Options are instruments of probability. They are priced using a complex mathematical formula which boils down to the measurement of two variables: (1) Intrinsic value (or how much “in the money” it is), and (2) ‘Time and Probability’ value (most commonly just known as time value). Understanding these two variables is key to trading options profitably.
Far too many traders lose money simply because they don’t understand how market makers adjust option pricing in their own favor. The following simple truths about option pricing will help you recognize where option prices are likely to end up, and the probabilities associated with that final outcome.
Because these concepts are true, they lead to three important trading corollaries:
This lesson will explore each of these simple truths and their corollaries to help you understand how you can use the probability profiles and trading edge you learned in previous lessons to maximize profits in your option trading.