OPTION GREEKS DERIVATIVE MARKET
In our previous articles, we have discussed more options terminologies. Most of you would be ready for trading.
Still may have confusion about option premium, how it’s calculated, and nearby expiry out-of-the-money option was expired worthless why it is so?
Derivatives are a complex instrument. Let us simplify your doubts one by one. You all know option buyers give a premium and seller receive a premium, lest start the option premium calculation
Option premium = Intrinsic value + Time value of money
The amount of the option, the premium is determined by several factors, that include the volatility of the underlying, time to expiration, and intrinsic value of the stock.
Option intrinsic value refers to the amount by which the option is In-the-money. Remember one thing in your mind only In-the-money option has intrinsic value whereas at-the-money and out-of-the-money options have zero intrinsic value.
So, what are the intrinsic value in the call option and put option? Take one example, Nifty traded around 11600, call option buyer bought 11400 Call option and put option buyer bought 11700 put option strike, both the strike traded at a different premium like 260 and 160. Let us calculate the intrinsic value of the option. Look at the table below
NIFTY SPOT PRICE: 11600
SPOT PRICE – STRIKE PRICE
STRIKE PRICE – SPOT PRICE
11600-11400 = 200
11700-11600 = 100
We know the option premium and intrinsic value, using the above formula we can calculate the time value of the option.
Strike price and time to expiry are the key variables to determine the option prices. We have to look at some other variables determine the option price are
The sensitivities of the option price determined by the above variable generally called as “Greeks “.
The most important of the Greeks is the options Delta. This measures the sensitivity of the option value to a small change in the price of the underlying asset.
Delta = change in option value/change in the price of the underlying
It theoretically explains the option price change per unit change of the underlying asset.
The delta is often called hedge the ratio for example if you have a call option of 11600 CE and the delta value is 0.5 that means, one rupee price movement of nifty will move 0.5 rupees of your call option.
Gamma works as an acceleration of delta also determine the option price will go either in-the-money or out-the-money due to a change in the price of the underlying asset.
Gamma = change in an options delta/change in the unit price of underlying
Its measure of the sensitivity of an option to time decay. It is generally used to get an idea of how time decay is affecting your option position.
Theta = Change in an option premium/change in time to expiry
Time decay is the enemy of the option buyer and a friend of the option seller.
This is a measure of the sensitivity of an option price to changes in market volatility.
Vega = Change in an option premium / change in volatility
Vega is positive for long call and long put. An increase in the assumed volatility of the underlying increases the expected payout from a buy option, whether it is a call or put.
Rho measures the change in the option price per unit increase in the cost of funding to the underlying asset.
Rho = Change in an option premium/change in the cost of funding the underlying asset
We come to the final stage of the derivative market and cover the basic concepts. Let us have a quick view of the advantages of options trading.
· Options have great leverage to trade
· Cost efficiency compare to equities
· Probability of higher percentage return
· Option gives alternative strategic trades to hedge your portfolio
· Used as a hedging tool for the investors
· For speculators, options can give low-cost investment to go long or short the market with minimum risk.
CONCLUSION – OPTION GREEKS:
· We cover the beauty of options trading in a detailed manner, but be cautious, without risk management the option is a suicide game.
· Plan your trades as per your risk-taking capacity.
· The main part of the trading is greediness.
· Don’t maximize the position of your trades that will lead to you bankrupt.
· Before taking any position calculate your risk and consult your financial advisor.