Options Theory: The Most Powerful Instrument To Get Benefit From Fluctuating Market Conditions
After trading in financial markets, everybody is expecting fruitful results.
But to get the desired profit we need to manage our risks, we need to think about the profit or loss potential in advance.
The experienced traders never trade before knowing the outcomes. Before trading,
they employ alternatives to adapt to the changes in the financial markets. To achieve this win-win situation they trade using Options trading.
Opinion trading is one of the powerful instruments that give unparalleled flexibility to benefit from all market conditions, volatile or not.
Using a variety of options trading strategies, you can develop the ability to take advantage of any situation.
Let’s dive deeper and understand the Options theory
Options theory is an approach where we give a value (known as a premium) to a particular contract.
The approach we use depends upon the present market conditions, strike price, volatility, interest rate, and time of expiration.
How to understand the option theory?
The prime goal of option theory is to understand and predict the future price of a contract. Although there is risk involved as it is said, “Nothing comes free.” As market conditions constantly change due to fluctuations, it is not always easy to determine the future price.
However, the longer that a trader keeps the contract the greater chances are there to end in profit.
The way to evaluate the present market is targeted to the 1973 pricing model which was published by Fisher Black and Myron Scholes.
One of the most regarded models is The Black-Scholes model takes a long-normal distribution because asset price cannot be in loss. Other assumptions are that it has no cost of the transaction of taxes but there is a risk-free interest rate that is constant for all.
Although, some assumptions do not tell true most of the time. For example, this model also has some volatility which is constant over time. This is not realistic as the volatility keeps changing due to demand and supply.
Sometimes changes in options pricing models will also include volatility skew, which means the shape of implied fluctuations for options graphs across the range of strike prices for options with the same expiry.
This results in often shaping a smile.
To add on, Black-Scholes takes the options being priced as European way which is executed only at the expiry.
It does not follow the American way of options theory which can be done any time before the actual expiry day.
However, the binomial or trinomial ways can handle both styles as they can check the price options at any point.