Tag: options

Forensics: NIFTY Options – Theta(θ) Decay

The most intuitive option greek is theta (θ) – a measurement of the option’s time decay. Theta measures the rate at which options lose their time value, as the expiration date draws nearer. It is usually expressed as a negative number.

Simply put, theta of an option reflects the amount by which the option’s value will decrease every day.

Time and Theta

  1. Longer term options have theta of almost 0 as they do not lose value on a daily basis.
  2. Theta is higher for shorter term options.
  3. Theta is higher for at-the-money options.
  4. Theta changes at an exponential rate. It goes up dramatically as options near expiration as time decay is at its greatest during that period.

Theta decay in action: March 2014 NIFTY Options Since Jan

First, lets look at the underlying:

NIFTY

To capture the full move of the NIFTY, you’ll have to look at, at least, a dozen strikes between 5950 and 6900.

θ of Calls:

March 2014 NIFTY Theta (CE)

θ of Puts:

March 2014 NIFTY Theta (PE)

Does it mean that you should go out and sell the heck out of every option you can find close to expiry?
 
No! As expiration gets closer, the risk posed by extreme amounts of gamma outweighs the theta you’re collecting.
 
Stay tuned for more.
 

Related articles
Categories Tags ,

Forensics: NIFTY Options

Charting options is a tough task. The price of the option is probably the last thing that is important. Implied volatility (IV), underlying volatility (σ) and option greeks play a big part in putting on successful option trades. We ran a tool that we developed on ATM Nifty options that tries to capture most of these moving parts.

2013-01-31 Nifty Call Analysis

Observe:

  • Theta (θ) declines.
  • Vega declines.
  • Rho converges to zero.
  • Call Delta is, on an average, around 0.54 (std. dev. of 0.075)
  • Call IV has been stable and decreasing since January this year: (0.150260, 0.149456, 0.147249, 0.136280)

Nifty Call Delta and IV

Nifty Put Delta and IV

March 2014 charts

Calls
2014-03-27.CE

Puts
2014-03-27.PE

Pictures say a thousand words, don’t they? Stay tuned for more.

Related articles
Categories Tags ,

Buffett’s $1 billion bet on a basketball contest

We had discussed how an options trader can think of himself as The One Man Insurance Company (TOMIC.) Now Warren Buffett has gone out and insured a $1 billion basket ball contest.

The contest

The National Collegiate Athletic Association’s (NCAA’s) tournament consists of 63 games. A contestant who accurately predicts the outcome of each of those games wins $1 billion. The contest is sponsored by Quicken Loans. Warren Buffett’s Berkshire Hathaway has insured the prize money.

The ods

A blind guess has a one in 9.2 quintillion chance of winning.

If the average person submitting a bracket had a 78.6% chance of getting each game right, and the maximum 10 million people sent in their brackets. What is the likely number of correct brackets? One.

Buffett keeps the premium

Aleph Blog:

Every tournament has significant upsets. Someone who has a good understanding of how good the teams are will know how to pick the most likely team to win. It is tough to pick the upsets, and tougher to pick all of the upsets. There is no good model for upsets, or they wouldn’t be upsets.

 

This is the proverbial “fat pitch” of options trading. The chances of winning are so low but the payoff is so large, that both the option buyer and the option seller can agree on a reasonable premium and get the deal done.

Sources:

Tough for Buffett to Lose this One
Warren Buffett Bets $1B You Won’t Pick Perfect NCAA Tournament Bracket

Categories Tags

The One Man Insurance Company

I am recently reading a book bombastically titled “The Option Trader’s Hedge Fund” (Amazon). In that the author says that the best way to look at option trading is to think of it as an insurance business. So if you are an options trader, you should think of yourself as The One Man Insurance Company (TOMIC).

TOMIC

It sort of makes sense because what you are doing when you are trading options anyways? You are buying and selling insurance of some kind with different co-pays and terms. If you are hedging your positions then you are “reinsuring”, etc.

The chapter on volatility was insightful. It discusses the impact of ATM options price in the near term, volatility skew, and term structure on implied volatility. Its a useful framework to have.

Overall, its an interesting book that’s worth a read.

Categories Tags

Algorithms At Work!

The last few weeks have been brutal to cash-only equity investors. The NIFTY has gone nowhere even while swinging wildly on a daily basis. Is there a way to turn a profit given what has been going on?

Yes! With the help of option strategies it is possible to profit from stocks you expect to go side-ways. Here’s what we did.

ACC technical analysis chart

StockViz Option Ideas drew our attention to the ACC Long Call Butterfly around the 10th of December. The stock was under a pennant formation, and was on a decline from its 5 day high of Rs. 1445. With Bollinger bands enveloping 1450 and 1360 levels, there was a strong possibility that that stock was going to be range-bound for a bit.

We entered a long call butterfly trade for December expiry. With an outlay of Rs. 26,750 we bought 5 contracts (market lot of 250).

ACC long call butterfly trade P&L

The payoff chart for our butterfly looked something like this:

ACC long call butterfly payoff

With ACC ending at Rs. 1402 at option expiry, the position made us Rs. 9,950 (38%) profit in just 17 days even as equity holders sucked wind.

Here’s what your New Year’s resolution should be:

KEEP CALM trade options

call us qr code

[stockquote]ACC[/stockquote]

Categories Tags ,