
environment. The art of combining one kind of options and / or stocks to produce an equivalent of another type of options is known as
Study the tutorial on Synthetic Positions
Advanced Options Trading - Options Arbitrage
Option trading allows you to make totally risk-free profits through options arbitrage. Options arbitrage is when special options strategies
are used to take advantage of options price discrepancies. Such discrepancies are rare and gets filled out very quickly but they offer
the only source of risk-free profits in options trading.
Study the tutorial on Options Arbitrage
Advanced Options Trading - Options Trading Styles
Options trading is an extremely versatile financial instrument that can be traded in a variety of methodologies or styles. Choosing an
options trading style that is suitable for your personality as well as lifestyle is critical to your success in options trading. Trying
to trade a wrong style is the main reason why beginner options traders lose their shirts in options trading. Understanding your options trading
style, choosing the correct style and then further your options trading investment education along that chosen path will lead to a lifetime of
options trading success.
Study the tutorial on Options Trading Styles
Advanced Options Trading - Legging
Legging into a position is an extremely important options trading skill that all veteran options traders trading complex, multi-leg, options strategies use. Legging into a position allows each part of an options trading strategies to be filled at favorable prices thereby increasing profitability or simply ensuring profitability. Indeed, there are options strategies where the profit margin is so slim that a profit can only occur if the position is properly legged into.
Study the tutorial on Legging
Advanced Options Trading - Options Assignment
If you are an options trader pursuing credit spreads and options writing strategies, then you need to be aware of the fact that your positions could be automatically assigned at anytime prior to expiration.
Study the tutorial on Options Assignment