| Q.
What
is the theoretical option price
compared to the actual option
price?
A.
Theoretical option prices
are computed with the help
of Black-Scholes model. You
can learn more about option
pricing models here.
You can also check our glossary.
Theoretical
prices primarily reflect the
stock price volatility and
do not take into consideration
technical signals. However,
it is dangerous to ignore
these technical signals. Keep
in mind that the underlying
stock price movement is the
key factor which determines
the option price. That is
why we run technical analysis
when preselecting our picks.
Please pay attention to green
and red arrows in our resumes.
Actual
option prices can differ significantly
from theoretical ones for
the following reason: although
many traders take theoretical
prices as a starting point,
they use technical signals
to further adjust these prices.
For example, if the underlying
stock price is expected to
increase, the actual call
option prices will be higher
than theoretical ones. According
to the supply and demand theory,
demand for the call options
will rise as many market players
would like to catch the upward
stock price movement. Vice
versa, if the market anticipates
a price decline, the actual
put option prices would normally
exceed their theoretical
levels. Demand for put options
will go up as many market
players would like to get
a protective hedge for their
stocks.
Q.
Does this mean that the
option is overpriced if theoretical
price is $0.46 and actual price
is $1.35? A.
Not necessarily. Every
market situation needs to
be analyzed separately.
It
holds true only if the stock
price won't change significantly
and actual option prices will
start to tend to their theoretical
levels. But if the stock price
drops or surges as anticipated
by the market, then theoretical
prices are the ones far from
reality. There is a special
class of option strategies
when the trader bets on volatility
change and the corresponding
change of disparity between
theoretical and actual option
prices. Learn more about these
strategies here.
You
can also find our short-term
picks for "volatility" strategies
on our site on a daily basis.
Also please take into consideration
the general market volatility
trend that we compute and
publish on our main
page. It would be more risky
to bet on a particular stock
volatility drop if the market
volatility is on rise.
Q.
It seems to me that since 80%
of options expire worthless,
purchasing options with a net
credit makes more sense to me.
Is that sound judgment or am
I thinking wrong?
A.
It is a "myth" you should
not rely on! In fact, nobody
cares for numerous options
with different strikes and
expiration dates. Every trader
is focused on certain option
strikes and expiration months,
for which general rules of
that kind should not be applied.
It all depends on a particular
situation, underlying stock
price movement, volatility
changes, etc. Mathematically
there is no significant difference
between net credit and
net debit strategies (except
the small interest that you
earn on your credit balance).
The difference is purely psychological
and is not so important. In
the real situation there is
no simple solutions like that.
Our mission is to help you
put together all factors that
determine your success.
Q.
Could you please explain the
"average 1 day buy-call return"?
A.
One-day return for a "buy
call" option pick is calculated
in the following way:
Profit=sell price -buy price
Return = (profit/buy price)*100%
One-day return = return/(number
of days this option was held) |
