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How Implied Volatility Works
In our introduction to options trading, we discussed some basics of options, like the differences between calls and puts, how options contracts work, and why options is a zero sum game. Now we’re going to dig into the single most important options pricing concept: implied volatility. If you don’t understand implied volatility, you don’t understand options. Period. What Is Implied Volatility? Implied volatility is exactly what it sounds like: it is the amount of volatility implied by the price of an option. Put another way, by paying a certain price for an option, we are implying that the stock will have a certain level of volatility. There are 7 basic factors that determine an option’s price: The price of the stock The strike price Type of option Time to expiration Risk-free interest rate Dividend policy Implied Volatility Factors 1-6 have something in common: they are pre-determined. Implied volatility is different because it is determined by how much we pay for the option in question. Options are effectively insurance. A call option is an insurance contract that pays off when the stock rises. And a put option is an insurance contract that pays off when the stock falls. And like a car, the faster a stock moves, the higher it costs to insure it with options. It costs more to insure a Dodge Viper than a Honda Odyssey minivan. Why? Because there’s more potential for trouble (volatility) with a 645-horsepower sports car than a minivan. (WARNING: This video may Not be Safe for Work…) An Implied Volatility Example with Tesla As we’re writing this on October 17, 2017, Tesla (TSLA) is trading at $354.72. The implied volatility on the TSLA $355 December calls expiring in 59 days is 40%. What exactly does that 40% number mean? To successfully trade options, you don’t need to understand all the nitty gritty of options math. But you do need to understand the basic fundamentals of options prices. So let’s jump back to Statistics 101 so you understand what that 40% implied volatility number means. We use implied volatility to lay out the implied 1-standard deviation move in the underlying stock. This is the movement that is expected 68% of the time. Here is the formula to determine a 1 standard deviation move using implied volatility: Stock Price * Implied Volatility * Square Root of Calendar Days/365 = 1 Standard Deviation For our Tesla example, this becomes: $354.72 * 40% * .40205 = $57.05 This implies a 68% chance Tesla will move $57.05 or less by expiration in December. Put another way, it implies a 68% chance that Tesla will stay between $297.67 and $411.77. (calculated as $354.72 minus and plus $57.05) If implied volatility was just 30% instead of 40%, there would be less implied movement. And if it was 50%, there would be more implied movement Take a look at this table of implied stock movements at different implied volatility readings: As you can see, if implied volatility on our option is 30%, the implied movement (up or down) is just $42.78. And if it was 50%, it would imply movement of $71.31! You don’t need to do this math every time you look an option. Just remember this: the higher the implied volatility, the more movement in the underlying stock you need to make money on the option. Why? Because the higher the implied volatility, the more you’re paying for the option. Implied Volatility Levels on Different Kinds of Stocks Remember our car insurance comparison. The insurance company will charge a lot of money to insure a 645 horsepower Dodge Viper because there’s a lot of potential for trouble. Sellers of options are no different: if a stock can move a lot, the options seller (who is in effect selling insurance) will require a high premium for the related options. Here is a table showing implied volatility readings for at-the-money call options expiring in 59 days on 5 popular stocks: Applied Optoelectronics (AAOI), a very volatile semiconductor stock with a $860 million market cap, has 60% implied volatility. Snap (SNAP), a volatile tech name, is at 54%. And Pfizer (PFE), a slow moving pharma giant, has implied volatility of just 14%. Why the difference? AAOI and SNAP are much more volatile, so options seller demands higher options prices — which means higher implied volatility. Since Pfizer doesn’t move much, the seller must charge a lower price to draw in options buyers. Our TSLA Option Under Different Implied Volatility Scenarios Let’s take a look at our December TSLA $355 call one more time. Using the CBOE’s options calculator, we can calculate the price of the option under various scenarios. With a stock price of $354.72 and implied volatility of 40%, the December 355 call has a value of $22.95. But if we assume implied volatility of 30%, the value of the option drops to just $17.28. Here’s a table showing the value of the option at different implied volatility levels: As you can see, at 50% implied volatility, the option would be worth $28.61. Implied vs. Future Volatility As we’ll discuss in our next article on time decay (or theta), options are decaying assets. All things being equal, an option loses value every single day. You need movement — or volatility — in your favor to offset the impact of that time decay. So when you buy an option, you are essentially going long volatility on the underlying stock, ETF, index, or commodity. You are saying that the actual volatility in the future will be greater than the implied volatility that is currently priced in. And all things being equal, if you are long options, you want implied volatility to rise. However, there are some differences between calls and puts. When stocks fall, implied volatility typically rises. That’s great for owners of put options. But it’s not so good for calls, because a falling stock price will hurt the options price, and offset the impact of higher implied volatility. Implied Volatility
