Options Premium Explained

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    The Best Binary Options Broker 2020!
    Perfect Choice For Beginners!
    Free Demo Account!
    Free Trading Education!
    Get Your Sing-Up Bonus Now!

  • Binomo
    Binomo

    Only For Experienced Traders!

Contents

Basics Of Options Trading Explained

Before we delve deep into the world of options trading, let’s take a moment to understand why do we need options at all. If you are thinking it is just another way to make money and was created by some fancy guys in suits working in Wall Street, well, you are wrong. The options world predates the modern stock exchanges by a large margin.

While some credit the Samurai for giving us the foundation on which options contracts were based, some actually acknowledge the Greeks for giving us an idea on how to speculate on a commodity, in this case, the harvest of olives. In both cases, humans were trying to guess the price of a food item and trade accordingly (rice in the case of samurais), long before the modern world put in various rules and set up exchanges.

With this in mind, let us try to answer the first question in your mind.

What is options trading?

Let’s take a very simple example to understand options trading. Consider that you are buying a stock for Rs. 3000. But the broker tells you about an exciting offer, that you can buy it now for Rs. 3000 or you can give a token amount of Rs. 30 and reserve the right to buy it at Rs. 3000 after a month, even if the stock increases in value at that time. But that token amount is non-refundable!

You realise that there is a high chance that the stock would cross Rs. 3030 and thus, you can breakeven at least. Since you have to pay only Rs. 30 now, the remaining amount can be used elsewhere for a month. You wait for a month and then look at the stock price.

Now, depending on the stock price, you have the option to buy the stock from the broker or not. Of course, this is an over-simplification but this is options trading in a gist.In the world of trading, options are instruments that belong to the derivatives family, which means its price is derived from something else, mostly stocks. The price of an option is intrinsically linked to the price of the underlying stock.

A formal definition is given below:
A stock option is a contract between two parties in which the stock option buyer (holder) purchases the right (but not the obligation) to buy/sell shares of an underlying stock at a predetermined price from/to the option seller (writer) within a fixed period of time.

We are going to make sure that by the end of this article you are well versed with the options trading world along with trying out a few options trading strategies as well. We will cover the following points in this article. If you feel that you want to skip the basics of options, then head straight to the options trading strategies.

Let’s start now, shall we!

Options trading vs. Stock trading

There must be a doubt in your mind that why do we even have options trading if it is just another way of trading. Well, here are a few points which make it different from trading stocks

  • The Options contract has an expiration date, unlike stocks. The expiration can vary from weeks, months to years depending upon the regulations and the type of Options that you are practising. Stocks, on the other hand, do not have an expiration date.
  • Unlike Stocks, Options derive their value from something else and that’s why they fall under the derivatives category
  • Options are not definite by numbers like Stocks
  • Options owners have no right (voting or dividend) in a company unlike Stock owners

It is quite often that some people find the Option’s concept difficult to understand though they have already followed it in their other transactions, for e.g. car insurance or mortgages. In this part of the article, we will take you through some of the most important aspects of Options trading before we get down to the world of options trading.

Options terminologies

Strike Price

The Strike Price is the price at which the underlying stocks can be bought or sold as per the contract. In options trading, the Strike Price for a Call Option indicates the price at which the Stock can be bought (on or before its expiration) and for Put Options trading it refers to the price at which the seller can exercise its right to sell the underlying stocks (on or before its expiration)

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    The Best Binary Options Broker 2020!
    Perfect Choice For Beginners!
    Free Demo Account!
    Free Trading Education!
    Get Your Sing-Up Bonus Now!

  • Binomo
    Binomo

    Only For Experienced Traders!

Premium

Since the Options themselves don’t have an underlying value, the Options premium is the price that you have to pay in order to purchase an Option. The premium is determined by multiple factors including the underlying stock price, volatility in the market and the days until the Option’s expiration. In options trading, choosing the premium is one of the most important components.

Underlying Asset

In options trading, the underlying asset can be stocks, futures, index, commodity or currency. The price of Options is derived from its underlying asset. For the purpose of this article, we will be considering the underlying asset as the stock. The Option of stock gives the right to buy or sell the stock at a specific price and date to the holder. Hence its all about the underlying asset or stocks when it comes to Stock in Options Trading.

Expiration Date

In options trading, all stock options have an expiration date. The expiration date is also the last date on which the Options holder can exercise the right to buy or sell the Options that are in holding. In Options Trading, the expiration of Options can vary from weeks to months to years depending upon the market and the regulations.

Options Style

There are two major types of Options that are practised in most of the options trading markets.

  • American Options which can be exercised anytime before its expiration date
  • European Options which can only be exercised on the day of its expiration

Moneyness (ITM, OTM & ATM)

It is very important to understand the Options Moneyness before you start trading in Stock Options. A lot of options trading strategies are played around the Moneyness of an Option.

It basically defines the relationship between the strike price of an Option and the current price of the underlying Stocks. We will examine each term in detail below.

When is an Option in-the-money?

  • Call Option – when the underlying stock price is higher than the strike price
  • Put Option – when the underlying stock price is lower than the strike price

When is an Option out-of-the-money?

  • Call Option – when the underlying stock price is lower than the strike price
  • Put Option – when the underlying stock price is higher than the strike price

When is an Option at-the-money?

  • When the underlying stock price is equal to the strike price.

Take a break here to ponder over the different terms as we will find it extremely useful later when we go through the types of options as well as a few options trading strategies.

Type of options

In the true sense, there are only two types of Options i.e Call & Put Options. We will understand them in more detail.

