Application of Option Greeks

7/23/2019 Application of Option Greeks

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August 19, 2014

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Tags: Option Greeks (http://zerodha.com/z-connect/tag/option-greeks), Delta (http://zerodha.com/z-connect/tag/delta), Vega (http://zerodha.com/z-connect/tag/vega), Theta (http://zerodha.com/z-connect/tag/theta)

In the previous post (http://zerodha.com/z-connect/queries/stock-and-fo-queries/say-hello-to-the-greeks), we discussed the Option

Greeks and got a perspective on what they are. An understanding of the previous article is important for this article. In this article we

will attempt to help you understand the practical uses of Option Greeks, and how you can use the Greeks to trade options more

profitably.

Option Greeks are also called the option sensitivities, as each of the Greek is sensitive to a particular market variable. Sensitivity

represents risk in some form or the other. When you have an open option position, the intensity of these sensitivities have a magnifying

effect simply because they exert their influence on the option position ‘simultaneously’. Think about it.

No one can stop time hence, theta has a continuous effect

No one can stop the markets from its natural movement, hence the delta is on the move always

Market participants are always driven by emotions, which translates to market volatility, hence the vega gyrates all the time

To give you perspective, imagine a juggler, trying to juggle 5 different balls while standing at the edge of a mountain cliff. This is what

happens, when you trade options! The 5 different balls are equivalent to the Greeks, and the cliff itself is the markets!

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APPLICATION OF OPTION GREEKS

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(https://reader009.{domain}/reader009/html5/0317/5aaca14cbea75/5aaca14fa53Delta – Always add them up!

As we know, the delta helps the trader understand the rate at which the option premium is likely to change based on a

change in the underlying price. Hence delta is highly sensitive to the price change in the underlying. Any naked option

position has a non zero (for all practical purpose) delta value.

Before we proceed, let us revisit some basics. We know the delta varies between 0 and 1 for a call option, and -1 to 0 for a put option.For the sake of simplicity, let’s consider the call option delta to vary between 0 and 100, and put option delta to vary between -100 to 0.

Also, the delta of futures is always 100. This is because the future always move (magnitude and direction) in line with the underlying.

So, the delta of futures contracts (Nifty Futures, Infy futures, ACC futures etc) is always 100.

Keeping this in perspective, imagine the following situation.

A trader is long 3 lots of Nifty 7800 CE while the spot is trading at 7700. Clearly, the option is OTM(out of the money), hence the delta

should be less than 50. Let us assume the delta as 40. The intention is to hold the option position open for 2 weeks. However, after

initiating the long call position, the trader is now worried about a potential selloff in markets (maybe over the next two days), hence

would like to hedge the open option position.

The trader can hedge the position by calculating a simple ratio called the ‘Hedge Ratio’. The hedge ratio helps determine the number of futures lots one needs to short in order to be hedged against the anticipated fall in the market.

(http://zerodha.com/z-connect/wp-content/uploads/2014/08/Hedge-Ratio.jpg)

The hedge ratio is simply the ratio of the option delta to the futures delta. Remember, the futures delta is always 100.

Hence, going back to the example, the delta of the option is 40 and futures is 100; hence the hedge ratio would be:

= 40/100

= 0.4

This means to hedge 1 option position with 40 delta, the trader need to short 0.4 lots of futures. Since there are 3 lots of option, it would

be 0.4 x 3 = 1.2 lots. Obviously one cannot short 1.2 lots, hence the closest approximation would be 1 lot of futures short.

The trader now has 3 lots of 7800 CE long, and 1 short futures position. Think about this in terms of ‘total position delta’.

(http://zerodha.com/z-connect/wp-content/uploads/2014/08/Delta-table.jpg)

Without the hedge the trader had 3 lots of Call options with total position delta of 120. In other words, a delta of 120 indicates that for

every 1 point move in underlying, the option premium varies by 1.2 points. By adding the short futures position, the trader has now

neutralized the delta by 100 points, leaving a total delta exposure of 20.

Imagine that it was possible to short 1.2 lots of futures, in which case the short futures would contribute to -120 delta, which would

completely neutralize the long option’s 120 delta. The combined position ( 3 lots of CE , and 1 lot of short futures) yield 0 delta [ 120

delta from call option minus 120 delta from futures].

When you have a zero delta position, it is also called a ‘Delta Neutral’ position. When we have a delta neutral position, the total delta of

the combined positions is 0. This means for every 1 point change in the underlying, the position moves by 0 points.

A delta neutral position indicates that the option position’s sensitivity to directional risk is completely taken away. When one establishes

a delta neutral position, the direction does not matter – the market can go up or down but the position will not get affected. In other

words, the direction no longer matters!

Classic delta neutral strategies include the straddles and the strangles.

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In a straddle strategy, you buy both ATM(at the money) call and put option expiring at the same time. Consider this example…

Spot Nifty = 7780

Call Strike = 7800

Put Strike = 7800

Both the options are ATM, hence their approximate delta would be:

Call Delta = + 50

Put Delta = -50

Total position delta = +50 – 50 = 0, making it delta neutral.

So irrespective of how many positions you have, always add up the delta to know your position’s sensitivity to direction. Keep the

following two points in mind..

