Options Pricing
Factors affecting options price:
Volatility
It is a measure of risk, uncertainty or the variability in the future price of a stock
Higher volatility reflects greater expectations of fluctuations in either direction for a stock
Options are more valuable with increase in volatility
Introduction to Options
Options Pricing
Factors affecting options price:
Not possible to anticipate future volatility, however two ways to estimate the volatility:
- Historical volatility
- Implied Volatility: It is the market’s estimate of how volatile the stock will be from the present up to expiry
Introduction to Options
Options Greeks
Delta
Ceteris Paribus (stock price, risk free interest rate, strike price, time to expiry and volatility) - Delta of an option indicates how much the premium will change for a unit change in the price
Introduction to Options
Options Greeks
Delta
For an option with a delta of 0.50, the premium of option will change by 50 paise for a Re 1/- change in the price of stock
Delta is 0.50 for ATM options, as the option becomes ITM the value of delta increases and it decreases as the option becomes OTM
Introduction to Options
Options Greeks
Delta
Delta indicates that OTM options are less sensitive to price change as compared to ATM and ITM options
Delta is positive for bullish positions (long futures, long call, short put) and negative for bearish positions (short futures, long put and short call)
Introduction to Options
Options Greeks
Delta
Delta for call options varies from 0 to +1
Delta for put options varies from –1 to 0
Delta for long futures is +1
Delta for short futures is -1
Introduction to Options
Options Greeks
Theta
Theta shows how much value the option will lose after one day with all the parameters remaining same
Theta is always negative (positive) for the buyer (seller) of options, as the value of option loses value each day if the anticipated view is not realized
Introduction to Options
Options Greeks
Theta
Theta of one month Reliance 420 Call option is 1
Spot = 410
Call Premium = 15
Ceteris Paribus and one day passes, the value of RIL 420 call option will reduce by Re 1/-
Introduction to Options
Options Greeks
Vega
Vega indicates how much the option premium will change for a unit change in volatility of the spot
Volatility increase is advantageous to the buyer of option (I.e vega is +ve) and disadvantageous to the seller (I.e. vega is –ve)
Introduction to Options
Options Greeks
Vega
Vega of 1 month Reliance 420 Call option is 1, when volatility is 35
Spot = 410
Call Premium = 15
Ceteris Paribus and volatility moves to 36, call premium will increase to 16
Factors affecting options price:
Volatility
It is a measure of risk, uncertainty or the variability in the future price of a stock
Higher volatility reflects greater expectations of fluctuations in either direction for a stock
Options are more valuable with increase in volatility
Introduction to Options
Options Pricing
Factors affecting options price:
Not possible to anticipate future volatility, however two ways to estimate the volatility:
- Historical volatility
- Implied Volatility: It is the market’s estimate of how volatile the stock will be from the present up to expiry
Introduction to Options
Options Greeks
Delta
Ceteris Paribus (stock price, risk free interest rate, strike price, time to expiry and volatility) - Delta of an option indicates how much the premium will change for a unit change in the price
Introduction to Options
Options Greeks
Delta
For an option with a delta of 0.50, the premium of option will change by 50 paise for a Re 1/- change in the price of stock
Delta is 0.50 for ATM options, as the option becomes ITM the value of delta increases and it decreases as the option becomes OTM
Introduction to Options
Options Greeks
Delta
Delta indicates that OTM options are less sensitive to price change as compared to ATM and ITM options
Delta is positive for bullish positions (long futures, long call, short put) and negative for bearish positions (short futures, long put and short call)
Introduction to Options
Options Greeks
Delta
Delta for call options varies from 0 to +1
Delta for put options varies from –1 to 0
Delta for long futures is +1
Delta for short futures is -1
Introduction to Options
Options Greeks
Theta
Theta shows how much value the option will lose after one day with all the parameters remaining same
Theta is always negative (positive) for the buyer (seller) of options, as the value of option loses value each day if the anticipated view is not realized
Introduction to Options
Options Greeks
Theta
Theta of one month Reliance 420 Call option is 1
Spot = 410
Call Premium = 15
Ceteris Paribus and one day passes, the value of RIL 420 call option will reduce by Re 1/-
Introduction to Options
Options Greeks
Vega
Vega indicates how much the option premium will change for a unit change in volatility of the spot
Volatility increase is advantageous to the buyer of option (I.e vega is +ve) and disadvantageous to the seller (I.e. vega is –ve)
Introduction to Options
Options Greeks
Vega
Vega of 1 month Reliance 420 Call option is 1, when volatility is 35
Spot = 410
Call Premium = 15
Ceteris Paribus and volatility moves to 36, call premium will increase to 16