What was once a dream for private investors has become reality: everyone can now invest in options. Options involve a bit more risk, but then again you can gain more profit. And with options you have the ability to strategically protect your portfolio. Now let’s look at how trading options works.Don’t know what a options is? The read this article about Options
Trading in options
When you buy a share is always a fixed price, this is not the case when you buy options. Indeed, there are several values available, the exercise price, expiration time and pay premium differences. At any given time so there are several options, some examples:
Barclays shares with fair value of £282,97
Call option with strike price of £300.00 and expiration time of three months
Put option with strike price of £350.00 and expiration period of two years
Call option with strike price of £290.00 and expiration time of two weeks
If you don’t know what the difference is between a call option and a put option. Don’t worry you can find these answers in the article options.
In trading with options the price of an option is obviously determined by the demand of the market. A call option with a strike price below the current share price provides immediate profit and is therefore very attractive. With trading in options there are three possibilities:
Trading options in the money:
In this case the exercise price is below the current market price, the option is immediately worth money
Trading options at the money:
In this case the exercise price is equal to the current market price, the option now delivers nothing.
Trading options out of the money:
In this case the strike price is higher than the current share price, the option is worthless
How the value of an option is calculated
The value of an option is determined by the net asset value plus the expected value. The intrinsic value is the current value of an option. When a call option entitles you to buy a stock that now cost £30.00 to £25.00 you make direct £5.00 earnings per share. The net asset value is £5.00.
However, there is also a expecatation value. When you have a option that is out of the money with a long expiry date. The value of that option will increase more as share increase in value. The value of those kind of options can also increase big time in value if investors are believing that the share price will skyrocket on the short term.
So ultimately it depends whether one believes that the option will be worth money in the future.
So how is the value of an option being formed?
The value of an option is determined by the exchange rate and the volatility of the underlying. When you acquire the right to purchase an option at a price of £25.00 and the stock price is currently £26.00, then the intrinsic value £1.00 which option gives immediate value of at least £ 100.00 ( 100 X £1.00 earnings = £100.00).