i haven't traded them but what frustrates me is accounting for them (particularly in the context of consolidated reporting) and the fact that pricing models overestimate prices as the option moves closer to expiry
also something i've had on my mind since learning about options: following some not-so-sound logic (borrowed from game theory):
if i buy an option expiring in a month that yields positive gain only if i sell it, if it expires i make $0. my best response is clearly to sell that, but the other player in the game (or a set of identical players) is facing the same scenario, therefore they will not buy the option, i decrease asking price, still no sale, this repeats n times until option expiry but yet options still hold value.
obviously flawed logic and being able to convert options to shares is what stops this cycle from happening (that and asymmetric information) but still an interesting thought experiment
also what's kept me out of options is no leverage (strictly speaking about outright options trading, buy options from x and sell to y) with my minuscule risk capital entering a position would mean my 2% risk per trade would be about %10 of the spread lol
well options are based on probability theory as well as supply and demand. The supply and demand aspect is what makes them so dynamic.
Say an author comes out with a book and sells it on amazon for $15. A couple years pass and the book is out of print. Those demanding the book now have to pay a lot more because they can not find the book anywhere else.
So you have this theoretical price but the supply and demand aspect is what really drives the price. Now if the author were to reprint the book then the price of the book would go back to or close to it's original value.
I see this with book titles all the time, maybe you have as well. Options are similar in that aspect. Supply, demand and liquidity play a major factor.
Say you have you have xyz trading at 100 with 30 days left until expiration. The 100 call has a value of $3.00. If the xyz stays put in price or declines that option will expire worthless. The market maker has to make it attractive for both buyers and sellers. They don't necessarily want to be net buyers or net sellers of the option. They want to make money by selling the option for a little bit more than what it is worth to you and buy it for a little bit less than what it is worth from you.
So we use theory as an estimate for option value but we use the forces of supply and demand to get the actual option premium.
What makes the option have value is the "probability" or the potential that it can finish in the money or have intrinsic value.
As time passes the chances of the option reaches certain levels decreases and hence the option value decreases.
In many cases the more time associated with the option the greater the probability there is to see the underlying have large movements hence the higher option value for the longer term option.
Many studies have shown that option prices follow a normal distribution around the expected return more often the Black-Scholes model predicts but does an extremely terrible job of predicting price moves larger than 3 standard deviations (fat tails).
So you are very right in that there are deficiencies in pricing models. Based on your risk management plan you are also right in not trading if you are not giving yourself a chance to come out on top. If the trade doesn't make sense no reason to pursue it.
