How Much do Options Really Cost?

When you buy a stock option how much are you actually paying for that option? What are you paying for? Not many people realize that a large chunk of the option they are buying might not even be for the underlying stock.

An option price has three major things factored into it; intrinsic value, volatility, and time value. It is not all about the stock, all three of these factors play a large part of the option pricing.

Let’s say you find a $45 call that is trading for $6 the stock is trading at $48. In other words if you bought the option and exercised it you would lose $3. $48 - $45 is $3 so of the $6 call option you bought only half of it would actually be tied to the stock.

The other half would move with completely different criteria, meaning if the stock goes up you might not necessarily make money.

So how can you avoid getting to an option that does not follow the stock? Well for starters you could look for options that have more intrinsic value, or value that moves with the stock.

It is also helpful to buy options that will not expire for a few months. The further out an option it the less it will be affected by time decay.

The last thing you can do to not get any surprises is to check the options volatility. If the volatility is high and falls your option is going to fall in price because of it. So it can be very important to look at.
Above all else just make sure you understand what you are buying.

For more on pricing an option visit http://www.stocks-simplified.com/option-greeks.html

For more on trading stock options visit http://www.stocks-simplified.com/stock_options.html