Continue Reading -->Inside Sami Abusaad’s Swing Trading Watchlist
In this special video, Nightly Game Plan Moderator Sami Abusaad walks you through his current swatch list with his top swing trade picks so you can see how he spots potential setups. Typically, Sami focuses on a single swing trading setup, but since there weren’t any noteworthy trades, Sami decided to take you inside a key part of his trading process instead: In the video, Sami will show you: The sideways trend in QQQ, which provides a backdrop for bullis trades The recent broken uptrend in Activision Blizzard (ATVI) Chicago Bridge & Iron’s (CBIE) Weekly Sell Setup Sami’s 1-2-3 Play in Foot Locker (FL), which gave him an initial profit of $723* The Climactic Setup in Green Dot (GDOT), which may be reversing Norstrom’s (JWN) breakdown bar And more! *(click here for a breakdown of our P&L calculations) Click here to learn about Sami’s Nightly Game Plan
Continue Reading -->Trader’s Digest: The 10 Stories We’re Reading Right Now
Wonder what traders are talking about today?We’re here with the top 10 stories we’re sharing with colleagues today, covering topics like:The message from the Fed in today’s Meeting MinutesWhat the incredible passive investing/ETF boom means for tradersTips for success from billionaire Richard BransonAnd more!So check out these links right now and get up to speed:1) Fed Inflation Debate Finds Some Officials on Rate-Hike Fence (Bloomberg)Federal Reserve officials held a detailed debate last month over whether forces holding inflation down were persistent or temporary, with several policy makers looking for stronger evidence of price gains before supporting a third interest-rate hike this year.Read the Story ==>2) Vanguard is nearing the $5 trillion milestone — but here’s where the rush could end (MarketWatch) Given how this market shakes and shakes it off, another record for the Dow may well be in the offing. It’s no secret, then, that this can’t-go-wrong bull market has pumped up the demand for low-cost, passive mutual funds and ETFs.Read the Story ==>3) 9 Tips for Picking the Right Stocks for Swing Trading (T3 Live) As a swing trader, one of the most important decisions you’ll every make is choosing which stocks to trade. You can learn all the winning setups in the world, but if you trade the wrong stocks, you’re going to lose money.Continued Reading ==>4) Spain takes step toward direct rule over Catalonia’s independence move (Reuters)Spanish Prime Minister Mariano Rajoy took the first step on Wednesday toward suspending Catalonia’s political autonomy and ruling the region directly to thwart a push for independence.Continued Reading ==>5) Ethereum First: Investment Product Opens for Trading on Nasdaq Exchange (CoinDesk) A first-of-its-kind investment product focused on ethereum is now open to investors on the Nasdaq Stockholm exchange. Announced today, CoinShares, headed by former JPMorgan Chase trader Daniel Masters, is launching an exchange-traded note (ETN) for ether, the cryptocurrency that powers the ethereum blockchain.Continued Reading ==>6) FX Markets Are Stuck in Low-Volatility Quicksand With No Escape (Bloomberg)Currency markets are trapped by low volatility and only a fundamental break of historic proportions can shake them free. Foreign exchange trading has become significantly less responsive to shocks, and when currencies do react it typically isn’t long before they go calm again, according to a study by Bank of America Corp.’s Alice Leng.Continue Reading ==>7) 8 Interviews with 8 Top Traders (T3 Live) One of T3 Live’s most successful content features has been our “Meet the Traders” series, which gives you the backstories of our top traders and educators.Continue Reading ==>8) Investors giving ‘cash incineration engine’ Tesla a lot of rope, but may soon lose patience (CNBC) Tesla shares have crushed the market’s performance for years, but patience is starting to run thin among some investors after Chairman and CEO Elon Musk’s too ambitious Model 3 production goals.Continue Reading ==>9) Market Wizard Tony Saliba on Options Trading (HowMuch.com)The Market Wizards books blew my mind. The original book was one of the first ones I read on trading when I jumped into the industry in 1998. And Tony was the only options trader profiled.Continue Reading ==> 10) Tips for Success from Billionaire Richard Branson (The Tim Ferriss Show/YouTube) Podcaster Tim Ferriss sits down with billionaire Richard Branson for a wideranging discussion on everything from coping with dyslexia, PR stunts, and even Bitcoin.
