A Beginner's way to trade options.

[hawaisanjay]

Sir I have bought IFCI 65 [email protected] HPCL460 [email protected] is your view?

 

[tonyrajeshw]

Dear traderji members,

I know about arbitrage. But I want to know whether is there any possibility that we can do arbitrage in 1 lot of mini nifty. Because , even for farther month options in mini nifty there is not even a single option type in mini nifty whose best bidder value is greater than best seller option of nifty of same type. Similar thing holds up for seller in mini nifty and bidder in nifty. So, my point is whether are there any people who are doing arbitrage with single lot of mini nifty. I expect replies from experienced members..Thanks for it in advance.

 

[malunana]

Dear all,
I bought 2 lots of Axisbank 1350 put at 43.25. Seniors pls give ur views on this. Edelweiss advises that the underlying's downward target is 1240/1210. I shall be happy to exit at 66 so that I cud get 50% profit. Pls give ur views. Thanks in advance

 

[jovial01]

Let me attempt to address them in as simple was as I can..

Delta = Amount of Change in Premium for 1 Rs. change in Nifty. So delta = +0.4 means the option price will change by 40 paise for each 1 point move of nifty.
Calls have +ive delta i.e. call premium increases by increase in nifty. Puts hace -ive delta.. cuase their premium drops as market goes up..
ATM options have delta = 0.5
ITM options have delta > 0.5, Far deep ITM option have delta approaching towards 1..
OTM option have delta < 0.5. Far OTM options have delta near 0.
As option gets more and more ITM, its delta will start increasing..

Gamma = Show the spead of change in delta.. To keep it simple. Just forget about it for the time being. Generally its value is like 0.001xx .. i.e. 1/1000 of a Rs.
shall I really care of 1 paise change.. and overload my mind.. ? (Maybe u can go those details later. Just understand the way Delta changes as described above, and u get a decent ground).

Theta = Rate of premium decay for each passing day of options life.
So if theta is 3, means, on each passing day, option premium will change by 3 rs.
For long position, theta works -ively.. and for short position theta is +ive.
As we approach towards expiry, the time premium eventuly goes toward 0. Theta shows us at what speed it will go towards 0.

Again to keep it simple. Calculate the time premium that u are paying in the option.. and divide that by days left.
Option premium has 2 parts = intrinsic value or real value and time value or value of air around that option.
eg = mkt at 4535, 4500 call option is trading at 64 rs. So the intrinsic value = 4535 - 4500 = 35 rs.
Whatever u pay beyond real value is time value i.e 64- 35 = 29 rs.
So if remainig life is 10 days.. i.e. roughly u will loose 29/10 = 2.9rs everyday.

Ideally timedecay follows expontial curve.. but using above calculation , we will follow linear curve.. doesn't make much difference..in trading.. but makes differnece if you are plannig to do research

Vega = Reflects the impact on premium due to change in underlying volatilty. Sounds great.. but complicate to calcualate.. so let me try to make it simple..
When expected voliatity in remainging life of option is high, then option seller wants more money.. so premium goes up. Option premium depends on what is gong to come (i.e. right side of the chart)
not the left side.. hence lets use our judgement to find if mkt is going to go thru big swings in next few days or not. (election result, economic news, company result etc are typical events that result in higher volatity).. In such scenario.. the time value calculated above will go up.. so the 64 rs option might start going for 80 rs.. i.e u are paying 80-35 = 45 rs for remain 10days of time.
that gives us theta of 45/10 = 4.5 rs.
So if you just practice above simple calculations.. without going into the complexity of vega, u can find out if option is fairly price (i.e u are paying decent money for per day of time). or it is
exorbitantly high money that option write is asking from you.
With practice, u can find out the typical time premium / day.

Volatility is important concept in option but it gets reflected in time premium. So to keep it simple, just focus on time premium and understand it as best as possible.

Rho = forget it.. Doesn't make much difference.. cause it has minimum effect on pricing. And Interst rate don't change everyday..

To summarize, just understand Delta and Theta first / their movement with respect to ITM/OTM/ATM..
Then look at Gamma / Vega / Rho (when u have time....)

