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Trading Options with Support and Resistance

1-25-2004

Question:

I have been looking at trading options; however I am still confused as to how you calculate an option’s dollar value. Can you help me out?

Answer:

Pricing options is not that difficult if you remember that options are traded according to their point value. To get the dollar value you need to multiple the dollars/point for the commodity you are interested in.

This is the same dollars/point value as is used in the futures contracts.

Consider corn for instance. You know that each cent move in corn is equal to $50 on the futures contract. This means that if corn moves 5 cents in your direction then you have made $250 per corn contract.

Now if you’re trading options and you want to know the value of your option, you need to multiply the option value (expressed in points or cents) by the $/point (or $/cent) for the commodity you are trading.

Therefore if the March Corn 300 call option is trading a 6 cents, this means it is worth (6 x $50/cent) $300 per call option.

Beginning this week Tom will be addressing his favourite option strategy; vertical option spreads, so keep a look out for that. Vertical options, where you buy one and sell another option further out, take some of the implied volatility out of option trading. Implied volatility is what kills your option premium. This is why the market can be moving towards your option price, but the option fails to become more valuable!

Managing your trade, either with option or futures, is the same however. Don’t forget that. If the market breaks an important level that would have stopped you out of your futures contract, then you should liquidate your option position as well. Management is management. Don’t let the fact that options have predefined risk lull you into letting them expire worthless!

But we’ll be addressing option things more in the newsletter and on the webinars as well.

Is there a reason you don’t want to trade futures? Futures normally offer better return than options and are easier to manage as well. If you’re afraid of the “limitless” risk of futures, just be careful about which markets you choose to follow and you’ll be able to contain some of that risk.

The agricultural commodities are usually pretty safe (with the exception of soybeans) and some of the softs like sugar and cocoa can be good ones too – although be aware that they can move quickly at times.

The Eurodollar is an exceptional market for the small trader. It trends well and rarely gaps. Ever since Tom has brought it to my attention it has become one of my favourite markets to follow.

-Erich

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U.S. Government Required Disclaimer - Commodity Futures Trading Commission Futures and Options trading has large potential rewards, but also large potential risk. You must be aware of the risks and be willing to accept them in order to invest in the futures and options markets. Don't trade with money you can't afford to lose. This is neither a solicitation nor an offer to Buy/Sell futures or options. No representation is being made that any account will or is likely to achieve profits or losses similar to those discussed on this web site. The past performance of any trading system or methodology is not necessarily indicative of future results.

CFTC RULE 4.41 - HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT BEEN EXECUTED, THE RESULTS MAY HAVE UNDER-OR-OVER COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFIT OR LOSSES SIMILAR TO THOSE SHOWN.