This article was written by the I Know First Research Team.

We have written a lot about how Ai can help you with trading in stocks and building your portfolio around a specific strategy. But what about other kinds of assets, some of the more exotic ones, you might ask? As it turns out, artificial intelligence can help you with those as well, and in this article, we will be looking at AI in options trading.

Options Contracts: What’s It All About?

Options are derivatives that allow (but not oblige!) you to buy or sell a specific security at a certain price, known as the strike price, within a specified time period. The options that allow the holder to buy the security at the strike price before maturity are known as call options. Their counterparts providing for selling the underlying asset are referred to as put options. American options normally allow exercising (in other words, carrying out the transaction specified by the terms of the options contract) at any point within the period they cover, while European options can limit the window of opportunity to the time of their maturity.

(Source: I Know First)

In other words, let us say we are in possession of 100 stocks (which is how many an option contract normally covers) of Company A. While it is doing just fine right now, its stocks trading at $100 each, we are worried that an impeding market slump, coupled with the new regulations on its business sphere, could send this price all the way down to $50 per share and wipe out a major chunk of our capital. To prevent this, we buy a 3-year option contract that will allow us sell these specific stocks at $80 each. Or, alternatively, we issue an options contract ourselves. In doing so, we are effectively buying insurance for our portfolio, investing into a hedge against the upcoming trouble.

Hedging is a good way to use options, but not the only way. Another scenario is where we anticipate stocks of Company B to soar in the future, but instead of buying them right now, we acquire options, which can be cheaper and would give us more leverage if stock B rockets to the sky. Or, if we expect it to go down, we can acquire an options contract to sell it at a high price, buy it cheap in the future, after the plunge, and profit off the options contract as it allows us to sell high. These are, of course, only some of the ways to use options speculatively, but you get the main idea.

The price of the options themselves depends on the market price of the underlying asset and its initial price. Other key variables traders normally look at are volatility and time left until maturity. When talking about volatility, we normally distinguish between historical, or statistical, and implied volatility. The former is calculated from the historical data for stock price movements over a specific period of time, while the latter is an estimate of how much the price can fluctuate in the future. For example, implied volatility can run high amid rumors that company A is about to release a new product, because the big new thing could make a splash in the market – or end up collecting dust in warehouses.

These three variables are normally used to establish the probability of the underlying ending up on the right side of the strike price. Here is the idea: you multiply the current price of the underlying by its volatility and by square root from days until maturity divided by the number of days in a year. The result is a standard deviation of where the price of the underlying will end up at the moment of maturity. Under a normal distribution, it would end up within +/- 1 standard deviation off the current price. Note the plus-minus part: if the standard deviation for our stock A is 5, when the option matures, it can cost 105 or 95.

I Know First Predictive AI: Advanced Tech For New Era Of Finance

The rise of the artificial intelligence industry has shaken up the world, and the financial sphere has not been exceptional in this sense. Tech-savvy start-ups utilizing AI transform the financial sector, disrupting the conventional wisdom and processes. And while AI has many applications in FinTech, one of the most challenging and exciting areas for its use is stock market predictions. Among the leaders in this sphere is an Israeli company with an ambitious name I Know First.

(Source: Pixabay.com)

The company has trained a Deep Learning AI, while also drawing upon genetic programming. It utilizes artificial neural networks to go through fresh market data and model what happens next based on the trade signals it picks in it, identifying the best investment opportunities. The genetic programming components allow it to be aware of its performance, re-calibrating its models whenever they start underperforming and increasing the accuracy of predictions with every iteration. This also ensures that the AI re-gears itself to any new conditions, evolving hand in hand with the markets it analyzes. Furthermore, it can also be re-configured to simulate various scenarios for what-if scenario analysis.

The AI provides predictions for over 10,500 financial instruments, including stocks, ETFs, currencies, commodities and cryptocurrencies. The forecasts are delivered as a heatmap with two numeric indicators: signal and predictability. The signal is indicative of the performance of each asset on the forecast as measured against the other financial instruments on the forecast. The predictability indicator shows how well the algorithm has been predicting the stock so far. The time horizons for forecasts range from 3 to 365 days, covering short, mid- and long-term outlooks.

AI And Options Trading: Human Brilliance Meets Big Data

Now, going back to the option contracts, it is quite easy to see why predictive AI and these derivatives click so well together. In most cases, to make a profit on options, you need to have a picture of what happens next on the securities that you are working with. A skilled trader would conduct extensive research into the company and the market it is working on to figure out what the future could have it store for it and trade accordingly. An AI-generated forecast would come in handy here, joining the arsenal of the tools of the trade alongside technical or fundamental analysis. Derived exclusively from objective data and lacking any human bias or emotion, the AI would compliment the trader’s own skills and brilliance.

The scope for its in speculative trading is simply overwhelming. The I Know First AI can help options traders in their wagers by identifying the stocks with the highest potential for massive growth and slumps, helping them profit on the difference between the strike price and market price on long and short trading respectively. The proponents of directional strategies, in other words, those that are built around the underlying going up or down, are most likely to benefit from AI predictions.

And that is not to mention that the Ai delivers predictions not just on stocks, but on options as well, demonstrating quite an impressive accuracy rate in a recent evaluation. The use of such predictions is pretty much self-explanatory: they can greatly assist speculative traders in picking up the options for shorting and longing in the same way an investor a trader would pick the stocks to go for.

The Iknowfirst predictions for options have consistently beaten the benchmark in a recent evaluation. (Source: Iknowfirst.com)

Even for investors with no specific appetite for the options market, I Know First predictions can come off as an indicator for what to expect next. Is your portfolio about to tank, are there bad news on the horizon? If your crown jewels are in the red, it may be the time to get some options as a way to hedge against the upcoming storm.