Thursday, October 4, 2007

Options Trading, Part III

Yesterday I wrote about figuring out your comparative advantage. Today, I will discuss where this advantage will be applied.

First, we have to understand why options are valuable. Options have five basic characteristics:

(1) Underlying asset (ie. Google stock)
(2) Type of option, ie. Call or Put
(3) Strike Price - price at which option will be converted
(4) Expiration date - date when contract expires
(5) Volatility - how much periodic movement there is

So now you just have to pick at least two of the five characteristics that you have a comparative advantage in. The more you can be good at, the better your outcome will.

Of course, just because you are good at two of the five, doesn't mean you don't have to either explicitly or implicitly choose all the other five characteristics.

For instance, knowing that Google is going to go up, doesn't mean you can just go out and buy a Call option on Google. You have to consider the current price of Google, and pick a future price you think is obtainable.

The characteristic you can make the most money on is of course strike price. After price will be volatility plays and then duration plays. The last two of course will make you much less money.

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