To Call or Put

A Call Option is an option to buy an underlying Stock on or before its expiration date. At the time of buying a Call Option, you pay a certain amount of premium to the seller which grants you the right (but not the obligation) to buy the underlying stock at a specified price (strike price).

Purchasing a call option means that you are bullish about the market and hoping that the price of the underlying stock may go up. In order for you to make a profit, the price of the stock should go higher than the strike price plus the premium of the call option that you have purchased before or at the time of its expiration.

In contrast, a Put Option is an option to sell an underlying Stock on or before its expiration date. Purchasing a Put Option means that you are bearish about the market and hoping that the price of the underlying stock may go down. In order for you to make a profit, the price of the stock should go down from the strike price plus the premium of the Put Option that you have purchased before or at the time of its expiration.

In this manner, both Put and Call option buyer’s loss is limited to the premium paid but profit is unlimited. The above explanations were from the buyer’s point of view. We will now understand the put-call options from the seller’s point of view, ie options writers. The Put option seller, in return for the premium charged, is obligated to buy the underlying asset at the strike price.

Similarly, the Call option seller, in return for the premium charged, is obligated to sell the underlying asset at the strike price. Is there a way to visualise the potential profit/loss of an option buyer or seller? Actually, there is. An option payoff diagram is a graphical representation of the net Profit/Loss made by the option buyers and sellers.

Before we go through the diagrams, let’s understand what the four terms mean. As we know that going short means selling and going long means buying the asset, the same principle applies to options. Keeping this in mind, we will go through the four terms.

  • Short call – Here we are betting that the prices will fall and hence, a short call means you are selling calls.
  • Short put – Here the short put means we are selling a put option
  • Long call – it means that we are buying a call option since we are optimistic about the underlying asset’s share price
  • Long put – Here we are buying a put option.

S = Underlying Price
X = Strike Price

Break-even point is that point at which you make no profit or no loss.

The long call holder makes a profit equal to the stock price at expiration minus strike price minus premium if the option is in the money. Call option holder makes a loss equal to the amount of premium if the option expires out of money and the writer of the option makes a flat profit equal to the option premium.

Similarly, for the put option buyer, profit is made when the option is in the money and is equal to the strike price minus the stock price at expiration minus premium. And, the put writer makes a profit equal to the premium for the option.

All right, until now we have been going through a lot of theory. Let’s switch gears for a minute and come to the real world. How do options look like? Well, let’s find out.

What does an options trading quote consist of?

If you were to look for an options quote on Apple stock, it would look something like this:

When this was recorded, the stock price of Apple Inc. was $196. Now let’s take one line from the list and break it down further.

Eg.

In a typical options chain, you will have a list of call and put options with different strike prices and corresponding premiums. The call option details are on the left and the put option details are on the right with the strike price in the middle.

  • The symbol and option number is the first column.
  • The “last” column signifies the amount at which the last time the option was bought.
  • Change” indicates the variance between the last two trades of the said options
  • Bid” column indicates the bid submitted for the option.
  • Ask” indicates the asking price sought by the option seller.
  • Volume” indicates the number of options traded. Here the volume is 0.
  • Open Interest” indicates the number of options which can be bought for that strike price.

The columns are the same for the put options as well. In some cases, the data provider signifies whether the option is in the money, at the money or out of money as well. Of course, we need an example to really help our understanding of options trading. Thus, let’s go through one now.

Options Trading Example

We will go through two cases to better understand the call and put options.

For simplicity’s sake, let us assume the following:

  • Price of Stock when the option is written: $100
  • Premium: $5
  • Expiration date: 1 month after the option is bought

Case 1:

The current price of stock: $110. Strike price: $120

Case 2:

The current price of stock: $120. Strike price: $110

Considering that we have gone through the detailed scenario of each option, how about we combine a few options together. Let’s understand an important concept which many professionals use in options trading.

What is Put-Call Parity In Python?

Put-call parity is a concept that anyone who is interested in options trading needs to understand. By gaining an understanding of put-call parity you can understand how the value of call option, put option and the stock are related to each other. This enables you to create other synthetic position using various option and stock combination.

The principle of put-call parity

Put-call parity principle defines the relationship between the price of a European Put option and European Call option, both having the same underlying asset, strike price and expiration date. If there is a deviation from put-call parity, then it would result in an arbitrage opportunity. Traders would take advantage of this opportunity to make riskless profits till the time the put-call parity is established again.

The put-call parity principle can be used to validate an option pricing model. If the option prices as computed by the model violate the put-call parity rule, such a model can be considered to be incorrect.

Understanding Put-Call Parity

To understand put-call parity, consider a portfolio “A” comprising of a call option and cash. The amount of cash held equals the call strike price. Consider another portfolio “B” comprising of a put option and the underlying asset.

S0 is the initial price of the underlying asset and ST is its price at expiration.
Let “r” be the risk-free rate and “T” be the time for expiration.
In time “T” the Zero-coupon bond will be worth K (strike price) given the risk-free rate of “r”.

Portfolio A = Call option + Zero-coupon bond

Portfolio B = Put option + Underlying Asset

If the share price is higher than X the call option will be exercised. Else, cash will be retained. Hence, at “T” portfolio A’s worth will be given by max(ST, X).

If the share price is lower than X, the put option will be exercised. Else, the underlying asset will be retained. Hence, at “T”, portfolio B’s worth will be given by max (ST, X).

If the two portfolios are equal at time, “T”, then they should be equal at any time. This gives us the put-call parity equation.

