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Buying Options

The document discusses strategies for buying call and put options. When buying options, the buyer takes a long position and hopes the underlying stock price moves in their favor. The price paid for the option is called the premium, which depends on factors like moneyness, time to expiration, and implied volatility. Out of the money options are cheaper but less likely to be profitable, while at the money options have the highest time value. The document also notes that options are more expensive when implied volatility is high and less expensive when implied volatility is low.

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sanagopal
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42 views

Buying Options

The document discusses strategies for buying call and put options. When buying options, the buyer takes a long position and hopes the underlying stock price moves in their favor. The price paid for the option is called the premium, which depends on factors like moneyness, time to expiration, and implied volatility. Out of the money options are cheaper but less likely to be profitable, while at the money options have the highest time value. The document also notes that options are more expensive when implied volatility is high and less expensive when implied volatility is low.

Uploaded by

sanagopal
Copyright
© Attribution Non-Commercial (BY-NC)
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Buying Options

The most basic of options strategies is to simply buy call or put options. When you buy options, you are said to have
a long position in that option. You have a long call position when you buy calls or a long put position if you buy puts.
Generally, when you are bullish on the underlying asset, you can buy call options to implement the long call strategy
and when bearish, you buy put options to implement the long put strategy.
In both cases, you hope that the underlying stock price move far enough to cover the premiums paid for the options
and land you a profit.

Cost Considerations When Buying Options


The price you pay to own the option is called the premium which is affected by many factors such as moneyness,
time to expiration and underlying volatility.

Moneyness

Out-of-the-money options are cheaper to buy than in-the-money options but they are also more likely to expire
worthless.
For call options, this means that the higher the strike price, the cheaper the option. Similarly, put options with lower
strike prices are therefore less expensive to purchase.
However, the size of the premium alone does not tell us the whole story. In fact, at-the-money options can be
considered the most expensive even though their premiums are lower than in-the-money options. This is because
their time value is highest and time value is the part of the premium that will waste away as the expiration date
approaches.

Time to Expiration

Obviously, the longer the time to expiration, the more chance the option buyer have for the underlying price to move
in the right direction and therefore the more expensive the option.

Implied Volatility (IV)

Watch out for the implied volatility (IV) when buying options. Options are more expensive when the IV is high and less
expensive when it is low.

Selecting the Right Option to Buy


Which strike price and expiration you choose all depends on your outlook of the underlying. For instance, if you
believe that the underlying will make an explosive move upwards very soon, then it makes sense to buy an at-the-
money call option expiring in the nearest expiration month.

Buying Options for the Purpose of Hedging


Other than speculation, options can also be bought as a means to insure potential losses for an existing position in
the underlying. To hedge a long underlying position, a protective put can be purchased. Similarly, to protect a short
underlying position, a protective call strategy can be used.

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