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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Trading Options with Support
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