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The following article was published in our article directory on November 11, 2009.
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Online Options Trading – Profitability and Options Valuation

Article Category: Advice

When you venture into online options trading, there are many things you have to learn. One of the most fundamental is stock option valuation. Why do you need to be familiar with option valuation? Because the value of a stock option will determine your investment choices when trading options and help you to maximize your potential profits.

There are four factors that determine the price of an option. The first is a stock's present market price. Remember that when stock price rises, the premium of a call option also increases while that of a put option decreases. Therefore, buy calls if you think the market price of a stock will go up and buy puts if you think it will go down.

The second factor is the strike price. The strike price is the fixed price by which the holder of an option can either buy or sell the underlying stock when the option is exercised. There are certain guidelines for setting strike prices. For example if the stock price is less than $25 per share then the strike price is higher or lower than stock price in increments of $2.50. Therefore, if stock price is $15, then the range of strike prices can be anywhere from $10 to $17.50; if share price is between $25 to $200 then strike price rises in increments of $5.

There are three ways to describe the relationship between strike price and share price: in-the-money, at-the-money and out-of-the-money. A call option is said to be out-of-the-money when share price is lower than strike price; when it is in-the-money the opposite is true. Therefore, if share price is $11 but strike price is $13, you are out-of-the-money; if the reverse then you would be in-the-money because you could buy low and sell high. Options are at-the-money when strike and share prices are the same. It is advised that beginners pick at-the-money options until they gain more experience in trading.

The third factor to think about is the remaining life of the stock option, which in turn influences its valuation. The longer the time before the option expires the more it is worth and the more you have to pay for it. This is because stock prices go on moving considerably over a longer period of time.

Experienced traders suggest that you should purchase an option with a longer time left before expiration rather than one which has only a month left to go. This will give you more flexibility in making trading decisions. On the other hand, they also advise you to close out your position if your option has only a month to go, to stop you from losing money.
The final factor is the volatility of a stock's price. Volatility refers to a stock price's movement over time: it can be either high or low. The higher a stock's volatility, the more expensive the premium will be. If a stock you hold an option on abruptly becomes volatile after a long period of stability, the value of the option will likely go up and you can take advantage by trading it.

Knowledge of option valuation will make your online options trading more profitable and help you keep away from costly errors.

Keywords: option picks, options trading course, stock options trading, option trading online, options traders, online options trading

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