Binary Options Your guide to Binary Options and Binary Options Trading

Option Trading - Thinking “Outside the Box”

Wouldn’t it be great if we could buy an option with five months left until expiration and sell an option with 2 months left until expiration for the same price?

You couldn’t lose. Well we can’t. I love options spreads so much I realized something very important. We can buy a spread that has a lot of time value left at almost the same price as we can sell one with less time value left. The reason really opened my eyes and gave me new insight into options. Here is what I came to realize.

I started comparing how expensive options were in relation to the other strike prices in the same month and to the other months. I wanted to know based on the price per day which options were more expensive.

The first 1 or 2 option months, as everyone knows loses time value quickly. The at the money strike prices are very expensive compared to the out of the money strike prices. Since there is not that much time left, how much can they charge for an out of the money option? Not much.

The next several months, the opposite is true. Compared to each other, the strikes that are closer to the money are cheaper in terms of price per day than the options further out of the money. Let me explain it another way using the S&P market.

6 days left at the money option cost 12 points
6 days left out of the money option cost 2 points

70 days left at the money option cost 43 points
70 days left out of the money option cost 29 points

There is more than 10X the time left but the 70 day at the money option (43 points) is only less than 4X the price than the 6 day at the money option (12 points).

The 70 day out of the money option (29 points) is almost 15X the cost of the 6 day out of the money option (2 points) but only has 10X the time value. We will buy the cheaper options and sell the more expensive ones.

Sell 6 day at the money and sell 70 day out of the money. Buy 6 day out of the money and buy 70 day at the money. This will be done for a 4 point debit. We are now buying a spread that has 10X more time value than the one we are selling and are only paying 4 points for it.

When the 6 day options expire we can sell the next month to take in more premium, still keeping the 70 day option spread.

What is an option?
An option is a contract, or a provision of a contract, that gives one party (the option holder) the right, but not the obligation, to perform a specified transaction with another party (the option issuer or option writer) according to specified terms. The owner of a property might sell another party an option to purchase the property any time during the next three months at a specified price. A lease might contain a provision granting the renter the option to extend the lease for an additional year.

A corporate bond might have an option provision allowing the issuer to purchase the bond back from the purchaser five years prior to maturity for a specified price. A speculator might purchase an option to sell at any time during the next three months 100 shares of a particular stock for a specified price.

Option contracts are a form of derivative instrument. Stand-alone options trade on exchanges or OTC. They are linked to a variety of underliers. Most exchange-traded options have stocks or futures as underliers. OTC options have a greater variety of underliers, including bonds, currencies, physical commodities, swaps, or baskets of assets. Options can be embedded in almost any contract. Above, we gave examples of options embedded in a lease and a bond.

Options take many forms. The two most common are:
call options, which provide the holder the right to purchase an underlier at a specified price;
put options, which provide the holder the right to sell an underlier at a specified price.

The strike price of a call (put) option is the contractual price at which the underlier will be purchased (sold) in the event that the option is exercised. The last date on which an option can be exercised is called the expiration date. Options may allow for one of two forms of exercise:

With American exercise, the option can be exercised at any time up to the expiration date.
With European exercise, the option can be exercised only on the expiration date.

The origins of the names “American” and “European” in this context are unknown. They are unrelated to practices common in any particular geographic region.

A third form of exercise, which is occasionally used with OTC options, is Bermudan exercise. A Bermuda option can be exercised on a few specific dates prior to expiration. Yes, the name was chosen because Bermuda is half way between America and Europe.

As an example, consider a three-month, European exercise, strike USD 22.50 put option on 100,000 barrels of Brent oil. Such an option might trade OTC. It has:

underlier: Brent oil
notional amount: 100,000 barrels
expiration: in three months
strike price: USD 22.50

It gives the holder the right, but not the obligation, to sell the issuer 100,000 barrels of Brent oil three months from today for a price of USD 22.50 per barrel.
Puts and calls are sometimes called vanilla options to distinguish them from more exotic structures.

What are the Benefits of Options?
For a company, options are attractive because they are a good way to keep good workers and attract the best new employees. Companies can use options to ensure employee loyalty and to reward good employees. For companies that are just starting up or don’t have a great deal of cash, options are a good idea to make employees feel valued without a large cash output.

The Options Investing Process
When a company offers options, the usually offer a special price on option stock. This price is called a strike price or grant and is discounted. In many cases, the strike price is the actual market price of the stock at the time the option is granted. Since companies usually stipulate that options can only be exercised at specific times, there’s the very a possibility that shares will rise in prices .In that case the chances of profit are huge.

To understand investing process for options, an example may help. If a company offers options for buying 1000 shares at five dollars each, they will often stipulate that the options can be exercised only after specific dates. By the time that date has rolled around, the stock may have risen to eight dollars each. The person with stock options at this point can convert the options into actual stocks. This allows the investor to buy the stocks at only five dollars per share and after waiting for some time he can sell the stocks for profit. The investor can also sell some of the stocks and keep some shares for later. Some investors choose to convert their options in stocks and then hold on to the stocks with the hope that they will raise even the value.

The important part of this process is that options must be converted into stocks. This is because most options have an expiry date after which you lose your options. This means that you cannot be tardy when making your conversions.

One more important thing to remember when thinking about options, online trading are that there are in fact two types of options: call options and put options. Call options are simply those that give investors the right to buy stock, while put options offer investors the right to sell a stock. As with all options, there are time frames as well as set prices for the stocks that can be purchased through options.