I wanted to look a bit at Options trading-increasingly I am trading more and more options.They are extremely versatile and the more you use them and learn about them the more you will start to appreciate what they can do for your portfolio.
I like most options traders when they first started out made the classic mistake of focusing on price.I perceived that cheap meant they only cost 5 cents !!! and that an option costing $6 must be expensive. So like most people I watched as I bought a call or a put and .............YES fantastic the stock moved in the right direction AND my option-stayed the same or worse-went backwards.
I had made the classic mistake of buying "cheap" out of the money options.
Options can be one of three things :
- Out of the Money (OTM)
- At the Money (ATM)
- In the Money (ITM)
For example Stock XYZ is trading at $25
If you want to buy an option then
- a $25 option is at the money(same price as the stock),
- a $20 option is in the Money(less than the price of the stock)
- a $30 option is out of the money(More than the price of the stock)
Options that are out of the money do not move in line with the movement of the underlying stock, options that are at the money will move at approximately half the pace of the stock(i.e. for every $1 movement of the stock up or down then the option will move approx 50 cents).
For options that are in the money then the more they are in the money the closer they will move dollar for dollar with the stock.
There are other factors that affect the price like time to expiry etc-but we will cover that in another post.
Therefore the reason I was not getting any movement in my option even when the stock move din the direction I wanted it to was because I was buying "cheap" out of the money options-ahhhhh I eventually realised...there is a reason they are "Cheap"
In fact they were not cheap at all and in some instances they were a lot more expensive than options at 10 or 20 times the price.
In the next part of this article I will look in a bit more depth at why this is the case and what you can do and what you should look at to give yourself more of a chance .
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