Follow this complete guide & process to become an Advanced Option Trader.
Strategies for options trading are multiple, starting right from the ones suitable for the newbies to the complex ones.
While, the simple strategies are quite easy to be well versed with, they are suitable for the beginners. However, in order to become a pro at options trading, one must be well accustomed with the advanced strategies.
This required a person to have dept knowledge of the complex strategies, which generally have four legs. The simple ones however, are one legged trades.
Well, the basics will stay the same for all levels of strategies, i.e. options types of call and put. Traders must know highs and lows of such complex strategies and we have the information sorted.
Advanced Terms & Phrases
Top become an advanced option trader you have to first expand you knowledge of Options trading, which includes learning the technical terms and phrases.
This section is catered for the need of knowledge regarding key terms and phrases. Investors must be aware of those terms and the meaning before they proceed towards other aspects of advanced options trading.
Bear Traps and Bull Traps
The name signifies an alert, where investors must stay away from such traps. Your belief of the direction of price movement leads you to decision making, but the traps contain misleading information. In case you happen to fall for them, you are likely to make a wrong decision.
Basically, the common process of investment is to predict the price movement and invest accordingly. If you have a hold of the right price movement, the chance is you will excel at trading.
But, the real catch is to understand and predict the price movement. The indication you might refer to can be wrong regarding the bear or bull market trend.
Bear trap is when an investors views market to be on the verge of entering a bearish trend. Certain indicators might as well show the similar reading, but no assurance of the trend is obtained.
This would lead the investors to act in bearish way, whereas the market doesn’t follow up with the price.
Similar is the Bull trap, where investors views the market and reads indicators as bullish in trend. This is however not true and when the investors attempt a bullish trade, the price moves in opposite direction. This would lead to bearing losses.
Here, the risk factor is in a diminishing state whereas profit making scenario is constant. This is exactly how investors expect an investment to take place.
Well, in practical terms, this indeed is true, as there are certain ways in which Arbitrage is possible. Well, finding such an opportunity is somehow rare.
Arbitrage defines a situation where investor buys and sells an instrument discovering an inconsistency pricing fashion, which leads to instant risk free profit margins.
This concept is generally an adaptation for expert options traders, for the complexity it contains. Nonetheless, there are certain strategies even a beginner can apply and make trades.
Put Call Parity
This concept can be referred to as the determinant affecting options pricing, so Arbitrage is avoided.
The idea of this concept is positions having same risk and payoff profiles must end with the same profit or loss. Investors are barred from going go short on one position and long on another, to make assured profits.
This concept is referred to the 4 days of a year, specifically occurring during third Friday of March, June, September and December.
These respective days are the final trading day for a lot of investment segments in US. This is the reason why a lot of trades take place on this day and there is frequent fluctuation in price levels for the day.
However, all these days have no impact on the further rates of the financial instruments. With the fact of high volume of trades and constant fluctuation of price in a day, day traders are prepared for this day.
Level II Quotes
This concept is of high important for a section of traders, i.e. the active traders such as intraday traders. Level II quotes or Level 2 quotes are actually live quotes provided by specific exchanges.
It contains details of bid ask spread offered by market makers. Traders can choose from diverse options and invest with the most suitable market maker.
It is indeed a useful tool for investors, who constantly transact in the market with small margins. It is however deemed unsuitable for investors with long terms positions.
Hedge is a common terms, which refers to protection. Well, hedging is referred to as a protection from loss in the investment market, trying to diminish risk.
The common form of hedge used by peoples is insurance, to protect themselves from loss arising in their assets.
In options trading, investors take another position, to safeguard a prior position, which is referred to as hedging. Its worthiness is highly proved for short position holders, rather than the long term investors.
Trading volume and number of open positions are not related to each other, where open interest signifies the liquidity of a contract.
The positions open at a specific point of time in the market, are referred to as Open interest.
There are a lot of strategies which help you place successful trades, simple and the complex ones.
Though the simple ones posses the ability of earning profits, the complex strategies have a higher probability of making profits. Single position falls under simple strategies category.
The complex strategies however comprise of a combination of several positions, each of which is referred to as a leg. Placing separate transactions, i.e. each leg separating is referred to as legging.
Synthetic Positions are the positions taken by a trader to create a replica of another position, via same financial instrument or a number of financial instruments.
This is a concept attached with a lot of options investment strategies, which contribute to successful trades.
Contracts which lead the investors to the highest proportion of loss are referred to as options pain. Well, there are a lot of investors who perceive they can create profit from such options investment.
Rolling is referred to as a tool which is use to manage various positions. Here, an investor can open position post closing a position, in the same security, via options contract of different terms.
It is further classified into three forms – Rolling forward, rolling up and rolling down.
What is Volatility & Implied Volatility?
To learn advanced option trading or to become an advanced option trader, it is extremely important to learn about Volatility & Implied Volatility.
Volatility is a factor, a part of options trading, just like it is for stock trading. The trait of this factor is that the variation or change in prices is quite frequent.
The intensity of price variation is quite high and quick here. Accordingly, the instruments that have a uniform price movement are not volatile.