Hope I am able to keep it simple. (There is fair bit of approximation which is used here.. so what, whatever model u use and get the price, real market price of option can still be different form that. So
as a trader, we need to live in reality and use the pricing concept to understand what is going on.. and what shd be our trading decision / which strategy should fit well etc.)

If you understand above concepts, then u will know that there are time when buying option is wrong (low volatility ahead) and there are time when selling option is wrong (high volalitility ahead)..

Any question / doubt.. feel free to fire here..

Happy Trading

Dear AW10 Sir,
I m trying to apply ur explaination for Sterlite 120 Oct Option which i bought at Rs 2.20. Currently the price of the stock is 105.
Intrinsic Value of the Stock = 120-105= Rs 15

Time Value = ??

Pl help in finding Theta .

Regards
Jovial

 

[AW10]

I guess, you are talking about 120 PUT option.
the last quote for 120 put is bid - 10.75 ask - 16.90.

Yr calculation of intrinsic value of 15 rs is correct. Now u need to look at current option price. Say if you get current price of 16.9 then out of this 16.9, 15 is due to intrinsic value and remaining 1.9 is time value.

As this option is illiquid (clear from the wide spread between quotes), you will not fair value of it when u go to sell it back in the market. Last buyer is ready to pay 10rs for something which is worth 15+ right now. That is a smart market maker against you, who is waiting for novice like you to throw your towel and just sell it at discount of 5 rs.

to calculate option greeks, it is better to use a software called Option oracle (you can download it from this site www.samoasky.com )


Happy trading.

 

[jovial01]

Sir,
Sorry for the incomplete message.I bought 120 OCT Call of Sterlite.

Pl clarify from tht respect.

Regards
Jovial

 

[ethicaltrader]

I want to trade options with the help of technical analysis. I use chart nexus for TA. Which is the best indicator? Bollinger bands?

 

[AW10]

Sir,
Sorry for the incomplete message.I bought 120 OCT Call of Sterlite.

Pl clarify from tht respect.

Regards
Jovial

When you have 120 call, then it will have any intrinsic value only when stock is trading above 120. Say if stock is at 125, then intrinsic value is 5 rs. And the call should be trading at 5+ rate in market. (these options are also called In the money ITM)
If stock is below 120, intrinsic value is 0. and whatever premium u pay now is just timevalue. (these options are also called Out of the money OTM)

in short, ITM options have intrinsic value and time vlaue. OTM options have ZERO intrinsic and time value.

Hope this helps. You can also get these basics in many places on net. Plz chk first few posts of my Low risk options ... thread where I have mentioend a basic learning route for beginners and have also given some good links on the net.
happy trading.

 

[grcstocks]

Hi AW10,

While browsing for options volatility, I came across your blog and then from your blog to this beautiful spread post.

Just a lil intro for my options trade,
I started options in last year and lost 1L in 8months, then opted a option tips broker and lost 1 L in 2 months...gave a break for 4mnths to collect some capital...and used tat time for options study.

I am trying with Long Straddles having 45-60days left for expiry.
Before seeing this post 2 days ahead, I opened a long straddle position

Expiry: 24-Nov
Strike: 5000
Ce price: 213
Pe price : 163
--------------------

When ever I trade long straddle ... I worry about range movement, time and volatility decay. ( as this has 2*theta and 2*vega effect)

Is there any position I can add to the long straddle, to make it less prone to theta and volatility ?

Thanks in Advance
Ravi

 

[amyeole]

I am very much new to this field means for option. I had done equity trading. I am just learning now about options. Actual trading will start soon.
I have 1 problem
Suppose I had taken Reliance call at 26 (strike price =800) (1 lot of size 250) when spot price of reliance is 814. Then I had sell my call option on same day at 31 (strike price =800) and at that time spot price of reliance is 822. Forget the brokerage & taxes for time being. My breakeven is at 826 so what is the loss or profit & how is calculated?
Whether spot price should be greater than only strike price or it should be greater than (strike price + Premium) for square off the position on any date before expiry in case of stock options?


Thanks & Regards