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Options and Derivatives: Strategies for Trading

The price, or premium, paid for an option is affected by a range of variables. The relationship between the market price of the asset and the exercise price is a key variable. The option is more valuable the closer the two prices are. The value also increases with the time to the expiration of the contract. Purely on the basis of probability, there is a greater chance that the option may be exercised if the option has a long life. Similarly, the more volatile the price of the underlying asset, the greater is the value of the option, since there is an increased probability that the price of the asset may attain a level that would result in a profitable exercising of the option. Interest rates are the other variable that affects the value of an option. Unlike other variables, the relationship between interest rates and the value of the option differs between call and put options. In the case of the former, there is a positive relationship, and in the latter, the relationship is negative.

There is almost infinite range of options strategies that may be adopted by hedgers and speculators. The simplest strategies involve the use of a single option. More complex strategies involve the simultaneous purchase and/or sale of two or more types of options.