Volatility is also not direction inclined. This means sharp and steep rise or flow in prices, will both be considered as volatile price.
The very essence which defines this kind of market is lack of predicting ability, when investors are not sure about price. Investors generally witness constantly fluctuating prices.
Volatility gives rise to risk, and this is often avoided by beginners who have no idea of its worthiness. Upon the very nature of volatility, lies the high profit earning capacity.
An investor must be well aware of the stature volatility holds.
Constant fluctuation can be further studied, where financially it is possible to determine the rate of speed and changes.
Volatility is the profit factor for an investor, as the amount of shift happening in the market will fetch them likely returns.
Therefore, it is necessary for investors to keep a track on the changes in instruments, to predict the future behaviour.
Statistical volatility actually valuates the change in prices from the past data. It is also referred to as the historical volatility.
Other reference made to implied volatility is of – projected volatility. Here, the investors try and predict the future rate of changes, which might hit an investment option.
Projection of an instrument is done, where the rate of change the time frequency of change in price is considered.
This concept is abbreviated as IV, and is used as a variable and included in a lot of pricing models.
The most common models, where this concept is applied as a variable are Black Scholes Model and the Binomial Model. Also, a lot of factors are taken into account to figure out the IV.
Profiting from Volatility
The basic idea associated with IV is that, investors must buy contracts with increasing IV and vice versa.
This might seem a lot more easier in the form of a theory to read, but, while applying this formula practically, it can be a lot more complex and difficult in nature.
What is Risk Graphs & Risk to Reward Ratio?
Having a hold of your risk exposure is essential, if you have the idea of placing successful trades. If this idea is deployed, you shall gain the strength to safeguard your capital and spare yourself from losing a lot of funds.
Risk is a major part of making profits, but, it does not necessarily mean you go beyond your level of handling risk.
To become an advanced option trader, you should know in details about Risk Graphs & Risk Reward Ratio.
Meaning and use of Risk Graphs
Another reference of Risk graphs is attached to – profit/loss diagrams. Basically, such diagrams are graphical representation done, in order to evaluate the possibilities of incurring a loss or a profit.
Such representation can be done for a single position in options trade or even an options spread.
Such diagrams contain 2 axis, where vertical axis shows profit or loss scenario and the horizontal one shows the price.
The graph is then dotted across the price of the security to obtain a line which indicates the profit or loss. Precision of result may however diminish via this concept as; it only takes into consideration the security’s price.
The detailed graphs are an inclusion of other factors that affect the options as well. This seems obvious for success, as price is one of the determinants of Options, not all.
Using these graphs, you might be able to weigh in your risk and rewards at a time for positions and spreads. You can also use the graphs to establish a comparison measure among various other spreads.
Meaning and use of Risk to Reward Ratio
This is a simple ratio, which considers the profits an investor expects and the potential loses of a position. Commutation can be done, dividing expected profit with potential loss amount.
In this similar manner, an investor can also determine the risk to reward ratio of a spread, though finding potential loss for the same might be difficult.
Complying with this ration, you can form a rock solid decision of investment. Working on this ratio will reveal if your risk is great than your reward or vice versa.
However, what you need to remember is, you must stick to a risk amount which you can afford to lose, without going beyond your loss bearing threshold.
What is Black Scholes Model?
Back to the time when Black Scholes Model was not a thing, Options market was in a set back. The lack of methods to price options or add value to options, took over this form of trading and weighed it down to a great extent.
These short comings were an indicator that options trading lacked the traits of suitable investment instruments.
Now when the options market has grown multifolds, the credit goes out for black Scholes Model. This model is solely responsible for the stature and popularity Options trading acquired.
Simply put, Black Scholes Model comprises of a mathematical formula, which contributes to the process of evaluating option rightful price.
History and Purpose of the Model
Origin of this theory’s name is from American economists Fischer Black and Myron Scholes. Before this model came into existence, it was somehow difficult for an investor to check on an option’s price, and if it is fairly priced.
High potential of successful trade order is found in transactions made on assets that are overpriced and under-priced.
Since previously, it was difficult to determine the right price; risk factor was at its maximum. It was after Black Scholes model was introduced, that a fair pricing mechanism for buyers and sellers was deployed in options.
Input & Assumptions
A mathematical formula is deployed in the model, to obtain a figure, i.e. the true value of an option. A lot of variables go into the process, acting as the inputs required to commute the formula.
The inputs, or the variables are as follows:
- Current price of the underlying security
- The strike price
- Length of time until expiry
- The risk free interest rate during the period of the contract
- Implied volatility of the underlying security
The success of the formula relies upon a lot of underlying assumptions. Here are the ones you need to check out.
- Exercising the option is position at the time of expiration. This refers to the European Style
- The security’s price keeps fluctuating north and south, with no possible prediction of direction of movement
- No dividends tag is attached with the security
- Constant volatility is noticed across the entire period of contract
- No changes in the interest rates through the period of contract
- No commission charged while buying or selling the option
- Arbitrage opportunity being non existent
Usage of Black Scholes Model
Following the development of this model, investor began perceiving options as a potential investment alternative. There are online tools that are based on this model, which you can easily gain access to, for use.
