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In this option pricing tutorial I will explain options pricing differently from any books I read.

The reason is I want to break the option pricing theory down to its atom elements, not jargons after jargons, so hopefully no more confusions about option price after reading this.

Option Pricing Model

Black Scholes Option Pricing Model is the only option pricing model option traders refer to (today!).

When they ask "what's the model price" that's what it means.

Black Scholes are two great scientists' names combined, they won the Nobel Prize for discovering this model, yet they are not traders.

This is the price you need to check out when you get ready to offer the market makers a bid price on an option. Because there is always a bid/ask gap no matter how liquid the market is.

P.S. Market makers: these are the people "on the floor", their commissions? I estimate no less than 7 digits before the decimal point per annum, which are from the pennies pinched from your bid/ask slippage.

Volitility & Option Pricing

Volitility here refers to implied volitility.

Don't confuse it with historical volitility, which is the volitity of stocks or other options carriers, e.g. futures, bonds, commodities, etc.

Option pricing crash happens when an option is purchased when the IV is high and dropped after the purchase. So even the stock price goes up the option still won't make any money.

P.S. The example above assumes you trade american style options, and you long options, means buy. And particularly it is a call option.

Option Pricing Greeks

Greeks can make or break a trade, actually all the above atom elements are powerful enough to make or break your trade, if you drop one you drop an atomic bomb on your trading account.

Delta Option Pricing

Delta is the options pricing move versus a dollar pricing move of the stocks.

The value of delta is between [0,1] for calls and [-1,0] for puts.

Calls has a positive delta, because it moves in the same direction of the stocks, puts has a negative delta, means it moves in the opposite direction of the stock price.

Gamma & Option Pricing

Gamma measures the speed of options pricing change after the initial move of delta.

It measures how fast delta moves.

E.g. If the options was bought at $1.4 and delta is .15 and gamma is .05, then after 2 trading days everything else remains the same and options price moved in our direction, the option price will become 1.4+.15+.15+.05=1.75

Theta & Options Pricing

Theta means time, usually we say "time decay", because time is always against us when we long on options, and vice versa.

If you sell an option the more time decay the merrier you get, because it means the option value depletion for the buyer.

Interest Rate & Option Pricing

This is called Rho in option pricing Greeks, in modern option trading software this has already been factored in, so shouldn't be of concern.

If you are trading with a piece of option trading software that doesn't include this in price forecasting, time to upgrade!

A quick quiz:
Pricing Options: When does options get pricing?

Afterwords:

Some basic facts:
Option pricing tables are part of the parcel if you have an online options trading account. The Black Scholes pricing model is implemented by most online brokers as an option pricing tool

All examples used here are stock option pricing examples in the american options market. Same rules apply to commodity option pricing, equity option pricing, futures option pricing, etc. The only differences are the underlying vehicles, it doesn't change the basics of options. And only american option pricing models are discussed here.

1. BUY CALLS
2. BUY PUTS
3. SELL CALLS
4. SELL PUTS