Equation for put-call parity:

C + Xe-rT = P + S0

In this equation,

  • C is the premium on European Call Option
  • P is the premium of European Put Option
  • S0 is the spot price of the underlying stock
  • And, Xe-rT is the current value (discounted value) of Zero-coupon bond (X)

We can summarize the payoffs of both the portfolios under different conditions as shown in the table below.

From the above table, we can see that under both scenarios, the payoffs from both the portfolios are equal.

Required Conditions For Put-call Parity

For put-call parity to hold, the following conditions should be met. However, in the real world, they hardly hold true and put-call parity equation may need some modifications accordingly. For the purpose of this blog, we have assumed that these conditions are met.

  • The underlying stock doesn’t pay any dividend during the life of the European options
  • There are no transaction costs
  • There are no taxes
  • Shorting is allowed and there are no borrow charges

Hence, put-call parity will hold in a frictionless market with the underlying stock paying no dividends.

Arbitrage Opportunity

In options trading, when the put-call parity principle gets violated, traders will try to take advantage of the arbitrage opportunity. An arbitrage trader will go long on the undervalued portfolio and short the overvalued portfolio to make a risk-free profit.

How to take advantage of arbitrage opportunity

Let us now consider an example with some numbers to see how trade can take advantage of arbitrage opportunities. Let’s assume that the spot price of a stock is $31, the risk-free interest rate is 10% per annum, the premium on three-month European call and put are $3 and $2.25 respectively and the exercise price is $30.

In this case, the value of portfolio A will be,

C+Xe-rT = 3+30e-0.1 * 3/12 = $32.26

The value of portfolio B will be,

P + S0 = 2.25 + 31 = $33.25

Portfolio B is overvalued and hence an arbitrageur can earn by going long on portfolio A and short on portfolio B. The following steps can be followed to earn arbitrage profits.

  • Short the stock. This will generate a cash inflow of $31.
  • Short the put option. This will generate a cash inflow of $2.25.
  • Purchase the call option. This will generate cash outflow of $3.
  • Total cash inflow is -3 + 2.25 + 31 = $30.25.
  • Invest $30.25 in a zero-coupon bond with 3 months maturity with a yield of 10% per annum.

Return from the zero coupon bond after three months will be 30.25e 0.1 * 3/12 = $31.02.

If the stock price at maturity is above $30, the call option will be exercised and if the stock price is less than $30, the put option will be exercised. In both the scenarios, the arbitrageur will buy one stock at $30. This stock will be used to cover the short.

Total profit from the arbitrage = $31.02 – $30 = $1.02

Well, shouldn’t we look at some codes now?

Python Codes Used For Plotting The Charts

The below code can be used to plot the payoffs of the portfolios.

So far, we have gone through the basic concepts in options trading and looked at an options trading strategy as well. At this juncture, let’s look at the world of options trading and try to answer a simple question.

Why is Options Trading attractive?

Options are attractive instruments to trade in because of the higher returns. An option gives the right to the holder to do something, with the ‘option’ of not to exercise that right. This way, the holder can restrict his losses and multiply his returns.

While it is true that one options contract is for 100 shares, it is thus less risky to pay the premium and not risk the total amount which would have to be used if we had bought the shares instead. Thus your risk exposure is significantly reduced.However, in reality, options trading is very complex and that is because options pricing models are quite mathematical and complex.

So, how can you evaluate if the option is really worth buying? Let’s find out.

The key requirement in successful options trading strategies involves understanding and implementing options pricing models. In this section, we will get a brief understanding of Greeks in options which will help in creating and understanding the pricing models.

Options Pricing

Options Pricing is based on two types of values

Intrinsic Value of an option

Recall the moneyness concept that we had gone through a few sections ago. When the call option stock price is above the strike price or when put option stock price is below the strike price, the option is said to be “In-The-Money (ITM)”, i.e. it has an intrinsic value. On the other hand, “Out of the money (OTM)” options have no intrinsic value. For OTM call options, the stock price is below the strike price and for OTM put options; stock price is above the strike price. The price of these options consists entirely of time value.

Time Value of an option

If you subtract the amount of intrinsic value from an options price, you’re left with the time value. It is based on the time to expiration. You can enroll for this free online options trading python course on Quantra and understand basic terminologies and concepts that will help you in options trading. We know what is intrinsic and the time value of an option. We even looked at the moneyness of an option. But how do we know that one option is better than the other, and how to measure the changes in option pricing. Well, let’s take the help of the greeks then.

Options Greeks

Greeks are the risk measures associated with various positions in options trading. The common ones are delta, gamma, theta and vega. With the change in prices or volatility of the underlying stock, you need to know how your options pricing would be affected. Greeks in options help us understand how the various factors such as prices, time to expiry, volatility affect the options pricing.

Delta measures the sensitivity of an option’s price to a change in the price of the underlying stock. Simply put, delta is that options greek which tells you how much money a stock option will rise or drop in value with a $1 rise or drop in the underlying stock. Delta is dependent on underlying price, time to expiry and volatility. While the formula for calculating delta is on the basis of the Black-Scholes option pricing model, we can write it simply as,

Delta = [Expected change in Premium] / [Change in the price of the underlying stock]

Let’s understand this with an example for a call option:
We will create a table of historical prices to use as sample data. Let’s assume that the option will expire on 5th March and the strike price agreed upon is $140.

Thus, if we had to calculate the delta for the option on 2nd March, it would be $5/$10 = 0.5.

