General Topics
Technical Topics
Brokerage Firms
Community Lounge
Site Support

# how do options works

Discussion in 'Options' started by nouveau, Oct 30, 2008.

1. ### nouveau

PLEASE CORRECT ME IF I'M WRONG:

AN OPTION AS CAN'T CARRY A NEGATIVE VALUE IT CAN JUST BECOME WORTHLESS

so the parametres that's establish the profit or losses are
the value of the good controled by that option at the time of buying and selling.

the risk: in buying an option depends on

1)THE NATURE OF THE CONTRACT (THE QUANTITY OF GOODS CONTROLED WITH ONE OPTION)

2)THE NATURE OF THE GOOD CONTROLED OF COURSE

3) THE LENGTH OF THE CONTRACT

4) THE EVALUATION OF THE MARKET UP OR DOWN.

SO WHAT DOES THE STRIKING PRICE HAS TO DO WITH IT?

to make calculation simples let said the contract was1000 usd for 40 000 gal of oil
and the price of galon of oil at the time of buying was 2.00 dollards

if a buyer bough 3 call options and 1 put option total investment = 4000 usd.
the gallon goes up by 3c when he sell his options he gets \$400 (40000 gal X \$0.01) X 3c X 3options= 3600\$ + 3000\$ initial investment= 6600\$ total returns

if at the time of selling all his options. the price of the gal goes down by 3c he will lose completly his 3 call options but he will recoupe 3 X 400\$ = 1200+1000 on his 1 put option.

however if the market moves further down over 7.5c for exemple he will be start to be in his money again, I'm correct?

so as option can't be of negative value and if the contract , an if a contract has 45 ays left before expiration, the buyer as got 45 days during wich the market will have go up by at leat 1c or down by 7.5 for him to have a chance to be in his money. in other terms i can only loose it at the time of selling the price of the gal is between 1.925\$ and 2.01\$

2. ### theboxer

No no, many people believes this, but it wrong. the way an options works is like this:

The VIX is what you have to watch. As soon as you buy an option, the value is immediately subtracted from the VIX, so that when you sell back the option, you'll get (VIX - option price). Now, during the lifetime of an option (which is the exp date + 7 months) the option often "splits". This happen when half the option become valueless, and the other half gain in value by 2.5. You have to watch for this, because it has a 40% chance of happening for every option contract.

Secondly, remember that the pros only buy options, and selling options is stricktly for the sucker.

Finally, know what type of option you buy. An american-style option can only be exercised in the last week before striking date. A european style option cannot be exercised at all, but must be sold at a discount. A british style must be sold before it is exersized, and a middle eastern style option must be sold, period.

Options are complicated!

3. ### nouveau

PLEASE CORRECT ME IF I'M WRONG:

AN OPTION AS CAN'T CARRY A NEGATIVE VALUE IT CAN JUST BECOME WORTHLESS.

the value of an option = the premium X the qty of goods.
therefore the risk can't excede the value of the option

the parametres that's establish the profit or losses are
the value of the good controled by that option at the time of buying and selling.

the risk: in buying an option depends on

1)THE NATURE OF THE CONTRACT ( the premium)

2)THE NATURE OF THE GOOD CONTROLED OF COURSE

3) THE LENGTH OF THE CONTRACT

4) THE EVALUATION OF THE MARKET UP OR DOWN.

5) the value of the good at the ime of the transactions

SO WHAT DOES THE STRIKING PRICE HAS TO DO WITH IT?

to make calculation simples let said the premium was 0.025 usd for 40 000 gal of oil so price of the option will be 1000\$
and the price of galon of oil at the time of buying was 2.00 dollards

if a buyer bough 3 call options and 1 put option total investment = 4000 usd.
the gallon goes up by 3c when he sell his options he gets \$400 (40000 gal X \$0.01) X 3c X 3options= 3600\$ + 3000\$ initial investment= 6600\$ total returns

if at the time of selling all his options. the price of the gal goes down by 3c he will lose completly his 3 call options but he will recoupe 3 X 400\$ = 1200+1000 on his 1 put option.

