Open interest on the other hand is a tally of the total number of options 101 contracts open and active at each strike. This represents all trades that have not been closed or exercised.
The number is only updated at the end of the trading day once all trades have been tallied.
An interesting quirk is that volume can actually be higher in any given day than open interest. We have daily volume of 5 options 101 have 5 open contracts. Day 2: Trade A sells his 5 contracts and Trader B buys 20 contracts to open. On day 2, volume would be 25 and open interest would be The important thing to note is that traders should focus on options with high volume liquidity and open interest. Firstly, because the bid-ask spread is quite wide and there is no volume.
But also because this would represent basically all of the open interest in this strike. In this case, the market makers will take advantage of you if you options 101 to close the position in a hurry.
Options 101 luck getting filled at the mid-point on those! First and foremost, we have the calls on the left and the puts on the right.
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Looking at the calls we have the bid price and the ask price. The ask price is the lowest price the market will currently sell options 101 option.
Usually when trading options, you can receive a price close to the mid-point of the spread, but sometimes the market makers options 101 make you pay a little extra or receive a little less. AAPL is a highly liquid stock, so our chances options 101 getting filled near the mid-point is much higher than if we were trading options on a less liquid stock.
Implied volatility is the only unknown element in the options pricing model, because we cannot know in advance how much a stock will move between now and expiration. This value is options 101 estimate, but the key thing to remember is that, just like a stock, we want to buy low and sell high.
We want to be a net buyer of options when implied volatility is low options are cheap and be a net seller of options when implied volatility is high options are expensive. Another important thing to learn about implied volatility is skew. We can see below that each individual option has its own implied volatility and they are not all the same. This is known as skew. Some people refer to is as an implied volatility smile. Options 101 basically, there are three common cycles to which the stocks are assigned: January, April, July and October February, May, August and November March, June, September and December Stocks make money in a private house generally always have options for the current month and the next month in addition to whichever cycle it falls in from above.
In recent years, there has been a proliferation of weekly options, and some popular instruments like SPY have options expiring every few days. Margin Requirements For Options Margins are designed to protect options 101 financial security options 101 the market. If a trader sells an option contract, he has a potential obligation to the market because the buyer of the option may exercise their position.
Option margin is cash or securities that must be posted with the broker to cover collateral options 101. Margin requirements are set by FINRA and the options exchanges, however some brokers may add to the minimum requirements set by the regulators. Options strategies that involve naked options such as strangles and straddles require significant amounts of margin.
Other option strategies such as covered calls and covered puts require no margin as the stock is used as collateral. Likewise, debit spreads do not require margin because the obligation of the short option is offset by the long option. Most traders with small accounts will fall under Reg T margin requirements. Those with larger accounts may be eligible for Portfolio margin which is much more favorable for option traders.
This can result in substantially lower margin requirements if traders have uncorrelated positions. Remember that with options transactions there are two parties involved, a buyer and a seller.
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They buy shares if the option is a call and they sell shares if they held a put. The term assignment is used when someone has a short position in a call options 101 put and is called upon to fulfil their obligation by someone who is exercising their rights.
Unlike exercising the option, assignment means they must sell if it is a call and they must buy it if it is a put. You can read more about option assignment and exercise here.
Option Volatility Option volatility is a key concept for option traders and even if you are a beginner, you should try to have at least a basic understanding. In other words, an options Vega is a measure of the impact of changes in the underlying volatility on the option options 101. All else being equal no movement in share price, interest rates and no passage of timeoption prices will increase if there is an increase in volatility and decrease if there is a decrease in volatility.
Why Options? Many investors approach options with skepticism and caution — some simply refuse to even consider them. That's not entirely unreasonable — you don't need to use options in order to be a successful investor. Even I believed for a long time that options were not a Foolish way to invest. But as I options 101 to learn more about options, I discovered that they are excellent tools for generating income, protecting profits, hedging, and, ultimately, earning outsized gains.
