Traders are very opinionated and have their own view on everything. This is why we have a market of buyers and sellers. Otherwise, everyone would be on the same side of trades. This behaviour is built over time from experience and knowledge. You can do it too.
For example, you are able to tell if the stock is trending up or down by looking at the price movements in the following chart. As traders, we are trained to identify the trends and have an opinion on the stock’s direction. The next step is to pull the trigger: You can either buy the stock, short the stock (if you think it will drop) or use options. By using options, you benefit from better risk management. When you commit yourself to a long option trade, your risk is predefined. Even if the company suffers bad press overnight, the stock’s gap down at the open will not leave you with an irrecoverable losing position, because you will not lose more than the premium paid for the option.
To get started, you need to find out the expiry dates and strike prices that are available for trading. This is when an option chain comes in. If you are new to options, this is an option chain on the iShares S&P/TSX 60 Index ETF (ticker: XIU)
In an option chain, you find all the available option strike prices and expiries that are at your disposal for trading. The option chain is composed of:
Source : m-x.ca
What is the link between the Da Vinci Code reference and option chains? Every day, traders inject their prices and views into the options market and all this valuable information is encrypted into the option chains. Since option prices are embedded with a time value component, we can extrapolate how much a stock is expected to move before a specific date. This will not tell you the direction (up or down) of the stock, but rather by how much it will move. Once you decrypt this information, it is up to you to agree or not with the market.
As of the close on Wednesday January 10, 2018, XIU was trading at $24.25.
Decryption conclusion: This means that the participants in the options market are expecting XIU to move + or – $0.465 by February 16, 2018. Remember, this can be up or down $0.465 from the current price of $24.25. Based on this information, you know by how much XIU could move.
This is how you decrypt the option chains. This method should be taken with caution because bursts of volatility in the market can affect the model. Until next time, may the best trades be with you.
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