Showing posts with the label options-trading-for-dummies

Option Premiums- Introduction

Option Premiums Introduction As important as knowing the chances of a LEAP put winding up in the money is  knowing whether the option in question is over- or underpriced. When it comes to long- term options, market makers use one of several analytic formulas to calculate option  prices. This is because the computational complexity associated with multiperiod  binomial models increases dramatically with the number of steps involved, thus  restricting their applicability to standard, short-term option pricing. Depending on the sophistication of the market maker, option pricing is typically  determined either by straightforward use of the original pricing formula developed by  Fischer Black and Myron Scholes in 1973 or by the use of later extensions of this  formula by Robert Merton, Giovanni Barone-Adesi, and Robert Whaley.  In a nutshell,  the Black-Scholes model determines option prices for European-style options , ignoring the effects of dividends. The  Merton mod


INTRODUCTION TO OPTIONS   An option is a contract written by a seller that conveys to the buyer the right — but not the obligation — to buy (in the case of a call option) or to sell (in the case of a put option) a particular asset, at a particular price (Strike price / Exercise price) in future. In return for granting the option, the seller collects a payment (the premium) from the buyer. Exchange- traded options form an important class of options which have standardized contract features and trade on public exchanges, facilitating trading among large number of investors. They provide settlement guarantee by the Clearing Corporation thereby reducing counter party risk. Options can be used for hedging, taking a view on the future direction of the market, for arbitrage or for implementing strategies which can help in generating income for investors under various market conditions OPTION TERMINOLOGY   • Index options:  These options have the index as the unde