One reason serious investors love options is that they can be used for so many different strategies. Think a stock is going to rise? Want some protection should your stock unexpectedly plummet? Acquiring a put option gives you the ability to sleep easy, knowing you can sell it later at a pre-determined price and limit your losses.
The number of possible strategies goes on and on. Options can open the door to big gains or provide a safeguard against possible losses. And, unlike actually buying or short-selling shares, you can obtain a significant position in the stock with a modest upfront commitment. The more you know about the premium, the better you can recognize a good deal and back out of transactions when the odds are against you.
That's what is known as "in the money. This is where the second component of an option comes into play, which is how long the contract is good for. Even if your options contract is "out of the money," it eventually might have some value if there is a significant change in the asset's market price. That's what is known as the "time value" of the contract. It's whatever an investor is willing to pay above the contract's intrinsic value in the hope the investment will pay off eventually.
Part of the pricing of the option is your bet that the stock will pay off over time. It's important to note that the option's premium is constantly changing depending on the price of the underlying stock and the amount of time left in the contract. The more an options contract is "in the money," the more its premium rises. By the same token, if the option loses some of its intrinsic value, or is "out of the money," the premium will fall as well.
The amount of time left in the contract also affects its price. The closer the contract is to its expiration date, the less value it has and the premium will fall. While all options tend to decline in worth as the expiration nears, the pace at which they do so can vary considerably. Naturally, the chance of the stock rising or falling momentously is limited during this relatively short period. Consequently, its time value will taper off well ahead of expiry.
Option premiums for somewhat erratic securities — promising technology stocks, for example — tend to decay more slowly. Based on historical data, the standard deviation measures the degree of movement, either up and down, in relation to the mean price. A lower number indicates a relatively stable stock — one that will usually command a smaller options premium.
This propensity to jump in price means that any accompanying options will usually have a higher price tag. An equity with a beta less than 1 is comparatively stable and thus likely to have a smaller option premium. These yardsticks are by no means perfect. In addition, significant, one-time events have a way of making certain stocks look more unpredictable than they really are.
But when it comes to getting a general sense of how stable a company is, they can be very useful. Options can be a rewarding investment tool for the seasoned investor, though they do carry risks. Dictionary Term Of The Day. A conflict of interest inherent in any relationship where one party is expected to Broker Reviews Find the best broker for your trading or investing needs See Reviews.
Sophisticated content for financial advisors around investment strategies, industry trends, and advisor education. A celebration of the most influential advisors and their contributions to critical conversations on finance. Become a day trader. There are two basic components to an option's premium. Time Value Even if your options contract is "out of the money," it eventually might have some value if there is a significant change in the asset's market price.
Measuring Volatility While all options tend to decline in worth as the expiration nears, the pace at which they do so can vary considerably. The Bottom Line Options can be a rewarding investment tool for the seasoned investor, though they do carry risks. A conflict of interest inherent in any relationship where one party is expected to act in another's best interests.
Passive investing is an investment strategy that limits buying and selling actions. Passive investors will purchase investments How much a fixed asset is worth at the end of its lease, or at the end of its useful life. If you lease a car for three years, A target hash is a number that a hashed block header must be less than or equal to in order for a new block to be awarded. No thanks, I prefer not making money. Get Free Newsletters Newsletters.More...