For the inexperienced, the world of options trading can be daunting… even confusing, but once you understand the basics of how options work, they are as simple as buying or selling stocks.

That’s why we recently featured a quick primer on call options (here) and put options (here).

Today I’m going to explain how options are priced and how that knowledge has helped my readers and I close 85 straight winning trades.

It all starts with the idea of arbitrage, which means looking for assets that are equivalent to each other, but are traded in different markets.

If one market is mispricing the asset, an arbitrage trader can make a nearly risk-free profit by buying in the cheaper market and selling in the more expensive market.

Let me explain.

If bananas cost the same to produce in Brazil and the United States, but are sold for twice as much in the states, then Brazilian producers will ship their product to the more expensive market until prices have corrected.

Years ago, the classic example of arbitrage focused on stocks traded in New York City and futures traded in Chicago. Whenever the futures price on the S&P 500 deviated from the actual value of those 500 stocks, arbitrage traders would buy the (underpriced) stocks and sell the (overpriced) futures contract. When their contract expired, they’d receive the higher price for the stocks they purchased, for a riskless and guaranteed profit.

The financial theory of arbitrage may seem complex — and it is — but you actually see it in action every time you fill up your car with gasoline. Where I live, regular gasoline has an octane level of 85, mid-grade is 87 and premium is 89. If my car runs best on gas with an octane level of 87, then there are two ways for me to fill up:

1. Fill the entire tank with mid-grade, 87 octane gasoline.
2. Fill half the tank with regular and half with premium, which should still provide an octane level of 87.

Gas station owners know this, and it’s reflected in their pricing strategy. If regular costs $2.50 a gallon and premium costs $2.70, we would expect mid-grade gas to cost $2.60. But a gas station might charge $2.61 or $2.62 for mid-grade, because it’s easier to pay for one transaction than to go through the trouble of pumping the two different grades.

However, if mid-grade was as high as $2.68 a gallon, some consumers might be motivated to save the $0.08 a gallon by filling up with half regular and half premium.

Small mispricings like this can exist in any market because typically the transaction costs are too high to be advantageous. The extra cost for using two different grades of gasoline is the additional time and effort it takes to complete the process. Most people would rather not spend the extra time needed to save a few cents.

In the stock market, the transaction costs for high-frequency trades are so low that an arbitrage trader can make a nearly risk-free profit from any opportunity he finds.

And there are just so many opportunities. My database shows there are 2,895 stocks with options being traded and 267,783 different options contracts on those stocks, and each of these stocks and options can be traded on multiple exchanges.

There is a well-known formula to define the relationship between the three products an investor could buy — a stock, a put or a call. Basically, it says the value of a put and the stock is equal to a call and some cash.

This equation ensures that we’re getting a fair price for the option we’re trading. If we were not, then arbitrage traders would jump into the market and push the mispriced option back in line with the put-call parity equation.

But here’s the kicker.

Arbitrage traders simply look at what a stock’s value is at that exact moment. My Income Trader readers and I pay attention to behind-the-scenes numbers that give us insight into what that stock should be worth.

By identifying undervalued stocks, we’ve found a way to create a win-win scenario for ourselves. And it’s resulted in a perfect record, as I mentioned earlier.

Basically, by only making trades on undervalued stocks I identify, my readers and I either collect instant income if that stock remains at the same price or rises over the duration of our contract, or we get the opportunity to buy that undervalued stock at an even lower price, locking in future gains.

In fact, my readers have already generated $6,000… $19,500… and even just under $150,000 in instant income. You don’t have to take my word for it, here’s what regular investors are saying about my strategy:

Stanley B. of Sebring, FL says over the last few months he “averaged $ 1900 per month. I collected anywhere from $214 to $2154 per trade.”

California resident Aaron L. generates “about $250 a month,” and New Jersey resident Leslie L. averages “$2,000 — 3,000” a month.

And Richard K. from Dallas says, “I will never own a stock again if I can help it… I have increased my account by $150,000. Keep the recommendations coming!

For the first time ever, I’m revealing my investment secrets in an eight-minute training video. With a 100% win rate and average annualized gains of 53%, I won’t be giving away my strategy for very long. For a limited time you can watch my free training video here.