Here, we should add that since an option derives its value from the underlying stock, the delta option value will be between 0 and 1. Usually, the delta options creeps towards 1 as the option moves towards “in-the-money”.

While the delta for a call option increases as the price increases, it is the inverse for a put option. Think about it, as the stock price approaches the strike price, the value of the option would decrease. Thus, the delta put option is always ranging between -0 and 1.

Gamma measures the exposure of the options delta to the movement of the underlying stock price. Just like delta is the rate of change of options price with respect to underlying stock’s price; gamma is the rate of change of delta with respect to underlying stock’s price. Hence, gamma is called the second-order derivative.

Gamma = [Change in an options delta] / [Unit change in price of underlying asset]

Let’s see an example of how delta changes with respect to Gamma. Consider a call option of stock at a strike price of $300 for a premium of $15.

  • Strike price: $300
  • Initial Stock price: $150
  • Delta: 0.2
  • Gamma: 0.005
  • Premium: $15
  • New stock price: $180
  • Change in stock price: $180 – $150 = $30

Thus, Change in Premium = Delta * Change in price of stock = 0.2 * 30 = 6.
Thus, new premium = $15 + $6 = $21

Change in delta = Gamma * Change in stock price = 0.005 * 30 = 0.15
Thus, new delta = 0.2 + 0.15 = 0.35.

Let us take things a step further and assume the stock price increases another 30 points, to $210.

Now,
New stock price: $210
Change in stock price: $210 – $180 = $30

Change in premium = Delta *Change in 0.35*30 = $10.5
Thus, new premium = $21 + $10.5 = $31.5

Change in delta = Gamma * Change in stock price = 0.005 * 30 = 0.15
Thus, new delta = 0.35 + 0.15 = 0.5.

In this way, delta and gamma of an option changes with the change in the stock price. We should note that Gamma is the highest for a stock call option when the delta of an option is at the money. Since a slight change in the underlying stock leads to a dramatic increase in the delta. Similarly, the gamma is low for options which are either out of the money or in the money as the delta of stock changes marginally with changes in the stock option.

Highest Gamma for At-the-money (ATM) option
Among the three instruments, at-the-money (ATM), out-of-the-money (OTM) and in-the-money (ITM); at the money (ATM) has the highest gamma. You can watch this video to understand it in more detail.

Theta measures the exposure of the options price to the passage of time. It measures the rate at which options price, especially in terms of the time value, changes or decreases as the time to expiry is approached.

Vega measures the exposure of the option price to changes in the volatility of the underlying. Generally, options are more expensive for higher volatility. So, if the volatility goes up, the price of the option might go up to and vice-versa.

Vega increases or decreases with respect to the time to expiry?

What do you think? You can confirm your answer by watching this video.

One of the popular options pricing model is Black Scholes, which helps us to understand the options greeks of an option.

Black-Scholes options pricing model

The formula for the Black-Scholes options pricing model is given as:

C is the price of the call option
P represents the price of a put option.
S0 is the underlying price,
X is the strike price,
σ represents volatility,
r is the continuously compounded risk-free interest rate,
t is the time to expiration, and
q is the continuously compounded dividend yield.
N(x) is the standard normal cumulative distribution function.

The formulas for d1 and d2 are given as:

To calculate the Greeks in options we use the Black-Scholes options pricing model.

Delta and Gamma are calculated as:

In the example below, we have used the determinants of the BS model to compute the Greeks in options.

At an underlying price of 1615.45, the price of a call option is 21.6332.

If we were to increase the price of the underlying by Rs. 1, the change in the price of the call, put and values of the Greeks in the option is as given below.

As can be observed, the Delta of the call option in the first table was 0.5579. Hence, given the definition of the delta, we can expect the price of the call option to increase approximately by this value when the price of the underlying increases by Rs.1. The new price of the call option is 22.1954 which is

22.1954
22.1911

Let’s move to Gamma, another Greek in option.

If you observe the value of Gamma in both the tables, it is the same for both call and put options contracts since it has the same formula for both options types. If you are going long on the options, then you would prefer having a higher gamma and if you are short, then you would be looking for a low gamma. Thus, if an options trader is having a net-long options position then he will aim to maximize the gamma, whereas in case of a net-short position he will try to minimize the gamma value.

The third Greek, Theta has different formulas for both call and put options. These are given below:

In the first table on the LHS, there are 30 days remaining for the options contract to expire. We have a negative theta value of -0.4975 for a long call option position which means that the options trader is running against time.

He has to be sure about his analysis in order to profit from trade as time decay will affect this position. This impact of time decay is evident in the table on the RHS where the time left to expiry is now 21 days with other factors remaining the same. As a result, the value of the call option has fallen from 21.6332 to 16.9 behaviour 319. If an options trader wants to profit from the time decay property, he can sell options instead of going long which will result in a positive theta.

We have just discussed how some of the individual Greeks in options impact option pricing. However, it is very essential to understand the combined behaviour of Greeks in an options position to truly profit from your options position. If you want to work on options greeks in Excel, you can refer to this blog.

Let us now look at a Python package which is used to implement the Black Scholes Model.

Python Library – Mibian

What is Mibian?

Mibian is an options pricing Python library implementing the Black-Scholes along with a couple other models for European options on currencies and stocks. In the context of this article, we are going to look at the Black-Scholes part of this library. Mibian is compatible with python 2.7 and 3.x. This library requires scipy to work properly.

How to use Mibian for BS Model?