Continue Reading -->Scott Redler on CNBC: Is It Time to Buy Oil?
This afternoon, T3 Live Chief Strategic Officer Scott Redler appeared on CNBC’s Futures Now show to break down the action in crude oil and energy stocks. Crude hovering above $50 and @RedDogT3 says THIS could be your best chance to buy into year-end pic.twitter.com/1qYbwBKOav — CNBC Futures Now (@CNBCFuturesNow) October 3, 2017 In this video, Scott breaks down: Exactly where crude became buyable for momentum The best place to buy crude oil Why the next oil move could be to the upside 2 resistance areas oil could hit Scott’s forecast for oil in early 2018 A stop level oil traders can use What just changed in XLE Where traders can buy XLE, and where it can go Why Scott respects the technicals more than the fundamentals
Continue Reading -->Sami Abusaad: How I Traded Equifax for a $2,000 Profit in 4 Days
In this special video, Nightly Game Plan Moderator Sami Abusaad walks you through how he traded shares of credit reporting agency Equifax (EFX), which went into meltdown mode after a major security breach. In this video, Sami’s going to breakdown his Equifax trade, which earned him $2,000* in profit in just 4 days. *Click here for a breakdown on Nightly Game Plan P&L calculations Sami’s going to walk you through: The sideways trend in QQQ How to use the 20-period moving average to judge the trend A breakout/shakedown play in Express inc. (EXPR) on the daily chart A beautiful buy setup in Teva Pharmaceuticals (TEVA) after a pro gap up A weekly buy setup in Adtran (ADTN) A weekly transition sell setup in Masimo (MASM) Sami’s official trade of the week in Equifax (EFX), which has been under fire for a major security breach How to spot a potential bottom in a collapsing stock Sami’s strategy for his profitable exits on the trade Why Sami finally closed the position Click here to learn about Sami’s Nightly Game Plan
Continue Reading -->Your Intro to Options Trading: The ABC’s of Calls and Puts
Are you ready to start trading options?’ Then you’re in luck. You’re about to get a 100% FREE crash course in options trading, comprised of 5 in-depth articles: You’re going to understand how options work in the real world without understanding complex math or financial theory. You’re going to understand vital concepts like implied volatility and time decay, and you’ll get 3 simple strategies that you can use to speculate on stock price movements. Contrary to popular belief, options are actually not that complicated. And they’re not inherently risky — you can take as much, or as little risk as you want. Are you ready to start learning? Let’s go! What Are Options? Derivatives are securities which are priced based upon the price of another security, like a stock, ETF, index, or commodity. And options are the best-known form of derivatives. In this series, we’re going to focus exclusively on options on stocks and ETF’s. Options represent the right but not the obligation to buy or sell a certain stock at a certain price by a certain date. And as the price of the underlying stock fluctuate, those rights change in value. A sports betting analogy can help you understand this concept. An option is at its most basic level a bet on a bet. You’re betting that the value of the bet itself will change. Let’s say it’s the start of the NFL season, and we think the Green Bay Packers will win the Super Bowl. Options would allow us to bet that the value of a bet on the Packers to winning the Super Bowl will rise or fall. If the Packers win their first 10 games in a row, that bet will be worth a lot of money. But if they only win 5, it won’t. Calls vs. Puts Call options give a trader the right but not the obligation to buy a certain stock at a certain price by a certain date. All things being equal, when a stock price rises, the price of a call option goes up. Therefore, the buyer of the call option wants the price of the underlying stock to rise. Put options give a trader the right but not the obligation to sell a certain stock at a certain price by a certain date. All things being equal, when a stock price falls, the price of a put option goes up. So the buyer of the put option wants the price of the underlying stock to fall. Why Even Bother with Options? First, options require less capital to trade than stocks. Let’s assume we’re bullish on Tesla. If Tesla (TSLA) is trading at $380, it would take $38,000 to buy 100 shares of the stock. However, we could buy a call option on Tesla for $2,000 or less, giving us exposure to 100 