Applying this method is not a rule of thumb or mandatory for success, also it is not a precise indicator of profit.
The issue with the models is that assumptions do not always hold to be true. You can however use the model to draw up your strategies, but relying entire upon this model is not a good thought.
What is Binomial Model?
Moving on with the next model; the Binomial Model is used alternatively to the Black Scholes Model.
Original of this model’s name as it suggests is, commuting two values for one option, throughout the same time periods.
This model’s accuracy level is considered superior in the American Style options.
Binomial Pricing Model’s Theory
There is vast similarity in between Black Scholes model and this Binomial Model, and there are fine share of distinctions.
It is assumed that black schools theory is a likely precise model for European Styled options, whereas Binomial is more precise for American styled options.
Another point of distinction is the assumption of exercising at expiry, which is not present in Binomial Model. hence, this makes Binomial more precise for the American styled options.
How Binomial Pricing Model works
Ease in commutation level is found in Black Scholes, where Binomial is considered complex.
The concept of this model is to determine the changing price levels of an option, in accordance with passing time. Three steps are deployed in the model which makes it a complex commutation.
Carrying out the commutation is actually impractical and so we advise our readers to try out the online tools which can be used to determine the price of a security at different point of times.
Deploying Binomial Pricing Model
Similar as the Black Scholes model, Binamial model is not a mandatory procedure. There sure are a lot of uses attached with this model, but this does not necessarily make it vital to understand or use it.
Using this model, an investor can commute accurate theoretical value with early exercising, for American styled options.
However, it is deemed as not suitable for comparison or commuting values for high volume of options.
What is Auto Trading Options?
Understanding Auto trading is a must for an Advanced Option Trader.
This concept is not limited to only options trading. Auto Trading is a part of a lot of financial investment segments, stocks, forex and futures alike.
This concept of Options Auto Trading is a seek-out, for the wide investors who are new to investment in options.
New comers to the investment industry and also the advanced investors from other segments, interested in options and wish to try their luck at options, seek for Auto Trading Options.
Since you wish to stock up on the knowledge about Auto trading, it refers to delegation of authority.
To explain the process in brief, an investor avails for a third party services to invest in options and place trade orders for them.
The investor is actually not a part of the trade, and neither is involved in any process of transaction, whatsoever.
This delegation is done by investors, who have a motive of earning profits through investing in options, but have no knowledge.
Here exists the possibility of making returns from options investment, with absolutely zero knowledge about the market. Here is what else you must know about auto trading options.
How Auto Trading Options work?
The concept here is simple; the investor uses the suggestion of a third party to invest in options. No decisions are made by the investors, rather is a suggestion from third party.
Investors further provide a standing order to the broker, to carry out their trades, the trade directed by third party.
You can also deploy services where third party even places the transaction order with broker, on your behalf.
A sum is charged by the third party for the services provided and is somewhat similar to hiring an investment advisor.
You can have everything in motion alerting your broker to follow the standing orders from third party.
In a way, this is a smart decision without you being directly involved, while your funds are invested and growing multifolds accordingly.
Service to choose from
If you have no time to spare and learn about options investment, and wish to opt for this mode, you must get started with finding a service provider.
This is a key step as they will determine the position of your funds. You must search for a reputed organization which has industry experts in their team.
Secondly, a lot of brokers do not allows Auto Trading Options, and hence, you must search for a likewise broker.
Be transparent with your service provider and convey your goals and also evaluate the risk level you can afford.
What are Options Greeks?
Success in Options investment is derived from the returns you will be able to fetch.
If you want to succeed in this segment investment, by making sufficient returns, you must learn all about Options Greeks. Greeks will take our profit making possibility to a superior stage.
Beginners may find Options Greeks frightening, but it necessarily is not of such a trait. When one begins reading the concepts options Greeks contain, he/she can understanding how simple the concepts can get.
Each and every concept of options Greeks are easy to understand, and also, their effect on price options.
Meaning of Options Greeks
Via these components, investors can create a forecast of the future price movement. If you are aware of these changes precisely, you can place a great amount trade order.
Some Greeks are also great risk management tool, as they portray the extent of risk involved and where.
Greeks are a rather theoretical, to determine the price movement based on numerous factors. Investors can do the commutation themselves, but since they are complex, use of online tools are advised.
Delta: Compatible for great volume of trades, this Greek shows the theoretical value shift, on account of change in price of an option. Here, all the other factors of the security are considered equal.
Theta: This Greek is related with the time decay’s effect on an option’s price. Rate of diminishing intrinsic value is evaluated here, with an assumption of other factors being equal.
The above mentioned Greeks are precisely the simple ones; also there are a lot of other Greeks that are complex, such as Gamma, Vega, Rho.
Advanced Option Trader – Conclusion
Should you be well read of in-depth components of Options, you will be close to attaining advanced level in trading.
When you gain all the knowledge from this article, alongside other essential details, you can put the same into play.
After you practically implement all the strategies, you will grow in this investment, and upgrade to advanced level.
We hope to have contributed to your need of information about the options market. Make sure you go through other articles we constructed, that feature each and every strategy in detail with example.
This will help you prosper in this area since the beginning of your options trading journey.
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