The function which builds the Black-Scholes model in this library is the BS() function. The syntax for this function is as follows:

The first input is a list containing the underlying price, strike price, interest rate and days to expiration. This list has to be specified each time the function is being called. Next, we input the volatility, if we are interested in computing the price of options and the option greeks. The BS function will only contain two arguments.

If we are interested in computing the implied volatility, we will not input the volatility but instead will input either the call price or the put price. In case we are interested in computing the put-call parity, we will enter both the put price and call price after the list. The value returned would be:

(call price + price of the bond worth the strike price at maturity) – (put price + underlying asset price)

The syntax for returning the various desired outputs are mentioned below along with the usage of the BS function. The syntax for BS function with the input as volatility along with the list storing underlying price, strike price, interest rate and days to expiration:

Attributes of the returned value from the above-mentioned BS function:

The syntax for BS function with the input as callPrice along with the list storing underlying price, strike price, interest rate and days to expiration:

Attributes of the returned value from the above-mentioned BS function:

The syntax for BS function with the input as putPrice along with the list storing underlying price, strike price, interest rate and days to expiration:

Attributes of the returned value from the above-mentioned BS function:

The syntax for BS function with the inputs as callPrice and putPrice along with the list storing underlying price, strike price, interest rate and days to expiration:

Attributes of the returned value from the above-mentioned BS function:

While Black-Scholes is a relatively robust model, one of its shortcomings is its inability to predict the volatility smile. We will learn more about this as we move to the next pricing model.

Derman Kani Model

The Derman Kani model was developed to overcome the long-standing issue with the Black Scholes model, which is the volatility smile. One of the underlying assumptions of Black Scholes model is that the underlying follows a random walk with constant volatility. However, on calculating the implied volatility for different strikes, it is seen that the volatility curve is not a constant straight line as we would expect, but instead has the shape of a smile. This curve of implied volatility against the strike price is known as the volatility smile.

If the Black Scholes model is correct, it would mean that the underlying follows a lognormal distribution and the implied volatility curve would have been flat, but a volatility smile indicates that traders are implicitly attributing a unique non-lognormal distribution to the underlying. This non-lognormal distribution can be attributed to the underlying following a modified random walk, in the sense that the volatility is not constant and changes with both stock price and time. In order to correctly value the options, we would need to know the exact form of the modified random walk.

The Derman Kani model shows how to take the implied volatilities as inputs to deduce the form of the underlying’s random walk. More specifically a unique binomial tree is extracted from the smile corresponding to the random walk of the underlying, this tree is called the implied tree. This tree can be used to value other derivatives whose prices are not readily available from the market – for example, it can be used in standard but illiquid European options, American options, and exotic options.

What is the Heston Model?

Steven Heston provided a closed-form solution for the price of a European call option on an asset with stochastic volatility. This model was also developed to take into consideration the volatility smile, which could not be explained using the Black Scholes model.

The basic assumption of the Heston model is that volatility is a random variable. Therefore there are two random variables, one for the underlying and one for the volatility. Generally, when the variance of the underlying has been made stochastic, closed-form solutions will no longer exist.

But this is a major advantage of the Heston model, that closed-form solutions do exist for European plain vanilla options. This feature also makes calibration of the model feasible. If you are interested in learning about these models in more detail, you may go through the following research papers,

  • Derman Kani Model – “The Volatility Smile and Its Implied Tree” by Emanuel Derman and Iraj Kani.
  • Heston Model – “A Closed-Form Solution for Options with Stochastic Volatility with Applications to Bond and Currency Options”

So far, you have understood options trading and how to analyse an option as well as the pricing models used. Now, to apply this knowledge, you will need access to the markets, and this is where the role of a broker comes in.

Opening an options trading account

How to choose a broker for Options Trading?

Before we open an options trading account with a broker, let’s go over a few points to take into consideration when we choose a broker.

  • Understand your aim when you tread the options trading waters, whether it is a way of hedging risk, as a speculative instrument, for income generation etc.
  • Does the broker provide option evaluation tools of their own? It is always beneficial to have access to a plethora of tools when you are selecting the right option.
  • Enquire the transaction costs or the commission charged by the broker as this will eat into your investment gains.
  • Some brokers give access to research materials in various areas of the stock market. You can always check with the broker about access to research as well as subscriptions etc.
  • Check the payment options provided by the broker to make sure it is compatible with your convenience.

Searching for the right broker

Once the required background research is done, you can choose the right broker as per your need and convenience. In the global market, a list of the top brokers is provided below:

List of Top International Brokers (Options Trading)

The list of top international options brokers is given below:

  • E-trade ($0.65 per options contract)
  • Ally Invest ($0.5 per contract traded)
  • TD Ameritrade ($0.65 fee per contract)
  • Interactive Brokers (starts at $0.25 per options contract)
  • Schwab Brokerage ($0.65 per options contract)

List of Top Indian Brokers (Options Trading)

The list of top Indian options brokers is given below:

  • Zerodha
  • ICICI Direct
  • HDFC Securites
  • ShareKhan
  • Kotak Securities
  • Angel Broking
  • Axis Direct

Great! Now we look at some options trading strategies which can be used in the real world.

Options Trading Strategies

There are quite a few options trading strategies which can be used in today’s trading landscape. One of the most popular options trading strategies is based on Spreads and Butterflies. Let’s look at them in detail.

Spreads and Butterflies

Spreads or rather spread trading is simultaneously buying and selling the same option class but with different expiration date and strike price. Spread options trading is used to limit the risk but on the other hand, it also limits the reward for the person who indulges in spread trading.

