High Performance Options Trading Option Volatility & Pricing Strategies LEONARD YATES John Wiley & Sons, Inc. ccc_yates_fm_i-xviii.qxd 6/14/03 2:35 PM Page iii ccc_yates_fm_i-xviii.qxd 6/14/03 2:35 PM Page vi High Performance Options Trading ccc_yates_fm_i-xviii.qxd 6/14/03 2:35 PM Page i John Wiley & Sons Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States. With offices in North America, Europe, Aus- tralia, and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers’ professional and personal knowledge and understanding. The Wiley Trading Series features books by traders who have survived the market’s everchanging temperament and have prospered—some by rein- venting systems, others by getting back to basics. Whether a novice trader, professional or somewhere in between, these books will provide the ad- vice and strategies needed to prosper today and well into the future. For a list of available titles, please visit our Web site at www.Wiley Finance.com. ccc_yates_fm_i-xviii.qxd 6/14/03 2:35 PM Pageii High Performance Options Trading Option Volatility & Pricing Strategies LEONARD YATES John Wiley & Sons, Inc. ccc_yates_fm_i-xviii.qxd 6/14/03 2:35 PM Page iii Copyright © 2003 by Leonard Yates. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada. 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Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. For general information on our other products and services, or technical support, please contact our Customer Care Department within the United States at 800- 762-2974, outside the United States at 317-572-3993 or fax 317-572-4002. Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. Library of Congress Cataloging-in-Publication Data: Yates, Leonard. High performance options trading : option volatility & pricing strategies / Leonard Yates. p. cm.— (A marketplace book) ISBN 0-471-32365-9 (CLOTH/CD-ROM) 1. Options (Finance) I. Title. II. Series. HG6024.A3Y38 2003 332.64 '5—dc21 2003002428 Printed in the United States of America. 10987654 321 ccc_yates_fm_i-xviii.qxd 6/14/03 2:35 PM Page iv For more information about Wiley products, visit our web site at www.wiley.com. This book is dedicated to my loving wife, Karen. ccc_yates_fm_i-xviii.qxd 6/14/03 2:35 PM Page v ccc_yates_fm_i-xviii.qxd 6/14/03 2:35 PM Page vi Acknowledgments Many thanks to Elwood Brent, Jim Graham, Tom Heffernan, and Karen Yates for their tremendous help proofreading and editing. L. Y. vii ccc_yates_fm_i-xviii.qxd 6/14/03 2:35 PM Page vii ccc_yates_fm_i-xviii.qxd 6/14/03 2:35 PM Page viii [...]... in-the-money, at-the-money, or out-of-the-money? What is this option’s intrinsic value? What is this option’s time value? Answers: The option is in-the-money, has an intrinsic value of 5 and a time value of 1.60 ccc _yates0 1_ 1-2 4.qxd 6/4/03 1:25 PM Page 10 10 THE LANGUAGE OF OPTIONS 4 A stock is at 50 A 50 call on this stock has a price of 3.20 Is this option in-the-money, at-the-money, or out-of-the-money?... option’s time value? Answers: The option is out-of-the-money and has an intrinsic value of zero and a time value of 1.75 2 A stock is at 70 A 60 call on this stock has a price of 11.40 Is this op- tion in-the-money, at-the-money, or out-of-the-money? What is this option’s intrinsic value? What is this option’s time value? Answers: The option is in-the-money, has an intrinsic value of 10 and a time... from expensive to cheaper options as you go from in-the-money toward out-ofthe-money? Also, options expiring the soonest (called the nearbys) are in the left column, while farther out options flow to the right Do you see that the farther out options (with more time remaining) are more valuable than the nearby options? ccc _yates0 1_ 1-2 4.qxd 6/4/03 1:25 PM Page 14 14 THE LANGUAGE OF OPTIONS As this was a significant... call options dropped and the put options gained in value Higher-priced options changed the most However, lower-priced options probably changed by greater percentage amounts Also note that trading volume is especially concentrated in the nearby expiration months and in those options closest to the money Many of these options traded thousands of contracts on this day THE SPECIAL PROPERTIES OF OPTIONS Options... is frequently given in options books and literature is depicted in Figure 1.6 Option Value Time FIGURE 1.6 Traditional Time Decay Curve It is important for the option trader to understand that this is only correct for at-the-money options In-the-money and out-of-the-money options have different time decay curves (see Figures 1.7 and 1.8) OTM Option Value Time FIGURE 1.7 In-the-Money ... sense, options are like hot potatoes being tossed around among speculators This accounts for quite a bit of the options trading volume Another big source of trading volume is institutional trading Institutions may use options to hedge large positions, or simply trade large positions for speculation ccc _yates0 1_ 1-2 4.qxd 6/4/03 1:25 PM Page 6 6 THE LANGUAGE OF OPTIONS So far we have only talked about options. .. (“nickel”) intervals The options are separated into two sections: calls in the upper section and puts in the lower section In each section, the row where the strike is marked with a “>” represents the closest-to-the-money strike In the top section (calls), rows above that mark represent progressively farther out-of-the-money strikes, while rows beneath it represent progressively farther in-the-money strikes... estimate For that reason, options traders refer to mathematical models, implemented in computer programs, to compute the fair value of an option In the previous IBM example, we showed how an in-the-money option could be exercised to get into a stock position at below market price Would it ever make sense to exercise an out-of-the-money option? The answer is no To exercise an out-of-the-money call would be... about options in a short time Also, it’s easy to set up an account and begin trading options Almost every brokerage that allows you to trade stocks also allows you to trade stock or index options And almost every brokerage that allows you to trade futures also allows you to trade futures-based options Establishing an options trading account just requires a little extra paperwork, including 1 ccc _yates0 1_ 1-2 4.qxd... what I know about options trading High performance options trading has always been my goal If it is yours as well, then please accept my advice: “study up” and “tech up” first ccc _yates0 1_ 1-2 4.qxd 6/4/03 1:25 PM Page 1 CHAPTER 1 The Language of Options I n the Chicago area, where I live, many people know what options are That is because several of the world’s largest options exchanges are here, and many . Cataloging-in-Publication Data: Yates, Leonard. High performance options trading : option volatility & pricing strategies / Leonard Yates. p. cm.— (A marketplace book) ISBN 0-4 7 1-3 236 5-9 (CLOTH/CD-ROM) 1 High Performance Options Trading Option Volatility & Pricing Strategies LEONARD YATES John Wiley & Sons, Inc. ccc _yates_ fm_i-xviii.qxd 6/14/03 2:35 PM Page iii ccc _yates_ fm_i-xviii.qxd. Pageii High Performance Options Trading Option Volatility & Pricing Strategies LEONARD YATES John Wiley & Sons, Inc. ccc _yates_ fm_i-xviii.qxd 6/14/03 2:35 PM Page iii Copyright © 2003