Copyright 2020 by Cleta Arun M.D
All rights reserved. No part of this publication may be reproduced, distributed, or transmitted in any form or by any means, including photocopying, recording, or other electronic or mechanical methods, without the prior written permission of the publisher, except in the case of brief quotations embodied in critical reviews and certain other noncommercial uses permitted by copyright law
Table of Contents
Introduction
Options r financial ntrumnt that are drvtv bd on th vlu f underlying urt uh tk.
An tn contract ffr th bur th rtunt to buy or selldepending on th t f ntrt th hldth undrlng t. Unlk futur, th hldr nt required to buy or sell th t f they choose nt t.
Cll tn llw th hldr to bu th t t a ttd r wthn a f timeframe.
Put options llw the hldr t ll the t t a ttd price wthn a f timeframe.
Each tn contract will hv a specific xrtn dt by whh th holder must xr thr option.
The ttd r n n option knwn as th trk r.
Otn are tll bught and ld through nln r rtl brkr.
KEY TAKEAWAYS
Otn r financial drvtv that give bur th rght, but nt th blgtn, t bu r ll an undrlng asset t n grd-un r and date.
Call options nd ut options frm the b fr a wide range f option strategies designed fr hdgng, nm, r speculation.
Althugh thr r mn rtunt t rft with options, nvtr huld carefully wgh th risks.
Otn
Undrtndng Otn
Options are a versatile fnnl rdut. These ntrt nvlv a bur and a llr, whr the bur n tn rmum fr the rights grntd b th ntrt. Eh ll tn h a bullish bur and a brh llr, whl ut options hv a brh buyer and a bullh seller.
Options ntrt uull rrnt 100 hr f th underlying security, nd th bur wll a premium fee for h contract. For xml, f n option h a premium f 35 cents r ntrt, buying one tn would cost $35 ($0.35 x 100 = $35).
The premium rtll bd n th trk pricethe r for bung r llng th security untl th xrtn dt. Anthr ftr n th premium r the expiration dt.
Jut like with tht carton f mlk n the refrigerator, the expiration date ndt th d the option ntrt mut b used. The undrlng t wll determine th u-b dt. For tk, t uull the thrd Frd f th contract's month.
Trdr nd nvtr wll bu and ll options for vrl rn. Otn speculation llw a trdr t hold a lvrgd position in an asset t a lower t than bung shares of th t. Investors wll u tn t hdg or reduce th rk exposure f thr rtfl.
In some , the option hldr can gnrt nm when th bu ll tn r bm n tn writer. Options r l n f th mt drt w t invest n l. Fr tn trdr, n tn' dl trdng volume and n interest r th tw key numbr to wth n rdr t mk th most wll-nfrmd nvtmnt dn.
Amrn options can be xrd n tm bfr th xrtn dt f the option, whl Eurn tn can only be xrd n th xrtn dt or the xr dt. Exercising mn utlzng th rght t bu r sell th undrlng urt.
Otn Rk Mtr: The Grk
Th "Greeks" is a term ud in th tn mrkt t drb the dffrnt dimensions f risk nvlvd n tkng n tn position, thr n a particular tn r a portfolio f tn.
Th vrbl r called Grk bu they are tll td wth Grk mbl. Eh rk vrbl a result f an mrft umtn or relationship f th option wth another undrlng vrbl. Traders u dffrnt Grk vlu, uh as delta, theta, nd thr, t tn rk and mng tn portfolios.
Dlt
Delta () rrnt the rate f hng btwn the tn' r and a $1 hng n th underlying t' price. In thr wrd, th r ntvt f th tn relative t th underlying. Delta of a call tn h a rng between zero nd n, whl th dlt f a ut tn h a rng btwn zero and negative n. Fr xml, assume n nvtr is lng a ll tn wth a dlt f 0.50. Therefore, if the undrlng tk increases b $1, th tn' price would thrtll nr b 50 nt.
Fr tn trdr, dlt also represents the hdg rt for creating a dlt-nutrl tn. Fr xml f you urh a tndrd Amrn ll tn with a 0.40 delta, you will need to sell 40 hr f tk t b full hdgd. Nt delta for a portfolio f options n also b used t obtain the rtfl' hdg ration.
A l mmn ug f an tn' delta t' urrnt rbblt tht t wll xr in-the-money. Fr instance, a 0.40 dlt call option td h n implied 40% rbblt f fnhng in-the-money.
Tht
Theta () rrnt the rate f hng btwn the option r nd tm, r tm ntvt - mtm knwn an tn' time d.
Tht ndt th amount n tn' price wuld dr th tm to expiration dr, ll l ul. For xml, um n investor lng n tn with a theta f -0.50.
The tn' r wuld dr by 50 nt every d tht , ll l bng equal. If three trdng d , the tn' vlu wuld theoretically decrease by $1.50.
Tht nr whn options are t-th-mn, nd decreases whn tn r in- nd ut-f-th mn.
Options lr t xrtn l hv lrtng tm d. Lng ll and lng ut will uull have negative Tht; short calls nd hrt puts wll have positive Theta.
By mrn, n instrument wh value nt rdd by tm, uh as a tk, would have zr Theta.
Gamma
Gamma () represents th rt f hng btwn an option's delta nd th undrlng asset's r. Th is called nd-rdr (nd-drvtv) r ntvt. Gmm ndt th amount th dlt wuld hng gvn a $1 move in the undrlng urt. Fr xml, um an investor long one call tn n hthtl tk XYZ. The ll option h a dlt f 0.50 nd a gamma of 0.10. Therefore, if tk XYZ nr r decreases by $1, th ll tn' dlt wuld nr r decrease by 0.10.
Gmm is used t dtrmn how tbl an tn' dlt : hghr gamma vlu ndt tht dlt could change drmtll n rn t vn mll mvmnt n th undrlng' price.
Gamma higher fr tn that r t-th-mn nd lwr for options tht are n- and ut-f-th-mn, nd lrt in mgntud as expiration rh.
Gamma vlu r gnrll mllr the further w frm th date f xrtn; options with longer xrtn are less ntv t dlt hng. A xrtn approaches, gmm vlu r tll lrgr, r hng hv mr mt n gamma.
Otn traders m t to nt only hedge dlt but also gmm in rdr t b dlt-gmm nutrl, mnng that the undrlng r moves, th delta wll remain l t zero.
Vega
Vg (V) rrnt th rt f hng btwn n option's value nd the underlying t' mld vltlt. This is the option's sensitivity t vltlt.
Vega ndt th munt n tn' r hng gvn a 1% hng n mld volatility. Fr example, an tn wth a Vega f 0.10 ndt th tn' value xtd to hng b 10 nt if th mld vltlt hng b 1%.
Bu nrd volatility implies tht th undrlng ntrumnt mr lkl to experience xtrm vlu, a r n vltlt will rrndngl increase th vlu f n tn. Cnvrl, a dr in vltlt wll negatively affect the value f th option. Vg t t mxmum for at-the-money tn tht hv lngr tm until expiration.
Th fmlr wth th Grk lngug will nt out tht thr is no actual Greek lttr nmd vg. Thr are vru theories about hw th mbl, which rmbl the Grk lttr nu, found t w nt tk-trdng lng.
Rh
Rh (p) represents th rate of hng btwn n option's value nd a 1% hng in th ntrt rt. Th mur ntvt t th interest rate. For example, um a ll tn h a rh f 0.05 and a r f $1.25.
If interest rt rise by 1%, th value of the ll tn wuld increase t $1.30, all l bng equal. Th t tru fr ut tn. Rh is greatest fr t-th-mn tn with lng tm untl xrtn.
Minor Grk
Sm thr Greeks, wth aren't discussed as often, r lmbd, epsilon, vomma, vr, speed, zmm, color, ultima.
Th Grk r nd- or thrd-drvtv f th pricing mdl nd affect things such th hng in delta with a change n vltlt nd so n.
Th are increasingly ud n options trdng strategies as computer ftwr n quickly compute and account fr th mlx nd mtm tr rk ftr.
Rk nd Prft Frm Bung Cll Otn
A mntnd rlr, th ll options lt th holder buy an undrlng security at th stated trk r b th xrtn dt lld th xr.
Th hldr has n blgtn t bu th t f th d nt wnt to urh th asset. Th risk to the call tn buyer limited t the premium paid. Flututn f th undrlng stock have no impact.
Cll tn bur r bullh n a tk and blv th hr price wll r above the trk r before th tn' expiry.
If th nvtr' bullish utlk realized nd th tk price nr bv th trk r, the investor n xr the tn, buy th stock t th trk r, and mmdtl ll the stock t the urrnt mrkt price for a rft.
Thr rft n th trd is th mrkt hr r l the strike hr r plus th xn of the tnth premium nd any brkrg mmn t place th rdr.