Thus, if we are only interested in buying and selling call options of security, we will call it a call spread, and if it is only puts, then it will be called a put spread.

Depending on the changing factor, spreads can be categorised as:

  • Horizontal Spread – Different expiration date, Same Strike price
  • Vertical Spread – Same Expiration date, Different Strike price
  • Diagonal Spread – Different expiration date, Different Strike price

Remember that an option’s value is based on the underlying security (in this case, stock price). Thus, we can also distinguish an option spread on whether we want the price to go up (Bull spread) or go down (Bear spread).

Bull call spread

In a bull call spread, we buy more than one option to offset the potential loss if the trade does not go our way.

Let’s try to understand this with the help of an example.
The following is a table of the available options for the same underlying stock and same expiry date:

Normally, if we have done the analysis and think that the stock can rise to $200, one way would be to buy a call stock option with a strike price of $180 for a premium of $15. Thus, if we are right and the stock reaches $200 on expiry, we buy it at the strike price of $180 and pocket a profit of ($20 -$15) = $5 since we paid the premium of $15.

But if we were not right and the stock price reaches $180 or less, we will not exercise the option resulting in a loss of the premium of $15. One workaround is to buy a call option at $180 and sell a call option for $200 at $10.

Thus, when the stock’s price reaches $200 on expiry, we exercise the call option for a profit of $5 (as seen above) and also pocket a profit of the premium of $10 since it will not be exercised by the owner. Thus, in this way, the total profit is ($5 + $10) = $15.

If the stock price goes above $200 and the put option is exercised by the owner, the increase in the profit from bought call option at $180 will be the same as the loss accumulated from the sold call option at $200 and thus, the profit would always be $15 no matter the increase in the stock price above $200 at expiry date.

Let’s construct a table to understand the various scenarios.

You can go through this informative blog to understand how to implement it in Python.

Bear put spread

The bull call spread was executed when we thought the stock would be increasing, but what if we analyse and find the stock price would decrease. In that case, we use the bear put spread.

Let’s assume that we are looking at the different strike prices of the same stock with the same expiry date.

One way to go about it is to buy the put option for the strike price of 160 at a premium of $15 while selling a put option for the strike price of $140 for the strike price of $10.

Thus, we create a scenario table as follows:

In this way, we can minimize our losses by simultaneously buying and selling options. You can go through this informative blog to understand how to implement it in Python.

Butterfly Spread

A butterfly spread is actually a combination of bull and bear spreads. One example of the Butterfly Options Strategy consists of a Body (the middle double option position) and Wings (2 opposite end positions).

  • Its properties are listed as follows:
  • It is a three-leg strategy
  • Involves buying or selling of Call/Put options (unlike Covered Call Strategy where a stock is bought and an OTM call option is sold)
  • Can be constructed using Calls or Puts
  • 4 options contracts at the same expiry date
  • Have the same underlying asset
  • 3 different Strike Prices are involved (2 have the same strike price)
  • Create 2 Trades with these calls

Other Trading Strategies

We will list down a few more options trading strategies below:

Summary

We have covered all the basics of options trading which include the different Option terminologies as well as types. We also went through an options trading example and the option greeks. We understood various options trading strategies and things to consider before opening an options trading account.

If you have always been interested in automated trading and don’t know where to start, we have created a learning track for you at Quantra, which includes the. “Trading using Option Sentiment Indicators” course.

Disclaimer: All data and information provided in this article are for informational purposes only. QuantInsti ® makes no representations as to accuracy, completeness, currentness, suitability, or validity of any information in this article and will not be liable for any errors, omissions, or delays in this information or any losses, injuries, or damages arising from its display or use. All information is provided on an as-is basis.

LinkedIn Premium Explained: Is it Worth $25 Per Month?

You might already be using LinkedIn to network, find new employees and even score yourself a new job. The site has offered a paid Premium account option with expanded profile-viewing and email capabilities for the last few years. With it, you can even do more thorough searches of the network, sorting users by company size, interests, seniority within the company and whether or not they work for a Fortune 1000 company. But should you really be shelling out $24.95 or more per month for the extra features? We run through the benefits.

Pick an account type

First, you’ll need to pick an account type if you’re ready to go Premium; each of the three options is available at three levels. For all premium accounts, you can see who is searching for you and you get priority customer service. If you choose to upgrade to an annual contract, the monthly fee will be slightly lower than if you pay from month to month. If you’re using the site to find a new job, you’ll want to choose one of the three Job Seeker account options, all of which let recruiters message you for free and offer exclusive access to the LinkedIn job seeker community.

For those who use LinkedIn to recruit new employees, the site offers three Premium Talent account levels. A mix of personal and recruiter plans are covered by Business plans. With Talent and Business plans, you get to reference search candidates. Here’s how the rest of the features break down across the available plans.

InMail

While unpaid LinkedIn members must request an introduction to members in their extended network (i.e., a second- or third degree connection versus a first-degree connection), Premium members can email any LinkedIn user directly. Best of all, with InMail, your profile is attached to your outgoing message, making it more likely that the receiver will check you out. Plus, the social network guarantees your note won’t end up in a spam box.

Business Plus members receive 25 InMail credits for each month. LinkedIn guarantees that users will receive a response to their InMail. Since the service can’t really force a user to reply to you, the site will return your mail credit if you never get a response.

Why It’s Useful: Business owners will have unfettered access to potential clients and partners, while job-seekers can reach out to employees at a company to help make their resume stand out. InMail also offers media professionals expanded access to sources who may not be within their network. LinkedIn says you’re 30 times more likely to get a response to an InMail than to a cold call email.

