3. Volatility

To determine the fair price of an option contract, you must know the amount of time remaining before expiration, the current price of the underlying, the strike price, the risk-free interest rate, and the volatility. With the exception of volatility, each of these parameters has a precise known value. Unfortunately, the variable nature of volatility makes it difficult to accurately predict. Because the value of an option contract is very sensitive to the volatility component of the calculation, accurate assessment of volatility is a critical skill for an option trader. It is nearly impossible to generate a positive return without a reliable method for assessing volatility.

Long positions should be established only when you believe ...

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