Many investors first experience with stock options is buying a call or put as a cheap way to play an expected move on a stock. Unfortunately, those investors don’t understand how option prices are determined and therefore a majority of options end up expiring worthless.

When you buy a call option expecting the stock price to rise or a put option expecting the stock price to drop, you have to understand how options are priced. When buying an option need to understanding terms like option delta, implied volatility, theta decay and proximity of the option strike price to the underlying stock.

You can evaluate these factors by having an understanding of the Greeks which are the factors that help determine an options price.

The delta will tell you how much an option will move for each $1 move in the underlying stock. So if you own a call option with a delta of .40 and underlying stock price moves up $1 then your option’s price will increase $.40 a contract. So the more in the money the option is, the higher the delta. Many people make the mistake of buying an out of the money call option because they expect the stock to move up but if the delta is too low then the option won’t appreciate as quickly as the move in the stock.

Implied volatility is very important to understanding whether or not you are overpaying for an option. If a stock just had a big move like a gap up then the options price will jump with an increase in the volatility. If you buy an option with high volatility and the stock starts moving sideways after the initial big move then that volatility will decrease and your option will decrease in value too, even if the stock doesn’t move anywhere. Be careful overpaying for high volatility.

Time decay(also called theta decay in the greeks) reflects how fast an options price decreases each day as you get towards option expiration. Time decay will increase exponentially in the last couple weeks so if you buy an option in the front month too close to expiration you could end up seeing the premium decay faster than the benefit of an increase in price you would get if the underlying stock price moved in the direction you wanted.

As you can see there are multiple factors that you must consider when trading options. I only just touched on the basics of stock options and understanding how to trade options.

A solid understanding of option pricing is essential for being profitable in option trading. There is a significant amount of options trading strategies and methods for playing the markets.

Fortunately for the retail trader the quality of information, online brokers, and options analysis tools that have become available in recent years is phenomenal and allows an individual investor to trade many of the option strategies that were only done by professional traders.

You can visit my site for a review of an excellent product called Trading Pro System that covers the basics for learning how to trade options as a business.

Author Bio: Brian has followed the stock market for 15 years and writes for www.KineticTrader.com Read my review about a quality program for learning how to trade options for income called Trading Pro System

Category: Finances
Keywords: learn to trade options, how to trade options, trading pro system, option trading lessons