Profile Organizer

Whether you’re just browsing for potential networking connections or scouring LinkedIn for your next hire, the Premium account’s expanded profile-viewing features will come in handy. You can save profiles of interest into different folders and add notes and contact info. You’ll also be able to view your correspondence history with each contact.

Why It’s Useful: When you’re dealing with numerous clients, co-workers and industry associates on LinkedIn, chances are you won’t remember every person in your network. The profile organizer can serve as a quick refresher if you use notes to indicate how you met a contact.

See who’s viewed your profile

Unpaid LinkedIn users can only see a small number of people who have viewed their profile, but Premium members can see everyone. In addition to displaying the user names of whoever has stopped by your page, the site gives you data about how people found you, including what search terms they used. You also get an overview of how your profile views change over time.

Why It’s Useful: Aside from being just plain intriguing, the ability to see who’s viewed your page is useful for building your brand identity. If you know who has you on their radar, you can sculpt your profile and work your connections to get more of that attention or start attracting a different type of user, depending on your professional goals.

Premium Badge

It’s just as much about bragging rights as professional credibility, but the Premium badge—a gold circle with the word “in”—that shows up at the top of your LinkedIn profile distinguishes you from nonpaying users.

If you’re not one for showing off your status but still want to upgrade to Premium, you can toggle the badge off under Account & Settings > Name and Location.

Why It’s Useful: According to LinkedIn, Premium users who display the “in” badge get 15 times more profile views than users who don’t.

OpenLink

LinkedIn’s OpenLink is an opt-in service for Premium members that lets anyone on the site contact you for free. Unlike InMail, which lets you reach out to anyone, OpenLink opens the doors for all users to reach out to you.

Why It’s Useful: LinkedIn says that members who use OpenLink get about seven times more messages per month, so the service can certainly help you grasp more business opportunities. Additionally, you can save InMail credits by using OpenLink to email contacts who have the feature enabled.

Bottom Line

Is it worth shelling out for LinkedIn Premium? If you’re a professional looking to expand your network of contacts and land a new job, Premium can make that easier by letting you send messages to contacts who aren’t already in your network. For business owners looking for new employees and partners, the paid service also provides expanded access to the most relevant profiles. Sales professionals will find the Profile Organizer useful for organizing leads into different folders. You’ll have to evaluate how you’re already using the site and what more you’d like to get out of the service.

Options Premium

Options Premium – Definition

Options Premium is the price of an options contract.

Options Premium – Introduction

What is Options Premium? Is it like an insurance premium? How is does that work in options trading?

Options Premium is one of those terms that are always mentioned in options trading but few people know what it really means. In fact, options premium is one options trading term that has been used to mean very different things by different teachers or education materials and has caused considerable confusion. However, due to the widespread use of the term “Options Premium”, options traders must know exactly what it means in order to make sense of the many options lectures or lessons out there.

This tutorial shall explain the different meanings of Options Premium and how it affect your options trading.

What Is Options Premium?

1. The Whole Price of an Option

2. Extrinsic Value of an Option

That’s right. There is no standardization as to the exact meaning of the term “Options Premium” and you can still hear options experts on TV using the term to mean either one of the above interchangably. This is why it is very important to clarify the meaning of what “Options Premium” mean with the person delivering the options training particularly in the area of options spreads where the distinction between extrinsic value and the whole price of an option is extremely important.

Options Premium: Whole Price of an Option

When most of the experts on TV talk about the term “Options Premium” in general talks about investment alternatives, they usually mean the whole price of an option. Statements such as “You pay a premium of $X for a call option” or “You pay an options premium to buy an option” usually refers to the whole price of an option. The rationale behind using the term “Options Premium” in this way is in reference to options being like insurance where you pay a “premium” for the coverage. In this context, options premium usually mean the “Asking Price” of an option (read more about Options Prices).

Options Premium as Whole Price of an Option Example

Assuming AAPL is trading at $385 and its November $380 strike price call option is asking at $6.80.

In this case, the options premium of AAPL’s November $380 strike price call option is $6.80, referring to the whole price an the option.

Options Premium: Extrinsic Value of an Option

When talking about options pricing, writing options or options strategies, the term “Options Premium” is widely used to refer to the “Extrinsic Value” of an option. Statements such as “You earn the premium when you write an option” or “The premium value decays over time” usually refers to the extrinsic value of an option. The rationale behind using the term “Options Premium” in this way stems from the idea that you pay a “premium” over its intrinsic value, hence extrinsic value is also known as “premium value”.

Options Premium as Extrinsic Value of an Option Example

Assuming AAPL is trading at $385 and its November $380 strike price call option is asking at $6.80.

In this case, the options premium of AAPL’s November $380 strike price call option is:

Binary Options Explained For The Option Geeks

So lately, there has been a lot of talk about binary options ; they are a simple trade, it’s a yes or no, the trader is either right or wrong and it’s winner take all.

Well, that’s some of the story, but what it really boils down to is that binary options are just another option with a few nuances.

How do Binary Options Relate to What Traders Already Know?

First, binary options may also be referred to as Digital Options.

Trading binaries is quite similar to buying a call or buying a put with multiple choices of strikes and durations. One exception with Nadex binary options is that there is no option writer. Nadex binary options are European style and do not have a delivery option. The contracts are exercised only at expiration via a $100 payout per contract and are cash settled.

