Be your own casino: an option tutorial.

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Become your own casino: options tutorial.

I love Las Vegas. Of course, I like lush hotels, waterfalls, cirque du soleil acrobatics and buffets, but that’s not what I mean. I mean, I love the casino industry. This is the only business model I know based on mathematical certainty (life insurance is not far behind). Casinos know they will benefit from their gambling business (they don’t like the word) because odds are always good.

Bet on American roulette. Bets are 38 Numbers to choose from: 0, 00 and 1 to 36. Ivory ball to fall on a selected number is 37 1, in other words, 38 than 1. According to the price, if gamblers bet $1 on a digital, if her number appears on the wheel, he should get $38. Can casino investors get a $38 winning number? Noooooooo. She only has 36 dollars. The $2 deficit is known as the “edge of the house”, or 5.26 percent of every dollar bet. In other words, in the long run, the casino mathematically guaranteed a profit of $0.0526 per dollar. In fact, if the CARDS actually start to win, the CARDS start to heckle the gamblers, who accuse them of cheating.

What does this gambling statement have to do with stocks? Nothing, but it has a lot to do with stock options. Before I explain the link between casino and stock options, a quick review is needed. As fools have argued in the past, an option is a contract made up of a put option or a put option. Give the buyer the right to sell the stock at a specified price, but no obligation. The call gives the buyer the right to buy shares at a specific price, but is not obligated. Options can also be sold. (instead of stock paper, stock options create derivative contracts, and the securities and exchange commission has created “no ban on naked short selling in order to prevent naked short selling in stocks.”) Unlike the buyer, the option seller has no rights, only obligations, but pays those obligations. If the holder chooses to exercise the option, the option seller is obligated to sell the stock to the subscriber at a specified price. Similarly, if the voter chooses, the seller of the bet is obligated to buy the stock from the owner at a particular price.

Back to the steering wheel

Now back to the link between casino and stock options. Just as the roulette payment is based on the probability that the ball lands on the roulette wheel, the price of a stock option is also based on the probability that the stock lands at a certain price on the day of the option. Assume you are neutral about stocks and want to benefit from that view. For example, you can sell shares at December price differences. It is best to choose a large number of trading stocks with a currency options market. Including Motley Fool Inside Value, the possibility of some highly mobile choose Microsoft (nasdaq stock code: MSFT) and Intel (nasdaq stock code: INTC), valero (the New York stock exchange (stock code: VLO), general motors (New York stock exchange code: GM), altria group (New York stock exchange code: MO), stock advisor choose eBay (nasdaq stock code: eBay).

For argument’s sake, we chose to charge $32.50 / $35 on eBay in December. Credit spreads are the simultaneous sale and purchase of two options – a sale and a purchase – with different strike prices but the same expiry date. I like this spread because it limits my risk. Let’s say you sell a $32.50 phone and buy a $35 phone. A $32.50 phone costs $1.40, and a $35 phone costs $0.55. Your net “credits” (ie, after deducting cost buy options, the revenue generated by call options) will receive cash amount will be $0.85 per contract, fell $1.40 to $0.55) or $85 (0.85 times) per contract 100 shares). When the option matures, the call option even costs $33.35 ($32.50 plus $0.85).

Is the net gain on the call option 85 cents? The short answer is yes. Unlike a casino, the options market does not prevent you from pricing or being very close to “fair value,” as I will describe below.

In addition, I do not recommend placing any evidence in the press release stating that “undervalued” options have been found to have been purchased or “overvalued” options to sell. If the valuation differences do exist, then before the retail investors even see any such differences, market makers select institutions millions of dollars of computer models will use them in milliseconds. That said, let me refer to the 2004 Ibbotson Associates statement that looked at the prices of hedge index options and found that “option writing can be very profitable.” “According to this study, some index options [have historically been overpriced for the s&p 500]. So if I’m forced to choose between slightly overrated or slightly underrated options, I have to choose overrated options, which, of course, is good for the shoot (i.e., writing) option.

Due to the complexity of actual mathematical proof fair value choice is (anyone can say “binary tree distribution”), we need to use computer software and value options to determine the eBay option, closing below $33.35 in December deadline probability. Remember, in the options market pricing and valuation, even if is the best option valuation model is based on the estimate of the future stock volatility (and dice game is in order to determine the probability of dice), and this is “fair value” these estimates may be wrong. Even so, professional traders face millions of dollars of risk on these models every day, so they must be fairly accurate in the long run.

The rule of thumb is based on the option evaluation software I use, and when the option expires in December, eBay has a 65.6 percent chance of closing at $33.35. A simple rule of thumb can be used to verify that $0.85 net income is a reasonable price, with a 65.6 percent chance of success. Is fair for a price of $0.85, receive credit divided by the exercise price difference should be equal to the stock’s closing price of $33.35 ($0.85 = $2.50, or 34%) of the probability, so eBay’s closing price of $33.35, the fair value of probability options expire in December, the tax rate shall be 66% (100% minus 100%).

I should stress that you should never use the rule of thumb when investing in the options market. Always rely on reliable options to analyze the software to calculate the probability. After all, the rule of experience is considered the rule of experience because it is usually reliable, but not always. However, if the probability of the rule of thumb is not similar to the probability of software generation, there will be some strange phenomena, and I may convey this special difference.

Therefore, you have the basis for option spreads, trades, and related probabilities. In the second part of this series, I’ll explain how we assumed that eBay’s credit spread would make you money. Stay tuned.

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