• Option Definitions

• Option Terminology

• Option Intrinsic Value

• Write an Option

• Advantages and Disadvantages of Option

• Risk and Reward of Buying a Call Option

• Risk and Reward of Buying a Put Option

• Risk and Reward of Selling a Call Option

• Risk and Reward of Selling a Put Option

One of the best ways to see why options are used is to view a graph of the profit and loss potential of options versus outrights.

An example of outright future. The horizontal, or x axis, is the price of the future and the vertical, or y axis, is the profit or loss of the position. The positively sloping 45- line represents the profit and loss potential in buying the future, and the negatively sloped 45 - line represents the profit and loss potential of selling the future. For every dollar the future moves the position will make or lose one dollar.

Outright positions are the simplest and usually most popular form of trading. The profit and loss situation is straightforward and simply a function of the price of the future

Option Pricing

The advent of option pricing models which was led by the Black Scholes model opened up the field of option trading by quantum leaps. Options can now be evaluated to determine appropriate theoretical values. These models allow trading based on theoretical valuation as well as market direction, opening up entirely new arenas of trading.

• Option Pricing Overview

• The Black Scholes Model Option Pricing

• Option Pricing - Delta

• Option Pricing - Theta

• Option Pricing - Vega and Rho

• Delta Neutral Option Trading

• Why Trade options

The models provide a framework for option evaluation. An options trader cannot blindly use the models and watch money pour in. A "cheap" option according to the models may remain cheap or even get a lot cheaper. The models are guides not answers. The ultimate judge of value is the market price.

Market Volatility

Option prices are affected by various factors, but one of the most important factors is the volatility of the market. Anyone who trades options should have some understanding of what volatility is and how option prices are affected by it. Most intelligent option trading is done with a strong awareness of the volatility of the market.

• Market Volatility

• Typical Volatility Distributions

• A Second Look at Volatility

• Historical and Seasonal volatility

• Implied volatility

• Predicted, Future volatility and Price

Spreads

1. An intracommodity spread is a spread between different months in the same commodity. Buying July coffee and selling December coffee, or buying October sugar and selling March sugar are examples of intracommodity spreads.

2. An intercommodity spread is a spread between different commodities which are usually related. Buying March S&P500 and selling March NYSE, or selling June Treasury bonds and buying June Eurodollars are examples of intercommodity spreads.

3. An intermarket spread is a spread between the same commodity on different exchanges. Buying London sugar and selling NY sugar, or selling NY crude oil and buying London oil are examples of intermarket spreads.

• Determining Price Relationships

• Other Considerations of Price Relationships

• Intercommodity Spreads

• Intracommodity Spreads

• Matching Contract Value with Different Contracts

• The Crack Spread

• Index Spreads

• Intermarket Spreads and Spreading-Risk and Reward

• Legging a Spread

Spread trading is another way to approach the market without taking outright positions. Spread trading, like option trading, is no more or less risky, but the risks and rewards are of a different nature. Spreads are a means to trade the relative value of one market versus another.

Option Combinations

There are many ways to combine options and out-rights into more complex trading vehicles. Virtually every option strategy, no matter how complex, is really a combination of the basic ones.

Option strategies can become quite complex but even the most so­phisticated ones are based on the simple concept of buying or selling one or more options against another option or outright. These combinations are used by many traders and also form the basis of theoretical option trading where options are bought and sold based on their theoretical value versus trading on market direction. Some option combinations such as straddles and ratios may be traded on volatility considerations of the market versus a strong conviction on market direction.

• Straddles Option Strategy

• Strangles and Guts Option Strategy

• Vertical Call and Put Spreads Option Strategy

• Ratio Spreads Option Strategy

• Synthetic Positions, Synthetic Long or Short Position and Synthetic Calls and Puts

• Diagonals Option Strategy

• Horizontal or Time Spreads Option Strategy

• Fences Option Strategy and Spreads with Different Expirations

• Backspreads and Butterflies Option Strategy

• When Should These Option Trades Be Done?

• Advantages and Disadvantages of Options

• Hedging with Options

Options offer many ways to trade a market. Option combinations increase this variety by offering profit and loss combinations not available in any other trading method. Option spreads may at first seem difficult to understand but their use enhances the tools of the speculator and hedger.