how do you find underpriced stock options?

Question

what is the formula to find underpriced equity options?

Answer 1

Mr. Dredude is correct but there are ways to beat the volatility factor, which is the one that will make options worthwhile or make you nothing.
Try to find stocks that have as little volatility in them as possible that are about to make a major move. He is right in that these guys have teams of people adjusting these prices all day long. A five cent tick is worth potentially millions, so they have to be careful.
My theory is to go around those guys by looking at the underlying equity. Don't concentrate on the option itself but on the stock that just streams along and suddenly your trusted indicators say is going to break out either to the upside or downside.
If you buy at a low volatility, the price is relatively cheap. When it starts to move, the prices are adjusted at the exchanges for volatility and the price goes up. That's what you want to happen.

Take Honda Motor and Google. HMC options are relatively cheap as compared to Google because Honda is so much less volatile. When Honda makes a large move to the upside or downside, your return is much greater because you paid so much less for the volatility.

You can get an options calculator and adjust it for yourself to see some "what-if" scenarios. You can get it at http://www.cboe.com/ under the Educational Tools section. It is free. You can learn a lot from the CBOE.

Best of luck to you!

Answer 2

You need an option analysis program or some type of screener on an internet service, or a newsletter that does it for you. But there's always a catch.

Option pricing models give a good estimate of the option's price, if you can accurately describe what is going to happen to the underlying price and its volatility. Of course, that's an impossible task, so all you can do is get a fair idea, or close, like horseshoes, except this ain't horseshoes.

It doesn't matter which pricing model you use -- they are not substantially different -- but you need some form of a model. You are on the right track, and see that trading options without one is foolhardy, and puts you at an extreme disadvantage.

One of the benefits of a model is that it can give you estimates of what-if situations. One of the simplest is the delta of the option.

You also need a good handle on the time decay, or theta. It is usually a negative number.

But the number that will give you the most trouble is volatility; historical volatility is pretty easy, to obtain, but how does it change, and which way? Implied volatility, the volatility component built into the option price, is something you're trying to determine in the future. So you'll also need a crystal ball. It's a prediction.

If you want to try taking a look at the option pricing formala, the original one is called the Black Scholes model, and is easily obtained. But you won't want to mess with it, or try coming up with all of those numbers every day, let alone intraday.

You don't give us much information here about what you're trying to do, whether to buy options or write them., or do calendar spreads or ratio spreads or straddles, etc.

Mispricing is handled quickly in today's technological environment, and there are teams of people that hedge these things out of existence. You're messing with the big boys here, and Joe Public doesn't have an advantage.

The only way I've found to take advantage of these situations is to have an intraday data feed for options, and get to know the range of premium fluctuation, then anticipate the over/under pricing at extreme volatility. Psychologically, this will be the most challenging aspect of the trader, to trade against the market when it comes crashing down to your number, or takes off like a rocket and you are supposed to sell it. Not many can do it, or have the financial backing to do it.

This looks doable to the novice, but you should probably get a few more years experience with options before you try it. Your conventional definition of "underpriced" has no place here.

Answer 3

Learn & understand "The Greeks"........ (to understand Option pricing). BTW: A 14% profit in options is not great..... because... there will be moves in Options that will cut your Option price by 50% or more just as quickly. Remember: Demo (paper) trading is never a good indication of how well you'll do in real live trading.

Answer 4

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Answer 5

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Answer 6

1.Use Black Scholes Model .

2. If doing it is confusing check out for Softwares that calculate option prices. I am sure there are few.

3. Learn abt BS model..available at wikipedia.