Financial Markets Book Financial Markets For The Rest Of Us
An Easy Guide To Money, Bonds, Futures, Stocks, Options, And Mutual Funds
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by Robert Hashemian

Page 293

Many things could have happened during those 20 days that would push the stock price higher. With three days to go, there is much less time for the stock to make its move. In this case the risky trade paid off, but this does not happen often.

Here are some conditions that can render an option riskier:

Short time to expiration - an option with three days to go is riskier than an option with 20 days to go (given the same underlying stock and the same strike price).
Too far out of the money - an option $20 out of the money is riskier than an option $5 out of the money (given the same underlying stock and the same expiration date).
Low-priced underlying stock - an option on a $10 stock is riskier than an option on a $100 stock (given the same expiration date and the same amount in, at, or out of the money).
Low-volatility underlying stock - an option on a steady stock is riskier than an option on a volatile stock (given the same expiration date and the same amount in, at, or out of the money).

It is difficult to have a firm measurement of an option's risk. But the above factors are used in combination to determine an option's relative risk against other options. The supply and demand process works so effectively that all risk factors are often already built into the price of an option. There are, of course, always exceptions. In those times, experienced options traders can jump into a mispriced option and take a profit once the option's price is corrected. The point is that for the most part you can look at an option's price relative to its terms and make a quick judgment on how risky that option is. But in general, the lower an option's price, the riskier it is.


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    Bonds Futures Stocks Options
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