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Essay On Option Pricing

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Option Pricing

Paper trading really helps you grasp the fundamentals, However, when buying and selling options in the open marketplace with real money, things change quite a bit. During your simulations I bet you wondered about option pricing. If you wanted to geek out, you could use a complicated formula like the infamous Black and Scholes equations. Instead of eating aspirin by the hand full, let’s just focus on the basics. An option is a derivative, which means that it is based on the value of another asset. Thus, the stock price or underlying asset is an important feature in determining the pricing. When you want to buy a stock, you want to buy it for a cheap as possible, this works the same way for options. Here are the factors …show more content…

You make money with an option if there is a favorable change in price of the underlying asset, but this must happen before expiration. Therefore, the longer the lifetime of the option, the better chance there is for that opportunity. Generally, the more time remaining on an option makes it worth more> However, there is also more time for the stock to move in an unfavorable direction as well.

TYPE OF OPTION:

The type of option (put or call) is also highly relevant to pricing. Calls are expected to increase in value as the price of the underlying asset increases. While puts are expected to increase in value as the underlying asset’s price decreases. The other factors discussed can also affect the option. Options for stocks that pay a dividend are often worth less because the dividend is priced into the option. VOLATILITY: Some would argue that volatility is the greatest factor in determining the price of an option in the marketplace. Realistically, all of the other factors, strike price, type, interest rates, dividend, are known, where volatility isn’t. Since options are derivatives, stocks and options are interconnected. For either investment, volatility is one of the most important elements to consider. As an option buyer, you can use historical movements in price to make some projections. However, option prices are based on IV implied volatility. Implied volatility, most often

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