This Options concept are shared by Mr Raja Mohan an Expert Option Trader. I am thankful to Him for sharing his knowledge to all the Readers.
Option price depend on
1) Intrinisic value (Value if the option were to be used right now) (Strike- Stock price) for a money making option
2) Extrinisic value
1) Intrinisic value:-
Built in value of an option only increased or decrease when the underlying Interument increase decrease in Price. It will not effect by time to expiration On th day of expiry option pricing will have only intrinisic value.
2) Extrinisic value:- It includes the following
- Time to expiry
- Rate of interest (ROI)
Option premium will be caluculated on combine Intrinisic value+ Extrinisc value
How intrinisic value is caluculated for option:-
Call option intrinsic value:- Actual stock price-Option strike price
Put option intrinsic value:-Option strike price-Actual stock price
OTM options have only time value, ITM have both intrinsic value& Time value
ATM& OTM options do not have intrinisic value
If Nifty spot price 11200
- 11200 (ATM) option have 0 intrinic value
- 11100 (ITM) option value- Spot price- Strike price 11200-11100= 100 .
- If Nifty closes on expiry day at 11205. 111000 CE Option price wil closed at 105
If there is expectation (News based event).. Option trades with high premium and during Gapdown/Gapup and when extreme Fear and greed is there is market.. IV will be high and option have high premium.
- Historical voltality (Actual Voltality)
- Implied Voltality (Expected volatality)
Historical voltality (Actual Voltality):- It’s the std deviation of underlying stock/index closing price for last 21-23 days
Implied Voltality (Expected volatality):- It’s caluculated component derived from option price when using Black-scholes option pricing model. If there is sign diff b/w HV and IV.. trader can take advanatage.
Measures of uncertainity or fear in the mkt Higher voltality= Higher Option value
India VIX used as proxy for measure future volatality (IV)
Implied voltality is measure of how much movement the mkt expects
- When mkt expects huge moves IV increases
- Usually increases when Mkt down esepecially Gaps
- Usually decreases when mkt moves up or moves slowly
- Is very high near to events. Avoid buying Options to near to events when high IV.
Low Implied voltality-
- Option Buyer pays less
- Smaller expected movements
High Implied volatality:-
Option Buyer pays more and Option seller demands more premium wider expected movements
IV is not same for every strike
In Equity and indices IV is-
- Higher for lower strike prices
- Lower for higher strike prices
ITM Options Bid price/offer price may be diff and iliquid and STT ALWAYS CONSIDER ONLY OTM/ATM OPTION IV.
We can’t predict IV like stocks and up and down and no math forumula.
ATM IV is the only reality in options trading and ATM IV is the IV of the options.
ATM IV is usually consists within time horizon. ITM and OTM IV swing wild with strike distance and days to expiry.
OTM IV is always high
Put Options priced at higher IV bcoz of demand from investors to Puts used as Hedge options and Premium also high.
High for ATM options and low for ITM/OTM
Buy call:- (Stocks/Index)
When expect big quick upmoves (Guarentee)
When IV is low
Buy call If IV is very low
Sell Put if IV is very high
IVP (IV Percentiale at 100 days history)
If stock/Index IV is below then IVP.. it indicates below avg IV then historic average
Sell Put- Bullish view
Sell CE- Bearish view
Buy CE- Bullish view
Buy PE- Bearish view
Buy call- low iv
sell put- high iv
Buy call spread- small upmove
Sell put spread- no down move
Buy call- big upmove (low iv)
Sell put- no downmove (high iv)
Buy call spread- small upmove (iv does not matter) (meduim profit potential and max low loss)
Sell put spread- no down move (iv does not matter) (max loss high, profit potential high)