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Options by Michael C Thomsett

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Chapter 11 The Basics of Risk: What Every Trader Needs to Know

Educated risks are the key to success.

̶̶ William Olsten, in Success, February 1988

In the options world, the focus on risk invariably means volatility, the tendency of a product’s price to change quickly and, most critically, in an unpredictable manner. With options trading, two forms of volatility are of interest: historical and implied.

Historical volatility is the level of price activity in the underlying security. It demonstrates the rate of change in price over time. Implied volatility relates to the option’s price and is an estimate of how the value is expected to change in the future. As volatility grows, the option premium also grows; and as implied volatility shrinks, so ...

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