All binary option contracts are fully collateralized. So on a binary trade, the buyer and seller’s initial trade cost is their maximum risk which totaled is equivalent to the $100 per contract expiration payout. For example, if a binary option trades at 40, the buyer is risking $40, while the seller is risking $60.

Vertical Option Spread Review

In options trading, a vertical spread is an option strategy involving the buying and selling of an option of the same underlying security, same expiration date, but at different strike prices. A vertical spread can be created with either all calls or all puts.

With binary options, the strikes can be compared to a vertical spread but replaced with 0 and 100. For binary buyers, the 100 represents the ceiling and the 0 the floor while the binary pricing is traded between the two levels. For binary sellers, the 100 represents the floor and the 0 the ceiling to the trade.

The binary pricing ranges between 0 and 100 which would be similar to an option premium. The binary price is quoted in dollars per contract compared to the option premium where the cost is the price times a dollar multiplier. Another unique feature of the binary is its pricing is referenced as the delta or probability of the trade.

With regular options if the underlying is trading at the strike level, the option delta is 50 as is the approximate trade price of the binary (50).

So, if the underlying market is trading above the strike, then the binary pricing will be greater than 50. If the underlying is trading below the strike, then the binary pricing will be less than 50. The binary is a derivative and the pricing, like option premiums, will fluctuate dependent on the usual components of time, volatility and the relation of the strike to the underlying market.

Binary Options / Digital Options

Instead of the variable payout used for the vertical spreads at expiration, the binary payout is for all the marbles.

If the binary traded goes into expiration and has any intrinsic value at all (i.e. the underlying is above the strike) then the contract will settle at 100 in the buyer’s favor and the buyer receives the cash settled $100 per contract.

If the binary traded goes into expiration with no intrinsic value (i.e. the underlying is at or below the strike) then the contract will settle at 0 in the seller’s favor and the seller receives the cash settled $100 per contract.

Note that the expiration values that are used for the settlement process are derived by Nadex, based on the prices of the underlying product. This Nadex calculation uses a sample set of the last 25 futures trades (midpoints for FX) of the underlying right before the expiration time of the binary to arrive at a unique expiration value.

Binary Option Chain

Underlying Market: ESH 1871.00

Time left till Expiration: 2 hours 35 minutes

Binary Buyer Similar to Long CALL

A trader should buy the binary if they want the underlying market to go higher and finish above the strike at expiration to benefit from the full payout at expiration. Traders can also capitalize on the underlying market going higher prior to expiration to take profits from the increased delta in pricing.

As can be seen from the binary option chain, there are binary option strikes that are ITM, ATM and OTM relative to the underlying market at 1871.00.

Example: Buying the US500 (Mar) >1875 at 25 expires in 2 hours 35 minutes

OTM: Cost $25, Net Profit Potential $75 – 300 percent return at expiration (exchange fees not included)

Here, the binary cost would represent all option time value where the underlying needs to rally over four handles in the 2 hours 35 minutes.

Binary Seller Similar to Long PUT

A trader should sell the binary if they want the underlying market to sell off and finish at or below the strike at expiration to benefit from the full payout at expiration. Traders can also capitalize on the underlying market going lower by taking profits early prior to expiration from the binary pricing trading lower.

Same as before, there are ITM, ATM and OTM binary strikes to choose from but there is not a separate put options chain. By selling the binary at the trade price, the cost for the seller is 100 minus the binary trade price. So using the same example only selling, the 1875 strike is ITM relative to the underlying at 1871.00 (below the strike level)

Example: Selling the US500 (Mar) >1875 at 25 expires in 2 hours 35 minutes

ITM: Cost $75, Net Profit Potential $25 – 33 percent return at expiration (exchange fees not included)

Here, the binary cost would represent the option’s intrinsic value where the underlying can just sit there, be flat and even trade a little higher as long as it does not finish above the 1875 strike in 2 hours 35 minutes. This binary position would have 4 handles of edge or insurance to receive the $100/contract payout at expiration. For the ITM binary, time decay actually works in its favor.

Note the binary durations available at Nadex are two hours, one day and one week; a binary trade can be initiated and exited at any time prior to expiration.

A useful rule of thumb for binary pricing is that if the underlying is trading at or near the binary strike level, then the pricing should be around 50. At this point, neither the binary buyer nor seller has an immediate advantage.

As for the ITM or OTM binaries with longer durations, the edge is based on a greater differential between the strike price and the underlying price level. This reflects the greater time value associated with the longer duration. Remember this edge differential is the only variable since the expiration payout for the trade is capped at $100.

Final Thoughts

As the binary expiration nears, the strikes which are ITM for the buyers will be priced very close to 100 and the strikes that are ITM for the sellers will be priced close to 0. For the binary strike which is ATM as it nears expiration, traders should be forewarned that they could be in for a wild ride. Remember that the binary expiration value only needs to be a fraction of a tick above the strike price for the buyer to receive the $100 payout. The very nature of the all or none binary valuation results in the contract having a gamma play that can be very explosive.

Futures, options and swaps trading involves risk and may not be appropriate for all investors.

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    The Best Binary Options Broker 2020!
    Perfect Choice For Beginners!
    Free Demo Account!
    Free Trading Education!
    Get Your Sing-Up Bonus Now!

  • Binomo
    Binomo

    Only For Experienced Traders!

Like this post? Please share to your friends:
Binary Options Trading For Beginners
Leave a Reply

;-) :| :x :twisted: :smile: :shock: :sad: :roll: :razz: :oops: :o :mrgreen: :lol: :idea: :grin: :evil: :cry: :cool: :arrow: :???: :?: :!: