Options

Ironically, the day after I make a post about not updating this blog daily, I have another update in mind. Predicting short-term trends is difficult, if not impossible. :)

I was recently talking with a friend of mine who had just made his first options transaction. I argued that he had made two serious mistakes. First, he bought short-term options. Second, he bought options whose implied volatility was higher than the historical volatility of the underlying. (If you did not understand the previous sentence, an excellent introduction can be found at IVolatility.com.) Allow me to explain why I felt that these were mistakes:

1) Short-term options (generally) have higher implied volatility than long-term options.
2) Options and their underlying do not necessarily trade in tandem. Options are just like stocks - their prices change based on demand. You should only buy the contract when the implied volatility is lower than historical volatility, or else you are paying too much for your options.