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Offshore Options Pricing

August 23, 2012

Options

Offshore Options Pricing

Article by Berkeley Bahamas

Some people will have had success beating the market by their trading of various stocks utilising a well-organized process that anticipates a move either up or down. Some traders have also gained the self-assurance to make money in the markets identifying just one or two good stocks that they believe will make a big move. But if you don’t have this knowledge then you may be left behind. If that’s you then it is time to think about using options to plan your next move.

But before undertaking a journey into the world of options trading you should have a good appreciation of the features that determine the value of an option. They include the current stock price, the time to expiration, the intrinsic value and also the volatility, the time value current interest rates and dividends paid. What are these factors?

The current stock price is fairly obvious it’s the movement of the price of the stock up or down and this has a direct effect on the price of the option. As the price of a stock rises, the more likely the price of a call option will rise and the price of a put option will fall. If the stock price goes down, then the reverse will most likely happen to the price of the calls and puts.

The intrinsic value is the worth that any option would have if it were exercised. It is the portion of an option’s price that is not lost over the passage of time. The intrinsic value therefore reflects the financial advantage that would come from the instant exercise of an option.

The time value of an offshore option is the amount by which the price exceeds the intrinsic value. It is directly linked to the length of time until it expires and also the volatility. The actual value is a complex calculation but as a general rule, an option will lose two-thirds of its value in the last third of its time. This is important because the closer you get to expiration, the more the underlying security needs to move to impact on the price of the option.

The time value is basically the risk premium the seller of the option requires to offer the buyer of the option to buy/sell the stock up to the date the option expires. The time value is also dependent on the volatility the market expects the stock will display up to expiration. Where the volatility is low and the stock is not expected to move much, the time value will be relatively low. The opposite is true for more volatile stocks.

The consequence of volatility is much more subjective although there are several calculators that can be used to help estimate the effect. There are also various types of volatility the most notable being implied and historical. Historical Volatility is as it says the volatility shown by a stock in the past and it helps determine the possible extent of future moves of the stock.

Implied volatility is what is inferred by the current market prices, it helps to set the current price of an option. Implied volatility shows option traders what to expect from future volatility. Therefore implied volatility is a pointer to the current attitude of the markets and will be reflected in the price of the offshore option.

Conclusion

It is important that a potential investor who is interested in using options must understand how options are priced. As well as the underlying price of the stock, the key factors of the price of an offshore option are its intrinsic value and its time value. Volatility is of special interest to an options trader to gain an advantage. Historical volatility provides a perspective of how volatility impacts options price, while implied volatility shows what the market expects in the future. Knowing this current and expected volatility is essential for any investor that wants to benefit from the movement of a stock’s price.

About the Author

Forex TradingBerkeley (Bahamas) Limited2nd Floor, One Montague PlaceEast Bay StreetP O Box N-3927NassauBahamaTel: 1 (242) 393 8395Email: trader1@bahamas.net.bs

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whereby the original author’s information and copyright must be included.

Forex TradingBerkeley (Bahamas) Limited2nd Floor, One Montague PlaceEast Bay StreetP O Box N-3927NassauBahamaTel: 1 (242) 393 8395Email: trader1@bahamas.net.bs












Use and distribution of this article is subject to our Publisher Guidelines
whereby the original author’s information and copyright must be included.

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