5. Interest Rates
Interest rates are a factor in the pricing of an Option but they are minor compared with say Volatility or the underlying share price.
For the average retail client the effect they have are not worth bothering about.
Options and The Role Of Mathematics
Whereas in the general stock market maths doesn’t play a big role, in options it does.
The pricing of options is always based on a series of mathematical calculations using such pricing methods as the Black Scholes model (wikipedia link). But is it necessary to get bogged down in all the analysis especially if maths has never been your strong point?
There is of course no right answer; it all depends on how you view your own trading and analysis. But traders who do want a more analytical approach should look into this topic further. There is an excellent free Excel based program designed just for this at www.hoadley.net and we would advise all options users to download it.
Ultimately though, what will make or lose you money with options is not how much theory you know, how intelligent you are or even how much money you have in your account. What will be the decider is simply your view on the underlying market and this is where most traders should spend at least 80% of their research.
If having a great mathematical mind was the solution to options trading then the average trader wouldn't stand a chance against the quantitative analysts and so-called rocket scientists. While there is evidence to state that some of these people do make a lot of money, there have also been many examples of where they've crashed and burned.
The most famous being the destruction of Long Term Capital Management (Wikipedia link) in 1998 which lost about $4billion or 90% of their capital in little over 6 months. The principals of this fund were a mixture of Nobel Prize laureates, PhDs, university boffins, economic wizards etc, and were once regarded as the most talented bunch of market participants ever assembled.
The reason for their downfall was simple, it was a combination of -
- Being too clever
- Thinking that their mathematical models had considered all possible variables of potential market movement
- And the big one, the downfall of most traders, irrelevant of how good they are (or have been) - using too much leverage
