# Options

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What are in-the-money options? A call option is in-the-money if its strike price is below the current market price of the underlier (stock,Index etc) . For example, if you bought a 4000 strike NIFTY CALL OPTION and NIFTY is trading at 4200 the call option is in-the-money. A Put option is in the money when its strike price is above the current market price of the underlier (stock, Index etc.) . For example, if you bought a 5000 NIFTY PUT OPTION and NIFTY is trading at 4900 the put option is in-the-money. What are out-of-money options? A call option is out-of-money when its strike price is above the current market price of the underlier (stock) . For example, if you bought a 5000 NIFTY CALL OPTION and NIFTY is trading at 4900 the call option is out of money. A Put option is out-of-money when its strike price is below the current market price of the underlier (stock) . For example, if you bought a 5000 NIFTY PUT OPTION and NIFTY is trading at 5100 the put option is in-the-money. What are at-the-money options? An option is at-the-money if the strike price of the option equals (or nearly equals) the market price of the underlying security(stock). What is intrinsic value of the option? Intrinsic value can be defined as the amount by which the strike price of an option is in-the-money . Some people view it as the value that any given option would have if it were exercised today For Call options, Intrinsic value = Current Stock price – Strike Price For Put Options, Intrinsic value = Strike Price - Current Stock price Note intrinsic value cannot have negative value so minimum intrinsic value is 0 for an option What is time value of the option? Time Value = Option Price - Intrinsic Value Lets take an example: If stock XYZ is trading at Rs 105 and the XYZ 100 call option is trading at Rs 7, Intrinsic value = 105 – 100 = 5 Time Value = 7 – 5 = 2 So, we would say that this option has time value = Rs 2 Open Interest and Trading Volume What is open interest? The total number of options contracts on an underlyer that have not yet been closed i.e. they have not been exercised, expired or squared off. Is increased open interest bullish?

Different people view it in different manner. Generalizing it may not be a good idea. Many people interpret open interest as described below: Rise or fall in the open interest may be interpreted as an indicator of the future expectations of the market. A rising open interest number indicates that the present trend is likely to continue. If the open interest number is stagnant, then it may suggest that the market is in a cautious mode. If Open interest starts declining, then the market suggests a trend reversal mood. In a rising market, continuous decline of open interest indicates an expectation of downward movement. Similarly, in a falling market, the decline of open interest indicates that the market expects an upward trend. What is the difference between volume and open interest? Volume is the number of contracts of a particular option contract that have traded on a given day, similar to it meaning the number of shares traded on a particular stock on a given day. Open interest is the number of option contracts for a particular stock at a specific strike price and a specific expiration date that were open at the close of trading on the prior trading day. While some traders look at this information as an indication of liquidity of a particular option or option chain, a more reliable indicator may be the tightness of the bid / ask spread. A common misconception is that open interest is the same thing as volume of options and futures trades. This is not correct, as demonstrated in the following example

Time

Jan1 Jan2 Jan3 Jan4

Trading Activity Open Interest A buys 1 option and B sells 1 option contract C buys 5 option and D sells 5 option 1 contracts 6 A sells his 1 option and D buys 1 option 5 contract 5 E buys 5 options from C who sells 5 options contracts

-On January 1, A buys an option, which leaves an open interest and also creates trading volume of 1. -On January 2, C and D create trading volume of 5 and there are also five more options left open. -On January 3, A takes an offsetting position, open interest is reduced by 1 and trading volume is 1. -On January 4, E simply replaces C and open interest does not change, trading volume increases by 5. What does liquidity mean? Ability of an option or other tradable security to get bought or sold in the market without affecting the price.

the option will be relatively high, and vice versa. How can I find out how much margin is applicable for an options? You can find out the applicable margin from your broker. Many online brokers like www.hdfcsec.com , www.icicidirect.com etc. do provide tools to calculate margin requirements. Will I get margin benefits if I have positions on different underlying? No, you will not get margin benefits in this case. Will I get margin benefits if I have positions in both futures and options on same underlying? Yes, you will get benefits in this case. Will I get margin benefit if I have counter positions in different months on same underlying? Yes, you will get margin benefits in this case. However, the benefit will be removed three days prior to expiry if the near month contract. Options Geeks What is option DELTA? Delta can be defined as amount by which an option’s price will change for corresponding 1 point change in price of the underlying stock or index. Long Call options have positive deltas, whereas Long put options have negative delta whereas Short Call options have negative delta, and Short put options have positive delta. Let understand using couple of examples. • Delta of NIFTY Mar-2009 3000 CALL is 0.50. Theoretically, this means that if NIFTY moves up by 1 point, this option’s price will go up by 0.5 point. Similarly, if NIFTY moves down by 1 point, this options price will go down by 0.5 point • Delta of NIFTY Mar-2009 2800 PUT is -0.75. Theoretically, this means that if NIFTY moves up by 1 point, this option’s price will go down by 0.75 point. Similarly, if NIFTY moves down by 1 point, this options price will go up by 0.75 point Note that DELTA values are dynamic and changes almost everyday. What is option GAMMA? If Delta is viewed as the ‘speed’ of price movement of option relative to underlying then option Gamma can be viewed as the acceleration. Basically, Gamma measures the amount by which delta changes for a 1 point change in the stock price. For example, if Gamma of an option is 0.5, that means theoretically that with 1 point price movement of underlying the delta will move 0.5. Long calls and long puts have positive gamma whereas short calls and short puts have negative gamma. What is an option VEGA? Vega can be interpreted as the amount by which the price of an option will change with 1% change in implied volatility of the underlying. One common scenario when option Vega changes is when there is a large movement in underlying price. Long calls and long puts both have positive vega where as short calls and short puts will always have negative Vega. What is an option THETA?

Option theta can be interpreted as change in the price of the option with one day decrease in the remaining life of the option. To put is simply it is a measure of time decay. Note that longer the life of an option, the higher will be the premium and vice versa. With each passing day the value of option decreases (considering all factors equal). What is theoretical value of an option? When you want to buy an option you probably want to know what is the fair value of the option and what should be the fair price of an option, whether the option is undervalued, over valued or rightly valued. You can get answers to these questions by calculating the theoretical value of an option. There are many mathematical models and formulas available which can be used. What are Binomial and Black-holes equations? These are mathematical models that can be used to calculate the theoretical value and greeks of an options. How important is it to use options geeks? If you consider option Greeks in taking decisions to buy or sell options you are basically increasing your probability to make a profit in your trades.

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