Put/call parity is a crucial concept in options trading that establishes the basics of option pricing. The formula, introduced in 1969, came years before the seminal Black-Scholes pricing model. As such, it was one of the first formulations of quantitative option pricing and served as the foundation for future pioneers like Black, Merton, and Scholes.
Options are finite, wasting assets. They have a shelf-life, and they cease to exist after their expiration. So when that expiration date comes, there needs to be a mechanism in place to ensure that both sides of an option contract hold up their side of the bargain.
The fear of being assigned early on a short option position is enough to cripple many would-be options traders into sticking by their tried-and-true habit of simply buying puts or calls. After all, theoretically, the counterparty to your short options trade could exercise the option at any time, potentially triggering a Margin Call on your account if you’re undercapitalized.
Most traders get their start with options in stock options. Perhaps they want to bet on a big move in a stock or hedge a long stock position. However, there’s more to the world of options than simply stock options, Index Options, which are options listed for indexes like the S&P 500 index or Nasdaq 100 index.
Making the shift from ordinary financial instruments like stocks and futures to options requires several adjustments. For one, options are nonlinear--an option can go up 10% when the underlying goes from $50 to $51, and then double in price when the underlying goes from $51 to $52.
Undoubtedly, options are more challenging to understand than stocks or futures. The stock price is based on the market's opinion of an honest company's value. An option, on the other hand, derives all of its value from the price of the underlying security.
Options are dynamic, “delta-one” instruments, while stocks and futures are static. No matter how high the price of Tesla stock goes, a $1.00 move will create $1.00 in P&L per share. That same $1.00 price in an underlying alters the Delta, Gamma, and Vega to the point where an option position evolves. The following $1.00 price move will have different implications.
At their core, options involve buying and selling the rights to transact in a specific asset. When you buy a call option on AAPL, you're paying for the right to buy AAPL at a special price before a particular date. But all options expire, and at expiration, the two parties of the contract need to settle up with each other. This process is called settlement.
Weekly options used to be a niche product only reserved for gamblers and last-minute hedgers. However, weekly options are now listed on most major stocks and account for a significant portion of overall options trading.
The journey of an options trader's development typically has several stops along the way. The first is generally related to using options to leverage their directional bets using outright calls, puts, or vertical spreads. Somewhere along the way, a novice options trader begins to understand volatility's importance to the options market.
Gamma is one of the primary Options Greeks, which measure an option's sensitivity to specific factors that could affect an option price. Despite traders hyping up several different Greeks and second-order Greeks like "Vanna" and "charm," there are only four primary Greeks that you need to be familiar with to understand options trading.
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