1. If the delta add up to 0, then you have a delta neutral position. This means you are completely insulated to any directional risk

2. If the delta add up to 100 (for example buying 2 ATM Nifty call option yields a combined delta of 100) this is as good as owning a

Nifty futures, since nifty futures has a delta of 100

If you aspire to be a full time options trader, I would suggest you internalize the concept of delta quite well as it forms the foundation

for interesting strategies such as –‘Volatility arbitrage using dynamic delta hedging’.

(https://reader009.{domain}/reader009/html5/0317/5aaca14cbea75/5aaca151885c

– Trade the trend

Traders usually underestimate the effect of vega, and the massive influence it has on an options position. Understanding

vega and its implication on an option position is one of the keys to successful options trading. In the previous article

(http://zerodha.com/z-connect/queries/stock-and-fo-queries/say-hello-to-the-greeks), we stated that the options premium (both call,

and put) increases with increase in volatility. Let us explore this a bit deeper.

The chart below shows the behavior of a call option premium with regards to increasing volatility, when there are

1. 5 days to expiry (red line)

2. 15 days to expiry (green line)

3. 30 days to expiry (blue line)

The graph below shows what would happen to the options premium, if volatility were to increase when there are 5 days to expiry.

(http://zerodha.com/z-connect/wp-content/uploads/2014/08/Call-vs-Vega_v1.jpg)

As you can see, irrespective of how many days are left to expiry, the option premium always increases with respect to increase involatility. However, on a closer observation there are few other things that come to light. When volatility increased from 15% to 30%:

1. The call option premium changed to 58 from 37 (54%) when there were just 5 days to expiry


http://zerodha.com/z-connect/wp-content/uploads/2014/07/vega.png



2. The call option premium changed to 127 from 69 (84% ) when there were 15 days to expiry

3. The call option premium changed to 190 from 96 (97%) when there were 30 days to expiry

Similar observation can be made for put options.

(http://zerodha.com/z-connect/wp-content/uploads/2014/08/put-vs-vega_v1.jpg)

We can generalize two things:

1. Premium always increases when the volatility increases

2. The effect of volatility is high when there is more time to expiry. This is because, with more time to expiry, higher the probability of

extreme events occurring

Notice, when there were 30 days left to expiry, a change in volatility from 15% to 30% resulted in a massive 97% move in the option

premium. However the same change in volatility when there were just 5 days left to expiry resulted in only a 54% move in option

premium!

Let us summarize these observation into action items. The following points hold good for a simple, plain vanilla 1 leg option trade.

1. When you intend to buy an option, always have a view on vega. For volatility to work in your favor, you should time the option

purchase in such a way that you expect the vega to increase. This naturally means one should avoid buying options when volatility

is high

2. Likewise, when you intend to sell options, you should again have a view on volatility. Avoid selling options when you expect vega

to increase. Which means when you are short options, for vega to work in your favor, the vega should fall

3. Avoid shorting options when you are at the start of a series (more number of days to expire), and/or expect vega to increase

4. When we are close to expiry, shorting options is a good idea, especially if one anticipates a drop in vega

5. As a corollary to point 4, one should avoid buying options when there are just few days left to expiry, and/or when one anticipates

a drop in vega

A slightly more mature option trader who trades in option spreads may wonder how would the volatility impacts the strategy cost, of let

us say a 2 leg spread position such as the bull call spread or a bear put spread.

To understand the effect of volatility or the vega on the strategy cost of the spread position, have a look at the following chart.



(http://zerodha.com/z-connect/wp-content/uploads/2014/08/spreads-vs-vega_v1.jpg)

Looking at the above graph, it is clear– increase in volatility increases the cost of strategy.

On further inspection, it is also quite evident that at the start of a new series (blue line) even with an increase in volatility, the strategy

cost does not increase much. However, volatility seems to have a massive effect on the strategy cost when there are fewer days to

expiry (red line).

Translating this to an action item, when you intend to initiate a spread position (bull call, bear put), always have a view on volatility, and

therefore the Vega. For Vega to work in your favor:

1. Ensure the vega is expected to go higher

2. If you expect vega to go down, avoid taking the spread trade. One can even look at shorting the spreads

3. The vega has little impact at the start of the new series (as in when there is more time to expiry)

4. Initiate the spread position anytime after the midway of the expiry. This is when there is a maximum impact of volatility

(assuming it is expected to increase)

One can develop visualizations to analyze the effect of vega vs time vs premium (strategy cost) on any strategy. However, the rule of

thumb is the same – for a net buyer of an option, increasing vega benefits, and for a net seller of an option, decreasing vega helps.

(https://reader009.{domain}/reader009/html5/0317/5aaca14cbea75/5aaca153cb8Theta – helps you strike right!

Time has a decreasing effect on the premium. In fact for this reason options are considered a depreciating asset.

Previously, we learnt about the time decay factor. However, there is another interesting and important angle to theta. It

helps the trader identify the right strike to trade under a given circumstance.

To help you develop a perspective with respect to strike selection methodology (we will first deal with a long call option) we will set up

few practical trading scenarios that we regularly come across.

Assume we are at the beginning of a new series, where a stock is trading at 5,000, and we are of the opinion that it will hit a target of

5,200. Given this target expectation, the objective is to select a strike in such a way that it gives the trader maximum bang for the buck.

Now, here is the situation, we are at the start of a new series (maximum number of days to expiry). Which strike of call options would

you choose to trade, given the following expectation?

