Options Trading: Understanding Option Prices

now that you understand why options exist I'm going to show you ways you can trade options to make a profit so most of your favorite companies that you use everyday have stock options and you can trade them right from your computer cell phone or tablet there are two types of options there are calls and puts if you buy call you want the stock to go up if you buy a put you want the stock to go down now since there are two sides to every market you can also do the opposite where you would sell the option as an opening trade and hopefully buy it back at a lower price as a closing trade this will make more sense in a second option prices are based on three elements of its underlying stock the first one is time to expiration in the last video we talked about how options are basically insurance and of course you pay money for this insurance now the thing about insurance is you don't just get to pay a one-time payment and have insurance forever you have to pay month after month to keep your insurance so the longer you have it the more money you will have to pay options are the same way they have expiration dates for the exact same reason you have to pay monthly for car insurance an option with 60 days until expiration might cost $500 when the option with only 30 days to expiration only cost $250 so more time equals more money so naturally as time passes an options time value will decay this is known as time decay now let's take a look at how an options time value will decay over time the curve will look something like this as you can see time decay isn't linear it's exponential meaning that as you get closer to expiration time decay will rapidly speed up the important thing for you to understand right now is that an options time value is always decaying 100% of the time every day every hour this can be your worst enemy if you trade options the wrong way or it can be a huge advantage if you trade them correctly which I'll show you in the next few videos most stocks have options with weekly monthly and quarterly expirations and you can choose whatever expert you want to trade in and some of my other videos I talked about the best expiration that provides the lowest risk and the highest returns so be sure to check those out so the second factor that goes into option pricing is the price of the underlying stock itself for each stock there are multiple options at different price increments these are called the options strike price the strike price is the predetermined price at which the shares of stock will be exchanged if the option is exercised for example if you own the stock at $125 per share you could buy the 125-foot because that's where you could sell your shares in case the stock goes lower and you need to exercise your option so again the strike price is simply the price that the shares of stock will be exchanged if the option is exercised of course you don't have to own shares of stock to trade options but the strike price of the option you're trading has a huge effect on what the options price will be let me explain let's say the current stock price is 125 dollars per share for call options any option that has a strike price above the current stock price is referred to as out of the money it's a strike prices below the stock's price it is referred to as in the money and for put options it's the exact opposite I know this is a lot to digest right now but soon it will become second nature so here's an idea of what each options price will look like with let's say 30 days to expiration and just a quick note each option contract represents 100 shares of stock so these prices have a multiplier of 100 so for example if you buy one contract of the 125 call this will actually cost you 500 dollars not $5 so here's the thing all out of the money options have no value at expiration let me repeat if an option is out of the money at the expiration date it will be worthless so if they won't have any value at the expiration then why did it have value now because stock prices move and there is a chance that the out of the money options could become in the money if there is still time left to expiration now you can see that the further out of the money an option is the cheaper it is that's because the likelihood of it being of any value is less than an option that is closer to the stock price right because for example this stock is more likely to get to 130 than it is to 135 and as stock prices move on a day-to-day basis the option prices will also move if the stock goes up the calls will become more expensive and the puts will become cheaper and vice-versa now a common misconception is that you have to hold your position until the expiration this isn't true if you buy a call option today that expires in 30 days and the stock goes up overnight and your call option is now worth $100 more than it was when you bought it you can sell it for a profit the expiration date of 30 days does not mean that you have to hold the position that long now you see the prices of these options with 30 days left until expiration let's take a look at what these option prices will look like with 0 days left you can see all out of the money options are worthless and the end the money options are worth the difference between the stock and the strike price this is because since there is no time left there is no time value left on these options this is also referred to as extrinsic value the third and final factor that goes into option pricing is volatility volatility is referred to as the magnitude of a stock's price swings higher volatility means bigger price swings and ultimately more risk for the investor who own stock since there is more risk involved options will be more expensive why would the option sell or not demand more money if they're taking more risk let me explain I know you're probably sick of the insurance analogy by now but let's say you are providing life insurance for two different people the first person is overweight smokes a pack a day and has a medical condition and the second person is healthy exercises regularly and has no signs of any life-threatening medical conditions now who do you think we'll have to pay more for life insurance exactly the person who is at more risk of dying now think of this person as a stock with high volatility and this one as a stock with low volatility now different stocks have different volatilities but volatility is something that moves around a stock with low volatility now might have high volatility in the future volatility is much more predictable than stock prices so if you're trading options it's important to position yourself on the right side of volatility this is a backbone of my trading strategy which you'll learn about in the next few videos and the combination of these three elements is what determines option prices [Music]

Channel: Sky View Trading

Views: 4,004,334

Rating: 4.8511467 out of 5

Keywords: stocks, options, nasdaq, dow, LNKD, SPY, AAPL, GOOG, finance, market, S&P, futures, puts, calls, weekly options, Stocks, Options, Market, Futures, SPX, NFLX, VIX, VXX, Spreads, TDAmeritrade, TOS, Thinkorswim, margin, exchange, etf, volatility, Implied, Put Option, Trading, Investment, Technical, what are options, option pricing, how to trade options, option trading basics, options explanation, stock options, adam thomas, skyview, sky view, sky view trading, adam thomas sky view trading

Id: MiybniIIvx0

Length: 7min 31sec (451 seconds)

Published: Mon Apr 27 2015

Reddit Comments

[u/SingingBreadmaker]

You're supposed to feel the market, not understand it...

[u/thehungryhippocrite]

Hi this still seems a bit risky, do you have any videos on risk free options strategies?

[u/rolllllll123]

That’s not very yolo of you

[u/Pokeman__]

Id like to invest in the overweight man with the heart condition who smokes

[u/Enferrari]

Damn you took the time to look up ELI5 YouTube videos? Apply for level 3 options - you’re ready.

[u/SmellyDurian]

I stopped watching after he said how I can make profit with options.

[u/A_Wizard1717]

Soooooo box spreads is free money?

[u/Drachenx]

this is the only sub where we use the word autistic more than fuck lol

[u/CaesarAugustus89]

“Volatility is more important than stock prices”. Good words