What are various scenarios for call and put options respectively?
When in the month do i buy and sell, how long do I keep the option in each circumstance?
- zman492Lv 74 weeks ago
The first thing you need to understand is options trading is all about volatility. There are three types of volatility:
Historical (statistical) volatility: This is the volatility the underlying security has experienced in the past.
Implied volatility: The amount of volatility the underlying security will experience prior to expiration of the option. This is also considered to be the consensus expectation of options traders.
Expected volatility: The amount of volatility you as an options trader expect the underlying security will experience prior to expiration.
NB: All volatility figures are annualized.
If your expected volatility is higher than the implied volatility of an option you want to buy volatility. If your expected volatility is lower than the implied volatility of an option you want to sell volatility. (With rare exceptions, all options with the same underlying security and the same expiration date will have the same implied volatility.)
<<<When in the month do i buy and sell>>>
You look at when expected events will occur instead of when in the month it is.
<<<how long do I keep the option in each circumstance?>>>
The shortest amount of time I have held an option position was approximately 20 minutes. In this case the underlying stock 20 minutes before the market closed on the Friday before expiration was selling at about $7. There was a bid quote of $0.05 for 6 put contracts with a strike price of $5. Clearly it was extremely unlike the stock would fall below $5 in 20 minutes. I risked $3,000 to make $30. I will not say that is anything I would recommend trying.
The longest I have held an option position was about 5 months. The underlying stock was from a company that was trading at approximately $33 and the company had just submitted a new drug application to the FDA. The put option which would expire in about 7 months with a strike price of $35 was trading at $17.50. I knew that it usually took about six months for the FDA to rule on a new drug application. Prior to the FDA ruling there was nothing likely to have a major impact on the stock price. Five months later the stock price was $34 and option was trading at $8.75. When I opened the position I was risking $1,750 and had a potential profit of $17.50 per contract.. If I left the position open I would be risking $2,625 per contract for a potential profit of $875 per contract. The risk/reward ratio was no longer attractive so I closed the position to realize a profit of $875 per contract.
NB: Both of these examples are cases where I sold naked puts on stocks I did not particularly want to own. I do NOT recommend that strategy.
There have been other occasions I have sold naked puts to acquire stock that I wanted to own at a discount. If, like me, you are primarily a stock investor and you have to cash to buy the stocks, this is a reasonable strategy that I would recommend. Just be aware you are accepting most of the risk of owning the stock but limiting your potential profit, the same as buying a stock and selling a covered call.
I do not recommend anyone trade options without learning how the "greeks" affect option pricing and the risks associated with each of the greeks. The major greeks are:
Delta: The amount an option price changes when the price of the underling security changes
Gamma: The amount delta changes when the price of the underlying security changes
Vega: The amount an option price changes when the implied volatility of the underlying security changes
Theta: The amount an option price changes as time passes
Rho: The amount an option price changes as interest rate changes.
Failure to respect the risks associated with the greeks often leads to big losses.
If you want a description of common option strategies seeSource(s): Experience trading options in the past.