1. We expect the target of 5,200 to be hit in 5 days

2. We expect the target to be hit in 15 days


4. We expect the target to be hit by expiry

Now obviously, just like the way one size does not fit all, we cannot select the same strike to trade for the above scenarios.

Have a look at the following graphs. It represents the profitability on Y axis, and strike on the X axis.

http://zerodha.com/z-connect/wp-content/uploads/2014/07/theta.png



(http://zerodha.com/z-connect/wp-content/uploads/2014/08/Call-vs-theta_start-of-the-series_v1.jpg)

Look at the first block of chart. In the backdrop of the stock moving 5000 to 5200 within 5 days this chart is telling us what would be the

profitability of each strike starting from 4700 (ITM) to 5500 (OTM). Clearly the profitability increases as you traverse from ITM to OTM. In

other words, it looks like the best strike to choose in terms of profitability, would be 5500 (OTM).

However, the same strike would have lost money in the 2 scenario, notice, 5500 actually made a small loss, even though the market

moved in the right direction. Also, the graphs suggest that the best strike to choose when one anticipates the target to be hit in 15 days

would be the ATM option.

You may have heard of traders say that they lost money on call option, even though the markets moved up. Now you know why this

happens –they simply choose the wrong strike!

Look at the 3 and 4 graph blocks, they are really interesting. The graph is suggesting you choose an ITM or at the best an ATM option

when you expect the target to be hit towards the end of the expiry. All other strikes lose money!

Now remember, this is with respect to initiating a position at the start of the series. What if you want to initiate a fresh long call trade

when we are half way through the series? Let us assume the same movement of 200 points (from 5000 to 5200), but slightly different

scenarios:

1. Target hits on the same day

2. Target hits within 5 days

3. Target hits within 10 days

4. Target hits on expiry

The following graph should help you in select the strike:

(http://zerodha.com/z-connect/wp-content/uploads/2014/08/call-vs-theta_2-weeks-before-expiry.jpg)

nd

rd th



Notice, when we expect the target to be hit on the same day, selecting an OTM option makes most sense. You may have heard of stories

where traders doubled their money on the same day trading options, this is because they have selected the right strike for the right

situation.

Notice in the 3 and 4 blocks, again selecting a strike beyond ATM tends to lose money, even if the market moves in your favor.

The same logic can be applied to Long Put option. Assume we are at the start of a new series, and you expect the stock to go down from

5000 to 4800 – a 200 point down move. Here are the various scenarios:




4. We expect the target to be hit by expiry

The graph below shows us which strikes seem appropriate under each of the above scenarios.

(http://zerodha.com/z-connect/wp-content/uploads/2014/08/put-vs-theta_start-of-the-series_v1.jpg)

Clearly, the same inference can be drawn as we did while analyzing the call option at the start of the series.

The graph below shows the profitability trading put options when we are half way through the series and expect

1. Target to hit on the same day

2. Target to hit within 5 days

3. Target to hit within 10 days

4. Target to hit on expiry

(http://zerodha.com/z-connect/wp-content/uploads/2014/08/put-vs-theta_2-weeks-before-expiry_v1.jpg)

The strike selection methodology irrespective of long call or long put are the same; hence we can generalize it with the following table.

rd th



¶ (http://zerodha.com/z-connect/comment/11237)

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(http://zerodha.com/z-connect/wp-content/uploads/2014/08/Strike-selection.jpg)

Conclusion

First of all, if you have read through the entire article, kudos to you as I can imagine application of Greeks can be a fairly complicated

topic, especially for a person new to this topic. If you plan to take options trading seriously it is imperative that you take the effort

to learn Option Greeks and their application in detail.

In the next article, we will talk about using the options calculator to calculate the Greeks.

Until then, stay tuned – stay profitable.

sridhartv25

Hi I think this may be the wrong place to post my question, sorry for that.

Is there any plans for Zerodha to provide its own demat accounts instead of depending on third party. Is there any plans in the future for

Zerodha owned demat accounts.

Reply (http://zerodha.com/z-connect/queries/stock-and-fo-queries/application-of-option-greeks?replytocom=11237#respond)


Nithin Kamath (http://www.zerodha.com)

Yes Sridhar, it will probably take a bit for this.


sridhartv25

Thank you very much for you reply Nithin. Other than the demat account opening I see zero issues with zerodha so I thought I a Zerodha

owned demat could solve this. I talmost takes 15-30 days for a demat account to open with ILFS where as trade account opens in one day.

Looking forward for the zerodha owned demat account.


swapnil

Thanks Karthik for useful information.

I have one query “how the trade is profitable if delta is 0?”

Karthik Rangappa ()

I've been trading and investing in the Indian markets for over a decade. I strongly believe that trading is not a gift that you are born with but

a skill that you can develop over time. At Zerodha, I’m involved in Equity Research & Education initiative. I hold a Masters Degree in Risk &

Asset Management from EDHEC Business School, France and a Bachelor of Engineering from Bangalore University.

http://zerodha.com/z-connect/queries/stock-and-fo-queries/application-of-option-greeks

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Karthik Rangappa (http://www.zerodha.com) Post author

Swapnil, sometimes the trader may just have an opinion on volatility instead of the direction of the market. For example you may think that the

volatility is way too high, and therefore you anticipate the volatility to cool off. Under such a situation you just want to play volatility, and suppressthe effect of the market direction. This means you will have to neutralize the delta to zero, and leave your option position exposed only to the

variations of vega.




