Today I am going to talk about the language of money.
You know how it is when you go to a law firm. How the language they use is familiar to them but baffling to you.
Well it's the same in the financial trading business.
But only for a little while.
Once you are familiar with it, you'll find that trading becomes an absolute pleasure. Soon you'll know that the 'spread' is the difference between 'Bid' and 'Ask,' and not something you put on your toast; and that in-the-money is way better for you financially than out-of-the-money, although the latter may be where you 'buy' and the former where you 'sell.'
Rightyho:
Basic Money Language.
The language of money is very simple.
Here are a few terms and explanations mainly applying to options and futures.
A Call is an option you take when you expect the price of the underlying security (the share) to rise. The more the share price rises, the more the Call price (premium) rises.
A Put is an option you take when you expect the price of the underlying security (the share) to fall. The more the share price falls, the more the Put price (premium) rises.
The Premium. The premium is the price you pay for the option and is vastly lower than the actual share price.
e.g. a share might be $69.00. An at the money option may be only $4 giving you financial leverage without actually buying the share at it's full price.
An Option is sold in terms of a contract. In the USA a contract is for 100 option units. If you bought 50 contracts in the USA you would control 5000 shares.
The Strike price is the listed price of an option. Movement of the share price, above or below the strike price of the option, determines the premium movement.
Sounds tricky huh?
Here's an example.
A share is selling at $20.00. A Call Option would be available at a strike price of $19.50, $20.00 and $20.50.
With a Call.
Strike price of $19.50 would be known as in the money (the actual share price is lower than the strike price).
Strike price $20.00 would be called at the money (the actual share price and the strike price are equal).
Strike price $20.50 would be known as out of the money (the actual share price is higher than the strike price).
Here's the guts of it. An option locks in price and buys time.
OK. I've mentioned the premium and how low this can be compared to the real share's actual price. Here's how the premium is made up.
An option premium price consists of intrinsic value (cash worth) and time (which decreases daily as time goes by). At the money is where the share begins to take on cash value. In the money is the accumulated cash value. When a share is below the strike price it is made up only of 'time' value, and sometimes 'anticipated' cash value, depending on volatility and a few other market fundamentals.
Turning this into something easily understood.
A share moves through an Open, High, Low and Close each day - Well so does the option. Our skill is to get in on the higher end of the scale and out on the lower end if playing Puts. Or in on the lower end of the movement and out on the higher end if playing Calls.
With Calls the premium price rises as the share price rises. And falls as the share price falls.
With Puts the premium rises as the share price falls And falls as the share price rises.
The strike price is the price at which the option may be exchanged for a share or for cash at the expiry date.
As traders, we never exchange options for shares.
We buy and sell options for profit and leave the exchanging to the market makers and other share professionals at expiry date.
If you bought the Call option when the share was $20.00 but you chose to buy the lower strike price of $19.50, you would pay more for your Call as the option was in the money. (in the money by 50 cents in fact).
If you bought the Call option when the share price was $20.00 and you chose to buy the $20.00 strike price you would pay a little less for your Call as you were buying at the money. (at the money the intrinsic value is $0 and you would be paying only for time).
If you bought the Call option when the share price was $20.00 and you chose to buy the $20.50 strike price you would pay even less for your Call as you are buying no intrinsic value and your premium is rated only on time.
On all of these Calls your option premium would increase as the real price of the shares increased - and it would decrease if the real share price decreased.
With Puts the exact same scenario exists except you are looking at a reverse of the above brief explanation, and you make money as the real share price decreases and your option premium increases.
What are these bulls and bears?
A bull, a bull market, bullish, or a bull-run all indicate that a share or a market is increasing in value.
A bear, a bear market, bearish, or a bear run all indicate that a share or a market is decreasing in value.
Volatility is an indication of the sentiment that drives the market. I just can't think of a better way to describe it.
You have no doubt heard that the two greatest driving forces in the share market are fear and greed. This is true!
Fear and greed are the sentiment that cause markets to fall or rise.
e.g. A circumstance that causes a share's profit forecast to be lowered causes fear that is expressed as negative sentiment and the share falls in price because of an increase of sellers in the market place.
100 sellers want to sell. 10 buyers want to buy. Why then the buyers dictate the price they will accept and the fear of the sellers lets them lower their prices to levels that are acceptable. Fear forces the market down.
A circumstance that causes an increase in profit expectancy creates greed and this positive sentiment generates additional buyers and the share price rises in the market place. And the 'herd effect' comes into play.
Understanding sentiment is part 'Fixed Odds Trading Master''s trading plan and can be calculated in moments per day.
Open - first price of a share, commodity or future on any day.
High - highest price of a share on any day.
Low - lowest price of a share on any day.
Close - final sale price of a share on any day.
DMA is daily moving average.
3DMA - average of daily closes calculated by adding together the last 3 days close and dividing by 3. This gives a general mini trend of direction which eliminates single days that trade in opposite direction overall trend.
10DMA - average of daily closes calculated by adding together the last 10 days close and dividing by 10, This gives a delayed figure and by reading this from day to day a delayed trend. By noting the difference of the size of the gaps on a day to day basis the 'speed' of the market or any share can be read.
Fibonacci figures of 8 and 13 and 21 are popular DMA figures used by technical analysts.
Trend - Direction of a share or a market over any given period of time. A direction that may be continued if interpreted correctly. All successful traders read the trend and work on the principle that 'the trend is their friend'
Trend can be determined in many ways, the simplest being lower highs which is a primary indication of a falling trend. Similarly. higher lows may be a primary indication of a rising trend.
There are a few more terms in the money language of the market.
Next Page - Lesson 3 - Puts and Calls
