Trading in Options to Make Money

In today's volatile market with its large ups and down swings, an investor may wonder if there is some way that they can take advantage of these swings and still make money. There is a way to deal with the current market conditions and still make money. The method that an investor can use is to trade in options to make money with their investments. Options are set up for an investor to be able to leverage their investment, insure their portfolio or to generate income. The trick is to know how to use trading options to your advantage.

Basic option trading is merely the purchasing of option calls or puts. With this strategy the investor does not risk losing any more money than their initial investment. If the underlying investment moves in the correct direction then the investor stands to make money. There are other investing strategies that the investor can use in their option trading to make money.

It is important when reviewing option trading that an investor understand what is the implied value which is built into the pricing of the option. The premium price which an investor would need to pay for the option is in simple terms based on the volatility of the stock price and the time remaining until the expiration of the option. The risk free interest rate also will play a part in the calculation.

If a stock strike price is $30.00 and its stock price is $35.00 then a value known as the intrinsic value is $5.00. What this means is that you can purchase the stock option for 30.00 and sell the underlying stock for 35.00. The intrinsic value is the difference between the stock price and the option strike price. If the premium to purchase the 30.00 option was 7.00 then the option is priced at 2.00 more than the intrinsic value. The amount of time that remains before the expiration date is also priced into the premium cost. If there is only 20 days until the expiration date the premium price will be different than if there was two months left.

Implied value is based on the amount of volatility that the stock price is expected to experience. The market will build in an expectation of what the stock price is going to do over the period of time until the expiration date. This creates a situation of supply and demand for that option. When expectations rise, then the demand rises. On the other side, as expectations decrease the demand will decrease. Since investments are driven by supply and demand, this effect will drive the option premium either up or down. This is important since an investor needs to be able to determine strategies of when to buy and sell options. Knowing how the premium price is calculated is part of that strategy.

One set of strategies in buying options is to use the expected volatility of the stock price. The use of Bollinger Bands can help in this strategy. Bollinger bands will be close together when the volatility is small and wide apart when it is high. One strategy is to buy options with low volatility with the expectation that the volatility will increase and the stock option value will go up. You would also sell options with high volatility and the expectation that the volatility will even out and then you can then buy back those options at a cheaper price.