Option Valuation

Option values change in direct proportion to the changing market value of the underlying stock. Every option is associated specifically with the stock of a single corporation and cannot be interchanged with others. How you fare in your option positions depends on how the stock's value changes in the immediate future.

The question of selecting stocks is more involved and complex than the method of picking an option. For options, the selection has to do with risk assessment, current value, time until expiration, and your own risk tolerance level; in addition, numerous strategies you may employ will affect the ultimate decision.
But option selection is formulated predictably. In comparison, stock selection involves no precise formula that works in every case. Price movement in the stock itself cannot be known in advance, whereas the reaction of option premium value is completely predictable, based on the way the stock's price changes.

The selection of a stock is the critical decision point that determines whether you will succeed with options. This observation applies for buying or selling stock, and also applies when you never intend to own the stock at all but only want to deal with options themselves. It is a mistake to pick options based only on current value and time, hoping to succeed, without also thinking about the particulars of the stock -- volatility, relation to striking price of the option, and much more. Of course, to some degree, the features of the option can be used to calculate likely outcomes, but that is only a part of the whole picture. Because option value is tied to stock price and volatility, you also need to develop a dependable method for evaluation of the underlying stock.

You may pick stocks strictly on the basis of fundamental analysis. This includes a study of financial statements, dividends paid to stockholders, management, the company's position within its industry, capitalization, product or service, and other financial information.

The importance of the fundamentals cannot be emphasized too much, as they define a company's long
By Michael C. Thomsett
Michael Thomsett is a British-born American author who has written over 75 books covering investing, business and real estate topics.

Copyrighted 2016. Content published with author's permission.

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