These Concepts Are Essential for Any Options Trader

Focus: OPTIONS

Fred Oltarsh at Options Strategy Network explains that by understanding liquidity, implied and historical volatility, and the skew, options traders are able to build strategies to either mitigate risk or speculate in a manner that provides a reasonable opportunity for successful trading.

The first topic to understand is liquidity. The importance of liquidity is often overlooked in options trading. Whether one is trading standard or binary options, it must be clear to the trader how expensive it is to initiate and liquidate a position. The wider the bid/ask spread as a percentage of the contract value, the costlier it is to trade the particular contract. Ideally, a trader would benefit from the largest contract with the bid/ask spread at a minimum. For those who don't focus on commissions and slippage, options traders don't have a chance of making money in the long run.

It is always important to evaluate the implied volatility of the option one is trading in comparison to the historical volatility of the underlying. One might use the 20-day historical volatility-or a lengthier period-to determine how the implied volatility of the options compares. Frequently, traders will sell options thinking that there is a small degree of risk in the transaction, but at the same time they will sell options with an implied volatility at a level that is less than the historical volatility of the underlying.