OPTION PRICING dictating Rates of Return

Option pricing is the result of properties of both the underlying stock and the terms of the option. The major quantifiable factors influencing the price of an option are:

1.) Price of the underlying stock

2.) Striking price of the option itself

3.) Time remaining until expiration of the option

4.) Volatility of the underlying stock

5.) Current risk-free interest rate (ex: 90 day Treasury bills), and

6.) Dividend rate of the underlying stock

The first four items are the major determinants of an option’s price, while the latter two are generally less important, although the dividend rate can be influential in the case of high-yield stock.

The markets just can’t seem to get up and run as if being somewhat stagnant. A decision hasn’t been made, bullish or bearish, which way do we go. Option prices are effected by volatilities and with present day market conditions our option prices are priced soft.

When you or I place a trade there is another party to that transaction, yes, the Market Maker. The Market Maker basically sets the prices of the options based upon specific pricing models. He prices options for sake of his own protection by pumping in volatility or sucking it out of the options price.

So, what am I trying to get at here? We at MasterMind Traders prefer safety in our Credit Spreads so we have been utilizing weekly options only to remain in the trade a shorter period of time for less exposure to the markets inability to make a decision on which way to go. That being the case, due to present day option pricing (Market Makers built in protection) it has been difficult to get a high rate of return in a safe trade (because Market Maker is first concerned about his own safety…he sets the prices).

Credit Spreads are directional trades which are basically set up for the stock to go in a desired direction. Today’s fickle markets and option prices offers a lesser return if we wish to stay as safe as possible.

Let’s remain safe! As the markets change so will pricing in options to allow higher returns, as well safety.

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