What Makes an Option an Option?
By Bill Johnson
Humorist Artemis Ward once said, “It ain’t so much thing things we don’t know that get us in trouble. It’s the things we know that just ain’t so.”
The options markets are filled with myths and misperceptions that prevent traders from using them to their fullest potential. One of the biggest misconceptions is that of cheap and expensive options. If you ask most traders, they’ll tell you that a cheap option is any that cost three dollars or less. While an expensive option cost more. In other words, they’ll have an arbitrary line in the sand to differentiate between cheap and expensive options.
However, professional traders know that it’s the extrinsic value, or the time value, that makes an option an option. If you have an option that’s made up entirely of intrinsic value, it’s not even an option – it’s stock. For instance, let’s say the underlying stock is trading for $120. If the $100 call is trading for $20, it’s entirely made up of intrinsic value and no extrinsic value. There’s not a single option in that deal. This is a condition called “parity,” which just means the option is trading equivalently to shares of stock. And if it’s trading just like stock, there’s no option in it. Even though it may look like an expensive option, it’s nothing but cheap shares of stock with a free insurance policy attached.
To see why, let’s say you bought this call while your friend bought shares of stock. If the stock price falls from $120 all the way down to $100 at expiration, your friend loses $20 and so do you. There’s no difference at all. However, if the stock continues to slide, your friend continues to lose while you’re limited to just the $20 loss. Because your losses are limited to $20, it’s as if you have an insurance policy that you didn’t have to pay for. That’s why you’ll rarely find options trading at parity unless you’re really close to expiration.
However, let’s say this $100 call was trading for $21 rather … [Read More...]
The Dow is currently trading right at the 50 day moving average. The Dow 10 minute chart has formed a Morning Star signal and trying to break back up through the T-line. The 50 day moving average will be an obvious potential support level. The NASDAQ, although trading lower, is currently trading backup above where it opened. This does not necessarily mean there isn't the possibility of more downside but it is indicating there is buying occurring. Numerous stocks have pulled back to test the T-line. Use the T-line as your ultimate decision-maker.
… [Read More...]
Morning Member Comments
Although the Dow is trading down hard, the other indexes are not showing the same selling pressure. Although they are trading lower, the NASDAQ opened on the T-line and is trading positive from there while the S&P 500 is trading lower, it is trading at the very top of its trading range. This provides an analysis that the markets are not selling off, merely the Dow. Numerous stocks opened lower but are now trading above where they opened. Continue to use the very simple trend analysis rule, as long as the prices are staying above the T-line, stay long. … [Read More...]
NV5 Holdings, Inc. (NVEE)Chart for NVEEOver the next 13 weeks, NV5 Holdings, Inc. has on average historically risen by 6.5% based on the past 4 years of stock performance.NV5 Holdings, Inc. has risen higher by an average 6.5% in 2 of those 4 years over the subsequent 13 week period, corresponding to a historical probability of 50%The holding period that leads to the greatest annualized return for NV5 Holdings, Inc., based on historical prices, is 1 week. Should NV5 Holdings, Inc. stock move in the future similarly to its average historical movement over this duration, an annualized return of 123% could result. … [Read More...]
June 20th Daily Market Comments
The concerns about tariffs apparently are not as dramatic Today. Although the Dow is trading down, the NASDAQ continues to trade higher. Soybeans are trading slightly lower but not nearly to the same magnitude as the huge down day yesterday before forming a large hammer signal. The candlestick patterns continue to demonstrate the strong bullish or bearish trades. Numerous breakouts of patterns are producing strong profits Today. … [Read More...]