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Essential Option Strategies by J. Kinahan

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Appendix C

Charts and Volatility Studies

You have heard it many times: A picture is worth a thousand words. When trading, the adage rings true. At a glance, a chart can show price trends and the highs or lows of a security over a period of days or even years. When this is combined with probabilities (Chapter 9), it is a powerful tool. Meanwhile, because volatility is an important component of options prices, volatility studies can help determine whether options premiums are relatively rich or cheap compared to past levels. This appendix covers just the basics of both stock charting and volatility studies. A brief discussion of volume is included as well.

Stock Charts 101

Stocks, bonds, commodities, or other tradable assets often move in trends. During periods when prices are moving higher, uptrends appear on the chart and are often characterized as a series of higher lows and higher highs. Lines can be drawn on the chart to highlight the trend, as seen in Figure C.1.

Graphical illustration of Uptrend.

Figure C.1 Uptrend

A downtrend is a period of time when prices are moving lower. When this happens, trend lines can be drawn along the top of the trend, as in Figure C.2. Therefore, while uptrends are characterized by a series of higher highs, downtrends occur when the security makes a series of lower lows.

Figure C.2 Downtrend

Trend lines can sometimes be drawn along the series of lower lows in a downtrend. ...

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