however if the market moves further down over 7.5c for exemple he will be start to be in his money again, I'm correct?

so as option can't be of negative value and if the contract , an if a contract has 45 ays left before expiration, the buyer as got 45 days during wich the market will have go up by at leat 1c or down by 7.5 for him to have a chance to be in his money. in other terms i can only loose it at the time of selling the price of the gal is between 1.925\$ and 2.01\$

4. ### nouveau

wahts the vix

5. ### theboxer

It stands for Volatility In Excitation, and it has to do with the increase in volatility of price dividides by the excitedness of the markets.

6. ### nouveau

so the premium is cost of the option. if you paid an option 1000\$ you only get into your money when the value of the goods rise or fell by 1000\$+ depending if it's put or a call correct?

7. ### Mud

First of all, ignore what theboxer replied as he's only trying to confuse you.

An option premium (the value of the option) can not be negative. So if you buy an option, you can lose nothing more than your premium. Keep in mind that this is still a 100% loss.
However, if you sell an option, you may end up owing something to the counter-party (the person who bought the option from you, although it's not that simple but that's irrelevant for now).
The strike price is the price at which the option can be exchanged for the underlying instrument (stock, future contract, etc). If you buy a call option with a strike price of \$30 on stock XYZ, you are allowed to buy stock XYZ for \$30. The factors that affect the value of an option can be classified into two categories: intrinsic value, and time value. The intrinsic value of an option is simply the difference between the current price of the underlying instrument and the strike price, with a minimum value of 0. If XYZ is trading for \$35 and you are allowed to buy it for \$30, it should be obvious that the value (premium) of the option should be at least \$5. The option will most likely be a bit more expensive than that, because we have to add the time value to the intrinsic value. The time value is complicated to calculate, but it includes a value for the amount of volatility that the market predicts for the underlying instrument. The more the prediction calls for high volatility, the higher the time value will be, because it will be more likely that at the expiry of the option, XYZ's price will be above the strike price (which is good for the call option). The other major factor in the time value is the time left before the option expires. The more time there is before the expiry, the more likely it is that the price of XYZ will have time to go above the strike price.
Option valuation is a very complex topic. Options trading can be very profitable (and safe). But you have to know what you are doing because if you don't, it will be very easy for you to lose all your money real quick.

Bonne chance, et informes toi de la base avant de poser des questions parceque les gens risquent de te dire n'importe quoi.

8. ### dagnyt

1) You are not the right person to be responding to the question.

2) Your knowledge of options is pitiful and you are not only confusing Nouveau, but you are completely wrong in your statements.

3) VIX is the CBOE volatility index and has nothing to do with the specific price of a specific option. Whatever you think VIX is, it's 'value' is NOT immediately subtracted from the price of the option.

4) Option contracts do not 'splits.' What are you talking about?

5) Selling options is not only NOT for suckers, it's the preferred methodology for the vast majority of option traders - including the professionals. What is a sucker bet is selling options naked.

Most pros protect the options they sold by buying a greater number of different options to own. And the net cost of thsoe trades is positive. that means they collect cash when compiling positions.

6) An American style option can be exercised ANY TIME prior to its expiration.

You are obviously toying with Nouveay. Why are you doing that? What did he do to antagonize you?

Mark

9. ### theboxer

Thanks for setting me straight!

10. ### donnap

If only it was that easy, then everybody could be a billionaire.

The option market, generally, prices volatility very well. So your straddle-like position would need movement, the sooner the better, to profit.

You may work this strategy month after month. Some months, it will seem like easy money. Others, not so good.

You may find yourself in a profitable position, only to lose it because you failed to act. Other times, you act too soon and give up the big profit needed to cover expenses and losses.

You may also find that the option market can be very uncooperative at times, forcing you to pay more and receive less for your options. Known as slippage - this may mean the difference between profit and loss.

#10     Oct 31, 2008
ET IS FREE BECAUSE OF THE FINANCIAL SUPPORT FROM THESE COMPANIES: