The first rule of trading options is that options are not stocks. Just because the underlying stock moves doesn’t mean that the option moves in the same direction. You need to think of options as a separate asset class.
For example, if you are in a ship at sea, you know that the tides are linked to the phases of the moon. But the tides are only a small part of what is involved in sailing, isn’t it? You should also know about ocean currents, developing weather patterns, presence of icebergs, reefs, etc… Similarly, the option premium is only lightly tethered to the value of the underlying.
The key thing to remember is that the option premium is a function of intrinsic value, time value and volatility.
Lets say you buy a April NIFTY 6750 Call @ Rs. 59.70 when the NIFTY was trading at 6733.10. Say, the NIFTY rallies by 1% to 6800.431 the next minute. Would your call option also increase by 1%? Nope. It will probably tick up by 0.5% Why? because the delta(δ) of that option is 0.49
But what if the NIFTY rallies tomorrow by 2%. Will your call option premium now increase by 1%? Nope. There are two opposing forces that are now acting on the option.
The first, and the strongest force, is time decay. It is known to crush the best laid plans of both men and mice.
The second, is volatility. As a buyer of an option, you want volatility to go up, and NIFTY rallying by 2% in a day is just that.
It is not only important to mind your greeks at the time of putting on the trade, but you need to monitor it constantly. Greeks change not only as the underlying moves, but also as expiration approaches.
Remember your Greeks:
| Vega(κ) | Theta(θ) | Delta(δ) | Gamma(γ) |
|---|---|---|---|
| Measures the impact of change in volatility (σ) | Measures the impact of change in time remaining | Measures the impact of change in underlying price | Measures the rate of change of delta(δ) |