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Day 24: Basic Stock Market Concepts
Fundamentals of Futures and Options
Trading:
1. Explain Options
Greeks
Option premium changes with the change in the factors that determine
option pricing I. e. factors such as strike price, volatility, time to expiry,
interest rates etc. These sensitivities collectively known as “Greeks of Options". These include Delta,
Theta, Gamma, Vega and Rho.
Options Greeks help traders too understand how different factors such as
changes in prices in underlying assets' prices, volatility, time decay etc.
impact the option price.
2. What is Delta in Option?
The
option's Delta is the rate of change of the price of the option premium in
respect with the underlying asset's price. It actually measures the sensitivity
of the option value to a given small change in underlying asset. Delta for call
option is positive and it ranges from 0 to 1.Delta for put option is negative
and it ranges from 0 to -1.
Delta
reflects the increase or decrease in price of the option in response to a 1
point movement of the underlying asset price.
Far
out-of-the-money (OTM) options have Delta values close to 0 while deep
in-of-the-money (ITM) options have Delta values close to 1.
3. What is Theta in Option?
Theta in
option is a measurement of the option's time decay. The theta measures the rate
at which options lose their values, specifically the time value, as the
expiration date comes closer. The theta of an option reflects the amount by
which the option's value will decrease each day and it is expressed as a
negative number.
Theta is
negative for option buyer, both call and put. It is the friend of option writer
or seller.
Options
in high volatility stocks have higher theta than low volatility stocks.
Because, the time value premium on these options are higher and so they have
greater chance to lose per day. Theta value erosion maximum during closing time
of the day.
4. What is Gamma in Option?
Gamma in
option is a measurement of the rate of change of its delta in respect to change
in the underlying asset. The gamma of an option is expressed as a percentage
and reflects change in the Delta in response to a 1 point movement of the
underlying asset price.
Delta,
gamma both are constantly changing, even with a too small movement of the
security. It generally reaches at its peak value when the asset or stock price
is near the strike price of the option and decreases as the option goes deeper
into or out if the money. Options which are deeply into or out of the money
have gamma values closer to 0.
5. Clarify Intrinsic Value and Time Value
Intrinsic value is the difference between strike price and CMP (Current
Market Price). Intrinsic value can always be found in ITM options, in OTM
options intrinsic value is zero.
Option value is the total of intrinsic value plus time value. OV=IV+TV.
Premium of time value evaporates at an accelerated rate as the option
approaching closer to expiration date.
6. Explain Synthetic
Options
Synthetic option involves buying options to protect futures. Like,
buying a put with going long in a futures or buying a call going short in a
futures. It is very helpful during volatile market conditions and can protect
your capital against downside.
When you are holding a position in futures, and the market has rallied
or corrected sharply in your favour, you can use calls or puts to further
tighten your exit points.
7. What is Covered
Option Writing?
This strategy basically involves selling call options and buying futures
or seeking put opinions and selling or shorting futures. This method can allow
you to the benefits of the high options premium but it is less risky in
volatile market.
8. What are
Straddles in Options Trading?
The combination of calls and puts altogether create the straddles. This
involves buying or selling puts and calls at the same strike price. During the
life of a straddle, it is almost a certainty that one of both of the options
will be in the money at any point of in time.
Buying a straddle: Suppose you buy a December 24000 call and put, paying
a total premium say 250. Here, you know the risk of this trade. You have
to surpass both the premiums to make money.
Selling a straddle: This strategy places the odds in your favour but
raises potential risk, If market moves within a range, only then you can make
money, otherwise not.
9. What is
Strangles in Option Trading?
Basically, these are option spreads that involve both calls and puts.
Strangles is of different strike prices, so it is less likely that both the
calls and puts, or even one of the spreads will be in the money at any point of
time.
Buying a strangle: In this strategy, trader uses different strike prices
usually at the either side if the market price, As a buyer, your rusk is
limited. Example... Buying 24000 call and 24100 put.
Selling a strangle: In this strategy most of the time traders make money
as most of the time, out of the money calls expire worthless if at least they
don't surpass the premiums paid.
10. What is
Butterfly Spreads in Options?
This strategy is a combination of both a bull spread and a bear
spread.
It involves three strike prices. The risks are limited, but profit
potential doesn't justify the spread costs involved. So, you need to be very
careful while deploying this strategy without understanding the risk to reward.
If you have any other questions in your mind relating to stock market basics or need any clarification, please put your query into the comment box, We will try our best to clarify the same
Disclaimer: The information provided on MoneyWiseMind is for educational and informational purposes only. It is not intended to be financial advice, and you should not rely on it as such. Before making any financial decisions, you should consult a licensed financial advisor.