shares of Tesla at a low cost. So options give you a lot more bang for your buck in terms of upside potential. On the downside, options have a fixed expiration date. You can theoretically wait forever for a stock to move, but an option has to move in your favor quickly. (In a future article, we’ll explain the role of time in options prices.) Otherwise, it will decline in value or expire worthless, giving you a 100% loss. And that’s just long options. Shorting options — a practice we don’t endorse — is even more dangerous, and can destroy your trading account. And that’s the trade-off: options require less capital and they have huge upside potential. But you also face serious downside risk. Another benefit of options is that they can be used to hedge an equity portfolio or individual stock positions at a reasonable cost. And finally, options are incredibly flexible. With options you can speculate that a stock will rise, fall, or even do nothing. Yes — you can use options to make money if a stock does absolutely nothing. We’ll be going over a strategy for this in the future. Strike Prices and Expiration Dates All options have a strike price and an expiration date. If a person says “I bought NVDA $180 November calls,” they are telling you two things: They have the right but not the obligation to buy NVDA at $180 (the strike price) That right expires in November And a person says “I bought TSLA $350 January puts,” they are telling you two things: They have the right but not the obligation to sell TSLA at $350 (the strike price) That right expires in January Most options expire on Fridays at 4:00 p.m. ET. Large-cap stocks tend to have options that expire every week. Small and mid-cap stocks sometimes have options that expire only on the third Friday of each month. The Basics of Options Contracts and Exercising Options Most options contracts represent 100 shares. So buying 1 call option gives you the right to buy 100 shares. 2 contracts give you the right to buy 200 shares. To determine the dollar value of an option, take the current price and multiply it by 100. If an option is trading at a price of $1, it actually costs $100 to buy. As we told you above, when you buy a call option, you have the right to buy a stock at a certain price by a certain date. Let’s say we own 1 NVDA $180 November call. This means that at any time before the November expiration date, we can buy 100 shares of NVDA at $180. Assume NVDA skyrockets on earnings and hits $200. We can then do two things: We can sell the option itself for a profit. Or, we can exercise our right to buy the stock, and purchase 100 shares for $180. That gives us an instant profit of $20 per share, or a total of $2,000. (minus whatever we paid for the call option in the first place) What Is an Options Contract? Options are not like stocks, which have a certain number of shares outstanding. Options don’t actually exist until a buyer and seller come
Continue Reading -->Sami Abusaad: How to Trade a Slow and Sleepy Market
In this special video, Nightly Game Plan Moderator Sami Abusaad walks you through how he traded a sleepy week for stocks. Typically, Sami showcases one of his swing trades so you can understand his strategies, but this was a particularly slow week, so instead, he’s going to break down a variety of this trades: In the video, Sami’s going to walk you throgh The extremely tight trend in QQQ, which didn’t matter in August, but which matters now The time frames Sami uses for finding patterns and perfecting entries The bearish 1-2-3-4 continuation pattern The weekly buy setup in Adtran (ADTN) An after-hours entry in Microbot Medical (MBOT) Why Sami bought the controversial Equifax (EFX) Earnings plays in Steeelcase (SCS) and Copart (CPRT) (click here to learn about Sami’s Earnings Play strategy) Click here to learn about Sami’s Nightly Game Plan
Continue Reading -->Trader’s Digest: The 10 Stories We’re Reading Right Now