In fact this is what one does (knowingly or unknowingly) when one initiates a delta neutral strategy such as straddles and strangles.


swapnil

Thanks karthik,

Is there any website which gives daily values for Implied volatility for nifty options for current and next series?

How to know that implied volatility will increase or decrease?

what are the factors affecting it?

Thanks,

Swapnil.




To get a sense about increasing or decreasing volatility one can use a tool called the ‘Volatility Cone’. I know, Samoa Sky’s Options Oracle gives this

information (it is a free tool). Need to check if they still support the Indian markets. If they do, they are quite good.


loke4300

thank you for this !!!! clear written and explained.


Ankur Shah

Not related to the Post but related to Trading Question: How do i add BSE Script in the Market Watch as it allows to add only NSE Script (P.S.:

My Account with Zerodha opened today only)?


































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Check this post (http://zerodha.com/z-connect/tradezerodha/zerodha-trader-software-version/zt-setting-up-marketwatch), and 3rd image.


Ankur Shah

Thank you so much for the Prompt reply.

I am using the the HTML Trading Platform & Mobile (as Desktop Trading Platform is not supported with Windows 8.1). Click on the

following Link to see the Problem:

https://reader009.{domain}/reader009/html5/0317/5aaca14cbea75/5aaca15758c71.9inisjt/Untitled-1.jpg (https://reader009.{domain}/reader009/html

It shows only NSE and not BSE.



Hanan (http://www.zerodha.com)

Ankur, our desktop trading platform ZT works very well on Windows 8.1. Get in touch with us if you’re having trouble installing and using it.

About BSE not being enabled, we’ve made note of this and will make sure you have BSE available for tomorrow’s trading session.


Ankur Shah

Thank you so much for Prompt Reply.


ajay mittal

hi nithin,

this is not related with subject. but i want to know ,if we have more than one accounts of a group with their consent , can we avail consolidated

margin facility to trade in fno ?




No Ajay, not possible. What you will probably have to do is open a partnership/LLP firm, get everyone to invest money into the firm, open a trading

account in the firms name and then trade of it.











https://www.dropbox.com/s/n3cpipng9inisjt/Untitled-1.jpg


http://zerodha.com/z-connect/tradezerodha/zerodha-trader-software-version/zt-setting-up-marketwatch






















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nilesh

sir, i am using trend following method to trade in intraday nifty fut. instead of nifty fut i am thinking to trade nifty option to save stt and other

costs. my system uses around 12 point stoploss and target till end of the day ( riding trend till it ends ).

around 32% trades are winner and 68% are lossers. so basically i am trading with small stoploss for big profits. which option should i trade,

buying ITM or OTM or ATM option or should i go for short option. all my postions squareoff at end of the day. pure intraday.




Nilesh, check the table in the theta section from the article above. If you are trading intraday, clearly you are expecting the target to hit on the

same day…it is always better you choose slightly OTM options.


Vaib

Thanks Karthik. On delta neutral, quick question for you – suppose you sell 7800 straddle for combined premium of 300, when the spot was

7700. Now, instead of keeping it till expiry, can you suggest some delta neutral adjustments along the way especially when trade goes against

so we get out of straddle position net positive? Nithin – your inputs will also be valuable. Thanks.




Vaib,

A straddle will be delta neutral as long as you initiate the position using ATM option. In the example you’ve quoted the position will not be delta

neutral..since 7800CE is OTM, assume a delta of -0.4, and 7800PE is ITM, assume a delta of +0.7. Note, the algebraic sign indicates a short (+ve for

Put, and -ve for Calls).

So the total delta adds to -0.4+0.7 = 0.3. Therefore in this position you are exposed to both directional, and volatility risk.

To negate the direction risk, you will have to ensure the delta becomes zero, and stays zero. There are many ways to do this, for example you can

consider adding 2 short calls, and 1 short PE..that would make -(2*0.4) +0.7 = – 0.1…closest approximation

After making this adjustment, the position becomes delta neutral, and the direction no longer matters. As long as your call is right on Vega, you willsurely make some profits.

Good luck.


Vaib

Thanks Karthik. Sorry, I mean’t ATM straddle only. My point – let’s say we sell 7700 straddle for combined premium of 300 when spot was

around 7700 only. BEP is 7400-8000. Now, spot comes to 7500, now what will you suggest – book 7700 call, sell 7300 call (since 7700 PE is

going against with 200 points ITM)? This will become a short gut with 7700PE & 7300CE sold. I can hedge it like this but I fear of more one

way down movement when the short gut range becomes more than combined premium eaten resulting into a loss. If you may guide on

these kind of adjustments, would be helpful. Hope I make some sense

























Dear Vaib,

Got your point. I’m going to elaborate a bit for the benefit of other readers..

When you initiate a straddle(both long and short), it is very clear the call is on volatility, and not on the direction of the market. .

When you short the straddle, it implies that you expect volatility to reduce. In other words, you plan to profit from a fall in volatility, and not from a

directional movement. Now, in order to fully exploit this point of view, you need to ensure your position is always hedged to directional risk.

When you initiate the position by shorting ATM options, needless to say you are directionally hedged…but when market makes big move, you are

no longer delta hedged. Quoting from your own example….

When you initiate the position when mkts are at 7700,

7700 CE delta= -0.5

7700 PE delta = +0.5

Position Delta = 0

However, when the markets falls to 7500 (a 200 point downward drift)..

7700 CE delta = – 0.1 (since its OTM)

7700 PE delta = +0.9 (since its ITM)

Position Delta = +0.8

Notice, with a delta of +0.8, the position is no longer delta neutral…which means along with the risk of volatility, you are also exposed to directional

risk.

This also means whenever you initiate a delta neural position, it is neutral at THAT point in time…as and when the markets moves, the delta varies,

and hence the position’s delta also varies. The trader has to continuously monitor the position;s delta and ensure they always add up to zero.

You suggested a short gut when markets fall to 7500, lets see how the deltas add up..

Spot = 7500

Short 7700 PE = delta of + 0.9 (as its ITM)

Short 7300 CE = delta of – 0.9 (as its OTM)

Total position delta = 0

(please note, I’ve just approximated the delta’s for ease of explanation)

Clearly, the position is delta neutral…and you can continue doing this, to ensure you are delta neutral. However, there are three things come to my

mind..

1) Your costs increase as you pile on more number of trades

2) It would be very hard to terminate the positions anytime before expiry

3) Your estimate on volatility has to be accurate. I f the Volatility does not cool off as expected, you may end up making a loss

For something like this to work in your favor, I’d suggest you initiate the position towards the 2nd half of the series. With this..

1) You will benefit from time decay

2) If you are right on volatility,then towards the 2nd half you will have an added advantage of decreasing volatility, and time (see the graph of Vol

vs time in the previous article)

3) Premiums will be lower, but so would be the stress on position

Also, from my experience I can tell you that trades such as these are best done before events such as budget, quarterly results, corporate

announcements etc. This is when volatility shoots up, and premiums swell.

Lastly, one of the best ways to play volatility is by initiating trades based on Volatility Arbitrage using dynamic delta hedging technique. I’d suggest

you explore this as well.

This turned out to be a post within a post, but as long as it helps

Good luck.










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Vaib

Thanks Karthik for your comments. To your points –

1. Costs and # of trades will anyway increase in any kind of delta adjustment.

2. We may terminate positions before expiry if spot comes back in the range and we take the benefit of theta/vol.

3. Even if vol remains high, when we shift to adjustment leg, we will get higher premiums to short.

I was hoping if you could provide some adjustments in this straddle case or suggest what to do in case short gut leg range becomes more

than combined premium eaten.

We may also want to avoid very frequent adjustments due to cost/complexity involved.

Thanks for your time and inputs.




Yup, costs and # trades are bound to go up. Elevated vols fetches you higher premium, agreed, but this is associated with elevated gamma levels.

As a rule of thumb, I’d personally prefer to keep option legs minimum, and also try to restrict layering up…for the simple reason that it gets too

complex.

Anyway, if I were to trade short straddle (expecting the volatility to cool off) I would prefer to adjust the position with futures.

After I initiate a short straddle, I’d profit as long as the market drift is minimum, but more often than not, this is not the case.

Hence as an adjustment strategy, I’d short futures if the markets fall (because option delta turns positive)…and buy futures if markets starts to go

up (because option delta turns negative).

Converting a straddle to a short gut is tricky, by doing so somewhere you are increasing the complexity of the whole situation.

I do remember you mentioning that you’d prefer not to touch the futures, but I personally think this is far more manageable than having to deal

with multiple option legs.

I hope I’ve added some value…please do feel free to revert.


Vaib

Thanks Karthik. Yes, your insights are very much helpful. I’ve never tried it on future but will test. Thanks again.




Thanks, and good luck.


subclt




























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Dear karthik

Thanks for nice and excellent explanation.Because of new to this option writing and Greeks segment, I am requesting you to please

elaborate dynamic delta hedging technique.so that I can try practically




Thanks Subramanian. We will surely blog about the technique sometime soon.


Deepak

Thanks for the detailed explanation of Option Greeks,But from where do we get the value of all the Option Greeks such as

Delta,Theta,Vega,Gamma etc. Is there any specific site where we can get all the required details. Can you please create the Platform in Zerodha

online trading Platform where we get to see the details easily




Deepak, the next post will be on using the Options calculator to calculate the Option Greeks.


Somesh Gupta

By option calculater we find accurate Delta,Vega n theta then how much accurate option premium we got…




Somesh, can you kindly elaborate your question? Thanks.


Somesh Gupta

Sir, At present we use approx value of option Greek that result some time we find accurate option premium and some time we find +/- 5

point. for ITM Call / Put we use approx + / – 0.50 to 1.So that questioningly we want to know when we use option calculator we find

accurate Delta,Vega n theta then how much accurate option premium we calculate.































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Somesh, thanks for elaborating your question. As long as your volatility estimate is right, you will get the a fairly accurate premium value. On the other

hand you can feed in the market value of the premium, and then get the volatility estimate. From my experience, most of the option calculators

(including Zerodha Trader) works quite accurately.


Somesh Gupta

Thank’s a lot SirJi…


Jeetu

Hi Sir, Just wanted to say that I am very excited & looking forward to the launch of the new platform “Pi”. The teaser seems to be very

promising with advanced tools & techniques, unlike anything I’ve seen before.

So, I’m very curious to know when is this being launched. It would be great if you can share a vague idea on the timeframe for its launch, i.e.

whether in a few days, weeks, or months.

Thanks,

Jeetu




Thanks Jeetu. Pi should be out soon..just waiting for few regulatory clearances.


gurumrao

Thanks Karthik for the structured explanation. I would like to know more on writing covered calls. Usually I write OTM calls at the beginning of

the series. If the underlying stock moves up, I keep averaging my write position. Allow it till expiry. While I do end up with profits, it is very

uncomfortable to keep monitoring the movement every day and average the positions. Is there any specific methodology in writing covered

calls – (a) selecting strike price; (b) when to take position; …




Thanks Guru Rao, I’m glad you liked the post.
































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For selecting the strike, and when to take the positions I would suggest you go through the Theta section of the article. Along with this, I’d also

suggest you look for the volatility of the stock. For example, if the monthly volatility of a stock trading at 100, is 15%, then it makes sense to write

options beyond the regular volatile range of the stock. In this case, I’d be happy to write 120 Call option.

Calculation as below..

Stock price = 100

Vol = 15%

Margin of safety on volatility = 5%Total room for Vol = 15%+5% = 20%

Strike to be selected = 100*(1+20%) = 120

Option writing does lead to sleepless night, one has to just adopt to it


gurumrao

Thank you very much Karthik. I do write covered calls against my holding (infy). Few basic questions – (a) where do I find the monthly

volatility info?; (b) do I need to take the average (or something like that) of last few months of “monthly volatility”?




You can easily calculate the historical monthly volatility on excel. Please check this link for historical volatility calculation –

http://tradingqna.com/3804/how-do-we-measure-volatility-for-stock-or-share?show=3804#q3804 (http://tradingqna.com/3804/how-do-we-

measure-volatility-for-stock-or-share?show=3804#q3804)

Always good to know the volatility range for last 1 year and 6 months. Do let me know if you face any issue in calculating the volatility for Infy.


gurumrao

Hi Karthik, I was able to calculate the volatility for Infy. Not sure how to share the excel with you for verification!!

Here is what I did …

– downloaded Infy data from NSE site for the period 1-Jan-13 to 28-Aug-14

– considered the “Close Price” and not the “LTP”

– Daily SD as on 28-Aug-14 came out as 2.03%

– Monthly volatility came out as 9.52% (considered 22 days for SQRT. Hope this is correct)

Let me know if there is any way I can share the excel with you.

If these calculations are correct, going by your earlier explanation, I should select strike price that is … may be around 11% (1.5% cushion)

away from the previous expiry closing price.

Ex. Infy closed at 3598.8 on Aug expiry day 28-Aug.

For Sep, with 11% safety, the strike price would be 4000.

Am I right?




This seems correct, however I’d like to see the Excel working once. Can you kindly share it? I’ll send you a test email. Thanks.





http://tradingqna.com/3804/how-do-we-measure-volatility-for-stock-or-share?show=3804#q3804
























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Srinivas

Very cumbersome, is it not better to sell ATM call and put options

and waitfor premiums put together to come out ?




Srinivas, I’m assuming you are referring to my reply to Mr.Guru Rao

If yes, well it actually is the right thing to do, unfortunately it is not straight forward, therefore seems a bit cumbersome

Selling ATM options is quite risky, especially at the start of the series, and when you don’t have a view on volatility.


Sukesh

Sir, Bit confused about ur comment. You have mentioned Selling ATM options are “the right things to do” and also “quite risky”..

Can you clarify pls.. Thanks..




Sukesh…you missed the words in between

I was talking about calculating the volatility and then writing the option at that strike as the right thing to do.

However selling ATM option especially at the start of the series as risky.Suggest you refer the above four conversation to get the flow


Sukesh

Thanks for correcting me, If i can bother you with one more question..

What does “At the start of the series mean”, is it Near month options (30 Days?), or 60 Days or 90 Days options?

Thanks




Near Month. For example the article considers today (1st Sept 2014) as the start of the series for September series.































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Sukesh

Hello,

Thanks for this wonderful article, really helpful for aspiring option traders.

My question is, to illustrate effect of volatility or vega, you have taken an example of a scenario where the volatility has increased from 15 to 30

percent.

I’m wondering is this example realistic, because volatility in Indian markets won’t show such increases even during critical events such as

budgets results etc. I think this might have happened only in 2008 even UPA came to power and the markets touched circuits.

Please advise.

Thanks




Hi Sukesh…glad you liked the article.

Nifty has exhibited Volatility range of anywhere between 14% to 24%…and of course during events it can peak beyond the normal range. However,

individual stock volatility can gyrate to a large extent. You may be surprised to know that stocks like Infosys exhibits volatility of close to 45% – 50%

ust before its quarterly result announcement.

Anyway, the whole point is to illustrate the fact that premiums react sharply to volatility, and one must always have a view on where vega is

heading before taking an options position.


Manish

Hello Sir

I want to take an Exponential moving average of highs for 20 days (Generally its close but i want to use field high) I use EMA(High, 20) but I am

informed this only catches the high in the last 20 periods so how do i get the average ??

Please guide

Manish




Manish, I’m a little confused. Can you kindly elaborate the question along with its relevance to options? Thanks.


Manish



























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()

Hello Karthik

What I meant was

Generally we use average for a particular number of periods with field as close but

I want to use EMA for 20 periods but field highs should be( Simple speaking I want an EMA of past 20 days high)

eg, day 1 50 55 45 49

day 2 55 57 46 50

day 3 54 56 40 51 and so on……..

Here now I want to calculate EMA for second field ie HIGH 55 57 56 ……. for 20 periods

When i used EMA(High, 20) I was informed this only catches the high of past 20 periods rather than returning me EMA

Please guide

Manish




EMA is a more reactive when compared to SMA, hence it tends to stick closer to the prices. You can use any variable (within OHLC) as a data feedto the EMA formula. EMA formula is insensitive to the data you feed.

EMA(High,20) seems to be the right expression.


Manish

Hello Karthik

For buy alert expression i use:

SET A = (RSI(CLOSE, 10)) (RSI(CLOSE, 10) > 55) and RSI(CLOSE, 10) > SMA(A, 10) and CLOSE > EMA(HIGH, 20)

For sell alert expression i use:

SET A = (RSI(CLOSE, 10)) (RSI(CLOSE, 10) < 45) and RSI(CLOSE, 10) < SMA(A, 10) and CLOSE < EMA(LOW, 20)

Buy exit alert 0

Buy sell alert 0

But this triggers trade only on the buy side and sell side trades r not generated. Sell expression is exactly simply reverse of buy

expression.

I have tried on many scripts , nifty as well as currency for 5 min interval

Could u guide

Manish 9820818028


Manish

I have even tried to set a different variable for the sell expression but still it seems not to generate sell trades. What could be the solution

?

Manish




















()




()




()

Sukesh

Correct me if i am wrong: There is no position which is delta neutral over a wide range of variation.

As the market moves, a position which was delta neutral will no longer be delta neutral??

Is there any strategy where delta stays neutral no matter how much the market moves?

Thanks




You are right. No position stays delta neutral. Delta changes as and when market changes. As far as I know there is no strategy that is delta neutral

tru its lifespan.


Sukesh

Are there any plans to teach Dynamic Delta Hedging? If not can you please refer me to some good source online where i can learn that?

Thanks




Stay tunes on Z Connect Sukesh. We will talk about dynamic delta hedging soon.


subclt

Dear karthik

I used to write both nifty call and put option,400 points away from the underlying nifty as a my strategy in the beginning of the series.But the

last month and this month (September contract) premiums are very low.For example the combined value of 8400 call and 7600 put is only 19

in September contract.In this scenario nifty option writing is worthless because of less profit.please guide me if you have any other good

strategy to get somewhat more profit or correct me if am wrong.Thank you




The premiums are low because the volatility is low. Use the volatility calculation as explained above (see my reply to Guru’s comment) to select the

right strike.





























()




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()


subclt

Thanks for the reply.Is it advisable to write the next month contract using the above said same strategy.




You can as long as you are comfortable with holding a short option position for so long. Also ensure you multiply the vol with sqrt of 60.

Example : If the daily volatility of Infy is 1.26%, the two months volatility will be 1.26%*sqrt(60) = 9.76%.


Deepak

Hello Karthick,What is the code for creating a backtesting based on RSI,Suppose for Reliance I want to do backtesting based on RSI such that It

should give buy signal when RSI is less than 30 and Sell Signal when RSI is >70. Is there any way to learn how to code




Deepak can you kinldy post your query here – http://zerodha.com/z-connect/charting-coding-and-backtesting/code-your-strategy-tutorial/code-

your-technical-analysis-strategy (http://zerodha.com/z-connect/charting-coding-and-backtesting/code-your-strategy-tutorial/code-your-technical-

analysis-strategy). It is a dedicated post for coding your technical strategy. I’m sure there are others who will benefit from it as well. Thanks.


Fakir Mohan Pradhan

Hi Karthik,

When you say ‘ x days left for expiry’, does it mean ‘x trading days’ or ‘x calendar days’.

Fakir.




That would be calendar days.







http://zerodha.com/z-connect/charting-coding-and-backtesting/code-your-strategy-tutorial/code-your-technical-analysis-strategy


























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Manimegalai.A

hello sir, post market open time is 3.40pm to 4.00pm, market price and equity, i have placed order. but order rejected, reason- admin stopped

AMO, why? please reply




Check this post (http://zerodha.com/z-connect/queries/stock-and-fo-queries/pre-marketpost-marketafter-market-orders). You can place AMO

orders only after 6.30 pm.


amit_bestus

Can u plz illustrate how to use Options calculator




Will be putting up the post soon.


Nagaraj patil

Hi Karthik,

Thanks for your great effort on Option Greeks,

When can we expect your next post on the same.

Regards,

Nagaraj patil


amit_bestus

Thanks Karthik….eagerly looking forward


santanu








http://zerodha.com/z-connect/queries/stock-and-fo-queries/pre-marketpost-marketafter-market-orders

























()


()

()

Dear Karthik, i am a graduate with honours in physics. i am also a previous bank employee and now a govt school teacher. i want to start trade

in options. as i have to continue my job , it is not possible for me to present before the terminal during market hours. is it possible for me to

trade in options ? what are the basic parameters and pros and cons of options trading ?