Therefore, it stands to reason that buyers of options those that are long either calls or putswill benefit from increased volatility and sellers will benefit from decreased volatility. The same can be said for spreads, debit spreads trades options 101 you pay to place the trade will benefit from increased volatility while credit spreads you receive money after placing the trade will benefit from decreased volatility. Here is a theoretical example to demonstrate the idea. As option traders, implied volatility is where we can gain an edge.
As the only unknown piece of the option pricing puzzle, if our estimate of volatility over the course of our trade is better than the market estimate, we win. Simple as that. Just like we would with a stock. Buy low, sell high. Or sell high, buy low.
Below is a graphical view of implied volatility and historical volatility on AAPL stock. Implied volatility is in gold and historical volatility is in blue. There are a couple of important things to note here: Implied volatility is generally always higher than historical volatility.
This is important because it shows us that the market over estimates the amount of volatility in the stock. The volatility is not always the same for different options. This is known as volatility skew.
For example, puts generally trade with higher implied volatility than calls. This is because markets tend to fall faster than they rise and option sellers want to be compensated for that risk. Below we have a table showing the implied volatility for 1-month put options in AAPL stock.
Notice that each strike price options 101 its own level of implied volatility and that the level rises as we move further out-of-the-money. This skew is known as vertical skew and is fairly common across most stocks and indexes. Generally speaking, the further out in time you go the higher the implied volatility.
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This is because with more time, there is more of a chance something can go wrong in the markets. This is a normal situation called Contango more on that in a minute. Another reason why horizontal skew can occur is because of earnings reports.
In the table below, you can see that the options that expire before the earnings announcement have lower volatility than the options that expire after the earnings announcement. The is much more risk of a big move options 101 the stock due to the unknown financial results, hence the implied volatility is larger. VIX is one number whereas the VIX Term Structure refers to a set of several numbers measuring expected volatility for different option expiry periods.
Contango and backwardation are key terms that come from the futures market. Contango refers to a situation where the price of a commodity is higher in the future compared to the current spot price. If you think about it; it options 101 perfect sense. Contango is the most common scenario for futures.
The opposite of Contango is Backwardation which occurs when the spot price is higher than the futures price. In the commodities market, this situation might occur when there is a perceived shortage of a options 101 and companies are willing to pay a premium to take delivery today in order to keep their production lines running.
While the terms Contango and Backwardation originated in the commodity futures market, they also apply to financial instruments. Like commodities, there is a cost of carry with financial instruments. Rather than storage costs, the cost of carry on financial instruments is the interest rate paid short term trading guide purchase and hold the instrument.
However, when there is a market panic, they options 101 flip into Backwardation pretty quickly. This is because the market knows that panics usually die down within a few weeks and things return to normal. Options 101 Term Structure is important because it tells us a lot about the current state of the market.
When the Term Structure is in Contango, markets are in a calm state and are behaving normally. When we shift to Backwardation, markets are in panic mode. Sometimes panics can reverse quickly such as during Brexit, but other times the market can remain options 101 Backwardation for an extended period such as during the financial crisis of Yes, taking a contrarian view can be profitable when markets panic, but we also need to be aware that some of the worst market declines in history have come AFTER the VIX Futures market moved into Backwardation.
The key premise is to: Wait for the market to move from Backwardation to Contango likely means the panic is over Buy VXX puts far out in time, usually that means at least months for me.
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This gives the trade plenty of time to work out. Takes profits systematically as the trade moves in your favor. Spot VIX may have had a big rise, but future months options 101 were not impacted as much. AUGUST was a very quiet time in the markets and volatility was incredibly low for most of the year. The VIX got as low as 8. On August 9th, VIX closed at In percentage terms, this was one of the biggest spikes in history. Notice that on August 10th we options 101 from Contango to Backwardation.
Also notice that the spike was the most pronounced in the front months of the curve. This is VERY important to understand as option traders. Anyone who was short volatility in those front month short-term options, would have been hit pretty hard. The move was much less pronounced going out 90 days and further. On February 5th, VIX spike an almighty Just let that sink in for a minute.
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The spike was nearly twice as big as the options 101 biggest spike. Similar to Augustnot all months on the curve were impacted and most of the damage was concentrated in the front months. Popular products for trading volatility include: VIX options.