WHY OPTIONS?

Categories

General

Options limit risk a. An option gives the holder a risk-limiting position in the underlying. b. Because they limit risk, they provide symmetric payoffs that can be used to reshape the profit/loss profile of a position.
Option premiums and volatility a. The single most important difference between an option and an underlying is that the option's price depends, to a great extent, on how volatile the market thinks the underlying price will be over the remaining life of the option. b. The more volatile the market expects the underlying price to be, the higher the option's price (and vice versa). Just like an insurance policy, the greater the perceived risk that the issuer takes, the greater the premium he will charge. c. Any increase or decrease in the market's volatility forecast translates directly into an increase or decrease in an option price's extrinsic value. d. If the market proves to be either more or less volatile than the market expected, the long option trade or hedge will perform better (more volatility) or worse (less volatility) than the underlying trade or hedge. e. Options allow you to trade not just the direction of the market, but its implied volatility as well.