Sir..unlike futures, options does not require you to stay glued to the terminal. You can begin with small positional trades until you get comfortable

with options. For basic parameters (at least on Option Greeks) I suggest you read our previous post (http://zerodha.com/z-connect/queries/stock-

and-fo-queries/say-hello-to-the-greeks).


Patel

Dear Karthik, I have missed your previous articles/posts. Please let me know how can I read them all, over again now? Uptill now how many

articles have been posted?




There are just 3 posts till now, all wrt to Options Trading.

Here are the links for you:

Post 1 – Introduction to Option Greeks (http://zerodha.com/z-connect/queries/stock-and-fo-queries/say-hello-to-the-greeks)

Post 2 – Application to Option Greeks (http://zerodha.com/z-connect/queries/stock-and-fo-queries/application-of-option-greeks)

Post 3 – How to use the Option Calculator (http://zerodha.com/z-connect/queries/stock-and-fo-queries/option-greeks/how-to-use-the-option-

calculator)


Sukesh

Hello Karthik,

I’m eagerly waiting for your article on ‘Dynamic Delta Hedging’ is it coming out any time soon?

Thanks


swapnil

Dear Karthik,



http://zerodha.com/z-connect/queries/stock-and-fo-queries/option-greeks/how-to-use-the-option-calculator



























()




()

()

I have a different question,

suppose I have Rs.50,000 in my trading account what will be the safest way of trading to earn 4-5k per month?

Thanks,

Swapnil




At 5K per month on a capital of 50K you are targeting 10% return PM, quite a task in my opinion. You could probably try buying and holding stocks

to begin with and see how it goes. Good luck.


sharesarthashastra

Thanks for the greeks.

Regards.

Sharesarthashastra.yola.com


Sukesh

Hi Karthick,

I understand that the time value of options keep decreasing and the rate of time decay is increases as we approach the end of the option’s life.

I wanted to understand in Indian markets, when is this time decay reflected in the option price?

Is it at the start of day or the end of the trading session?

Considering a long weekend, Is the time decay highest before closing for the week or is the decay reflected in the pricing after the markets

open after the long weekend?

Thanks




From my experience I have notice the decay drift happens from the close to open basis..especially as we approach the second half of the

series.Going by this the decay kicks when the markets open after the long weekend.


rajkarthik ji

1. to neutralise delta to 0 after in this instance , is it possible to buy a put of such a strike where the delta value -0.20 .




























()


()

2. when we sell a put, is the net delta value of that particular put become (+) ? as sell=(-) and delta value of put is always in (-), so….. please

clarify if i am going wrong.

regards…




Raj..you are right on both the cases.

1) Yes by adding a PUT option which has a delta of minus 20, the entire position is delta neutralized

2) When we sell a PUT, the delta is positive.


raj

sir

why option calculator not working after updating 2.9.0.0

plz advise




Can you please call support @ +91 80 4040 2020, someone from support will assist you with this. Thanks.


Sukesh

Hi Karthik,

I have a doubt on Futures contracts. There is always a difference between the current price of the underlying and its futures price and this

difference is usually positive (Futures price is higher than current price).

However i have observed that the difference between the current and the futures price changes continuously.

For example today, this morning the difference between Nifty Index & Futures was around 25 however now suddenly it has increased to 65.

So is there a logic or a formula through which we can compute the difference between current price and futures price of the asset?

Thanks























()


()




()

()


Sukesh

Hello Karthick/Nithin,

Request your guidance on the above question.

Thanks




Sorry, don’t know how I missed this question.

To understand why there is a difference between Futures and Spot I would suggest you read this (http://tradingqna.com/2652/futures-there-

different-rates-different-expiry-dates-future?show=2750#a2750). I have explained it with an example.

I reason why the difference between the two widens and narrows up simply attributable to demand supply situation.


raj

please let me know how I can make a market watch screen for option trading with all Greeks displayed in one screen beside the derivatives….

like, delta, gamma, theta, vega must be displayed beside the derivative with usual bid /ask price and volume.

please help on this, i m not finding it anywhere.


sastri

Please illustrate short strangle with delta neutralising. Thanks & Regards. Sastry




The same will be done shortly on Zerodha Varsity.


Glen

Thanks for the article, please could you let me know what are the factors to see the determine whether volatility is going to increase or

decrease.Also where can I see the change in volatility for NSE. Thanks







http://tradingqna.com/2652/futures-there-different-rates-different-expiry-dates-future?show=2750#a2750






















()




()




Usually events like budget, corporate results, monetary policy, major political rejigs, geo political issue, extreme market behavior etc drives up the

volatility. You can track the volatility change at the index level by observing India Vix –http://www.nseindia.com/live_market/dynaContent/live_watch/vix_home_page.htm

(http://www.nseindia.com/live_market/dynaContent/live_watch/vix_home_page.htm)


Vaibhav

Hi Karthik,

Can you share a link which explains how I can place pair trading orders for options?

Thanks


Rajat Bansal

Hello,

is there a tool within zerodha application that given historical volatility of stocks/index and implied volatility at the moment? that would be

really helpful to trade , if there is any such interactive chart similar charts are available with interactive broker application.




No Rajat, don’t have it right now. But it is on our list of things to do. It might take a while though.


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Application of Option Greeks

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