From Traderpedia

Revision as of 00:07, 7 July 2005

Description

An option is a contract which gives one party (the purchaser) the right, but not the obligation to execute a specific transaction. The seller of the option is referred to as th writer, who takes on the obligation to fulfill the contract if executed by the purchaser.

Types of Options

Call: An option to purchase or enter in to a long position. For example an IBM 110 call would give the owner the right to purchase IBM from the option writer at 110.

Put: An option to sell or enter in to a short position. For example a Microsoft 50 put would give the owner the right to sell Microsoft to the option writer at 50.

Option Strategies

• Bull
  • Very bullish: Buy calls
  • Moderately bullish and certain market won't fall: Sell puts
  • Moderately bullish and fairly certain market will not fall: Bull spread
  • Bearish short term and bullish in the longer term: Diagonal call spread, Calendar spread

• Bear
  • Very bearish: Buy puts
  • Moderately bearish and certain market won't rise: Sell calls
  • Moderately bearish and fairly certain market won't rise: Bear spread
  • Bullish short term and bearish in the longer term: Diagonal put spread
  • Hold stock and bearish on it: Put hedge

• Neutral
  • Expect prices to fluctuate in very narrow range: Short straddle
  • Expect prices to fluctuate in wider range Short strangle
  • Expect little fluctuation: Long butterfly
  • Hold stock and expect little fluctuation: Covered call

• Volatility
  • Expect extreme volatility: Long straddle
  • Expect high volatility: Long strangle
  • Expect moderate volatility: Short butterfly

Option Pricing

Option pricing is based on several variables, the most important of which is volatility. Some of the models employed are listed below.

Black-Scholes

The Black-Scholes Model is the most well known of the option pricing models.

Binary