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In response to a query titled “Criteria for Selecting Stocks Suitable for Buying Calls,” TxGolfer130 wrote as follows:
“You want to start with time frame first. 30-90 days good. Now the underlying, is it volatile, what is the 52 wk high/low. What are the technicals saying? Find support/resistance over & time frame (start 30, 60, 90). NOW, research option strikes near your target range. What is the IV, open interest & volume. What is underlying volume. What is P&L for each strike within 4 strikes of your target. Now you've got max/min/break-even calculated, time frame and plan for exit should you need to roll”.
Please suggest the yardsticks to follow. For example, for volatility, what is the optimum volatility expressed as a percentage of the market price. I am looking for yardsticks not only for volatility but for the other criteria as well
So your answer is not a simple here is a value at which ANYTHING is under/over valued. It is: It depends.
What are you trading. What is your perspective (bullish/bearish), these are are to do with the underlying asset. Implied volatility comes from the predicted price movement (delta change relative to expiration) of the underlying and the cost on the option (derivative) to insure that particular strike.
Here is a decent video that was recently put up by someone who was a market maker at the CBOE. It's a decent primer for what is implied volatility and how it's priced into the option. He gets a little off base discussing .VIX, but it's worth it b/c you need to know what the .VIX is and what it represents also.
By the way, years ago, I had to write a paper on the Black-Scholes Pricing Model referenced in rhe video. At that, time I had no clue what it meant.
Doctor TR
Know that B-S model is the most common IV calculator, however it uses the fixed expiration date in the binomial equation. The Cox-Ross-Rubenstein is a better IV calculator for American style options as it takes the day to day IV into the equation since American style options can be exercised at any time they are in the money.
LOL! I know it may seem that way, options are a much cheaper way to get an entry to a position (initial), attempt an arbitrage on an underlying and/or speculate on price movement.
Option traders are ruthless, and market makers more so, the learning curve has to be steep just to protect yourself. An easy way to dip your toes in are long calls. Pick an underlying, time frame, price range & go for it. You will most probably lose your premium as 80% of the time the calls will expire worthless. However, in this market you've got a better chance than ever to do it. I would suggest maybe taking a look at index options, it won't be as difficult with the research (as in-depth). You need to be aware though, that they are cash settled, and are European style options. You can do ETF's that are index benchmarked, DIA, QQQ, SPY, but those are American style options and require the minimal research.
Try maybe one of those if you want to get it, just understand what you want to do if it does go into the money AND that b/c they are ETF's they pay dividends.
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