Posts Tagged ‘Short Strangle’

VEGA IMPACT IN OPTION PRICING FINAL PART :)

The Vega is highest in ATM option and slightly less at OTM and ITM options. The change in Implied Volatility will impact the most on the price of ATM option ascompared to the ITM and OTM options. The Implied Volatility can only impact the time value not the intrinsic value of the option so while comparing in betweenthe OTM and ITM options the OTM option’s Vega will be higher.

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The Impact of the Theta (time decay) to the Vega is negative. As the time passes if other thingremain unchanged the Vega decrease near to the expiration. As stated above the Vega valueis the most at ATM options and near to expiration the time value get decreased so does theVega. This is also called as Vega decay.

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The graph display that keeping all factors same(Volatility, price of underlying) the ATM Strikeoption of nifty the Vega on decreasing mode as it comes near to the expiration. When thedays left for expiration is 24days the Vega is 5.521 and 4.366 when it only 15 days are leftwhereas it is only 1.128 on the last day.There are various volatility strategies which options traders execute at the times of high/lowvolatility.

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For example, during times of earnings, elections or other major events thevolatility generally raise and to capture this opportunity the trader or investor buy strangle/straddle which is Vega positive strategy.Many traders time to time require adjusting their position to reduce the risk exposure in the market. This can be done by various ways it can be either adjustingvega with decreasing theta or adjusting vega with increasing the theta. If there is a large movement expected in the market then a buy call or put, debit spread,long strangle and long strangle adds the vega to the position but there will be risk of theta decay whereas on sideways market long ATM butterfly and long ATMcondor decrease the Vega as well as theta in the position.

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If the goal is to increase the vega and theta then the calendar spread, double calendar and Iron condorstrategy should be added to the portfolio whereas the sell iron condor, ATM Calendar and sell call or put are vega negative and theta positive strategies.In nutshell, the option trader/investor should understand the risks involved in it before entering into the trade and how the volatility impacts the position.Before entering into a trade one must have view about the direction and volatility. If there is an expectation of rise in volatility then long strangle, long straddle,debit spread, ratio and calendar spread should be followed whereas in expectation of fall in volatility one should go for short straddle, short strangle, creditspread, backspread and butterfly spread.

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Theta Value of Options Final Part :)

Continuing the final part from where i have stopped writing……………. 🙂

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At-The-Money options have the maximum time value, because intrinsic value can begin to rise at this point.

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.The graph here indicates that the (absolute) value of Theta is highest at 2.67 for Nifty 5400 Call, which is At-The-Money (ATM) strike (which is at present the closest strike to the underlying’s spot value), as the strikes move away from ATM, and gets deep into the money or deep out of the money Theta and time value tends to decrease.

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Coming to the relationship between time value and the length of time remaining to expiration, time value of an option decays at a non-constant rate, as its expiration date approaches and becomes worthless after that date. This rate of time decay is known as Theta, which measures the amount by which option’s value decreases per day.

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Theta values are negative for all options as options are always losing time value while moving towards expiration, till options take zero time value at expiration. At expiration Theta wipes out all time value leaving the options with no value or some degree of intrinsic value. The most important characteristic of Theta is that it is not constant, as date of expiration comes closer, Theta increases, implying that the amount of time value decreasing from the option’s premium per day accelerates with each passing day.

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As you can see from the graph the rate of decay (Theta) is lower in the contracts expiring in more distant months. The August 5400 Nifty call (which has 34 Days remaining to expiry), have a Theta value of -2.67; meaning this option is losing Rs.2.67 in time value each day. This rate of decay is lower for each forward month, e.g. September 5400 call (69 days remaining to expiration) has a Theta of – 2.12. But in case of the present July 5400 call option, (with volatility and price of the underlying held constant) the rate of loss of time value accelerates as the call option gets nearer to expiration (i.e., the rate of decay is much faster on the option near to expiration than with a lot of time remaining on it). With 6 days remaining to expiration Theta is -5.03, and with 1 day remaining to expiration value of Theta has increased to 8.32.

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Considering time value and its dependence on volatility, higher volatility gives rise to higher time value as increased uncertainty about underlying’s price near expiration, tends to increase Theta.

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In conclusion, while trading options one has to consider Theta decay risk carefully as the option price may fall exponentially near expiration. However option traders can turn time value decay into profits by trading net selling option strategies which always have positive position Theta as income will be generated through time value option premiums even if the underlying remains stationary and range bound and options expire worthless. Covered Call or Covered Put Writing, Calendar Spreads, Call or Put Ratio Spreads, Call or Put Credit Spreads, Short Strangle or Straddle and even simple Call Writing and Put Writing are few common option strategies which have positive position Theta.

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