Wonder what traders are talking about today?We’re here with the top 10 stories we’re sharing with colleagues today, covering topics like:The latest twist in the Fed’s rate policy adventureThe danger of individual investors are jumping into stocksWhy the $1,000 iPhone X may actually be cheapAnd more!So check out these links right now and get up to speed:1) Fed Signals Another 2017 Rate Hike, Asset-Shrinking to Start Next Month (Bloomberg)Federal Reserve officials set an October start for shrinking their $4.5 trillion stockpile of assets, moving to unwind a pillar of their crisis-era support for the economy. They continued to forecast one more interest-rate hike later this year, saying storm damage will have only a temporary impact on the economy.Read the Story ==>2) The masses are going all-in for stocks, and that’s not a good thing (MarketWatch) The latest Wells Fargo/Gallup Investor and Retirement Optimism Index hit 138 in September, its highest level in 17 years. That was in September 2000, when investors still couldn’t shake their denial that the bull market of the 1990s was over.Read the Story ==>3) Tim Cook says the $1,000 iPhone X is a ‘value price’ – and he’s right (Boy Genius Report)The iPhone X represents a number of firsts. The iPhone X is the first iPhone in history to incorporate facial recognition. The iPhone X is also the first iPhone to do away with the home button, a staple of every single iPhone since the beginning. And economically, the iPhone X is the first iPhone to ever break the $1,000 threshold.Continued Reading ==>4) From Russia with fuel – North Korean ships may be undermining sanctions (Reuters)At least eight North Korean ships that left Russia with a cargo of fuel this year headed for their homeland despite declaring other destinations, a ploy that U.S. officials say is often used to undermine sanctions.Continued Reading ==>5) Merkel warned Germany needs a policy rethink to keep economy growing (CNBC)Angela Merkel is likely to win a fourth term as chancellor after a national election on Sunday but business leaders are already warning her that the next government must implement growth-friendly policies to ensure Germany remains the euro zone’s largest economy.Continued Reading ==>6) Ray Dalio, the Steve Jobs of Investing (Tim Ferriss Blog)Ray Dalio (@raydalio) grew up a middle-class kid from Long Island. He started his investment company Bridgewater Associates out of a two-bedroom apartment at age 26, and it now has roughly $160 billion in assets under management.Over 42 years, he has built Bridgewater into what Fortune considers the fifth most important private company in the U.S.Continue Reading ==>7) Why You Need to Know the Only 4 Stages of Market Movement (T3 Live) If you want to be an expert swing trader, then you have to understand the Foundation of stock movement, broken down into 4 clear stages:AmbivalenceGreedIndecisionFearContinue Reading ==>8) Bitcoin’s Parimutuel Problem (Or Why Shorting Doesn’t Pay Today) (CoinDesk) When the price of bitcoin plunges — as it did last week — seasoned investors are caught in a market that doesn’t exactly have the mechanisms they’re used to. Case in point, hedging long positions, is today a difficult prospect. Unlike most traditional stocks, where investors can open a margin account with their broker that allows them to short most shares, the tools in bitcoin are few and far between.Continue Reading ==>9) What Makes a Great Trader? An Interview with Jack Schwager (CFA Institute)If you peruse the Wikipedia entries that describe some of the world’s great investors, you’ll often find that they share a common footnote: a series of books entitled “The Market Wizards” which feature Jack Schwager’s profiles of a number of successful traders.Continue Reading ==> 10) How to Get Out of Your Own Head and Take Action (YouTube) In this video, author Mel Robins shows you how to stop worrying about your troubles, and start taking action.
Continue Reading -->Morning Call Express: Risk-On Ahead of the Weekend
Catch T3 Live’s latest Morning Call Express video with Kurt Capra:
Continue Reading -->Sami Abusaad’s Trade of the Week: NLNK
In this special video, Nightly Game Plan Moderator Sami Abusaad walks you through a winning trade in Newlink Genetics (NLNK). Biotechnology stocks have been hot as of late, but few are hotter than NLNK, which recently skyrocketed on positive results from a clinical study. After NLNK’s rally, Sami spotted the opportunity for a Climactic Sell Setup, giving him a profit of over $3,100 in 4 days*. Here’s how the trade worked: *(click here for a breakdown of our P&L calculations) In the video, Sami’s going to walk you through the trade from start to finish so you can understand: Why NLNK showed up on his radar What qualified NLNK as a climactic play Where Sami set his entry, stop, and target for a 3:1 reward:risk ratio How the Climactic Sell Setup works Why he used the 5-minute time frame on this trade The pattern that signaled a breakdown in NLNK was coming Click here to learn about Sami’s Nightly Game Plan
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