Decision Factors
A huge factor in deciding whether or not to purchase an option rests in the expected volatility (price movement) vs. the stock's historical volatility.
Volatility = magnitude of a stock move, this can be up or down.
If stock has low historical volatility, that means investors are willing to hold the stock and not trade it.
This usually indicates the stock will see low volatility in the future.
The 12m calculation for historical volatility is a good indicator.
Implied volatility measures the current expected volatility of the stock.
When we measure the historic against the implied, we can see if the stock's expected (implied) volatility is above or below normal historical volatility.
If implied volatility is higher than historic volatility, the option is overvalued.
If implied volatility is lower than historic volatility, the option is undervalued.
If implied volatility is close to the historic volatility, the option is fair valued.
All of this is done for you with a calculator called the Black Shoales Calculator.
The BSC allows you to project the future value of an option by allowing you to manually change the Strike price, share price , time to expiration, volatility, annual interest rate.
http://www.blobek.com/black-scholes.html.
Forecasting
Each time you invest, you must choose a strategy that takes advantage of your forecast for the market or a particular stock.
This is a tremendous challenge and is impossible to be right 100% of the time.
To make a forecast, use the best available info and tools and then apply your individual; interpretation of them.
Always forecast before making a trade. Most option traders focus on short time frames for their forecasting (generally 3 months or less).
As option traders we try to use the leverage of an option to profit from a short term move in the market or individual stock.
Rules
The Trend is your friend. Never buck the trend or you lose.
Spot trend of the major indexes first: DOW<S&P500,NASDAQ.
Keep in mind that the trend tells you WHAT to do, and the Indicator tells you WHEN to do it.
ALWAYS - check the trend before you check the indicator.