THE FOLLOWING QUERIES REMAIN UNANSWERED IN OPTIONS TRADING.
KINDLY REPLY TO dalalstreeet@gmail.com for the queries listed below..
Options contract are tradeable and it is a zero sum game In that case let us say there are 100 contracts. (100 buyers and 100 sellers). How there is a change in the Open interest?
For the same strike , why there is a variation in the put and call option premium?
For the same stock In selling a call option, and selling a put option, when both will be at loss?
Last week Bank Nifty premium before 5 days was Rs400 . But the theta was -16. How is that the premium would decay to zero on the last day of premium. Will the option seller make profit ? What are the other factors that are involved ? What are their effects?
Which strategy is preferable in a volatile market?
Which strategy is preferable in a neutral market?
Option Premium consists of intrinisic value and time value. For in the money option, when there is change in the spot price, then the intrinsic value will increase or time value will increase?
Vega affects time value or intrinsic value of the option premium?
Vega is how much the premium changes when there is 1% change in Volatility ? There are many stocks gaining when there is decrease in % change in volatility? What is the reason behind this?
There are many stocks Losing when there is increase in % change in volatility? What is the reason behind this?
How to estimate the implied volatility?
FOr what range of vega or volatility it is risk to trade ?
In which website we can see the graph for volatility for stock ?
In which website we can see the graph for volatility for index ?
How to view the graph of time vs delta, time vs vega, time vs gamma and time vs theta for the stock?
What is the importance of PUT CALL RATIO and OPEN INTEREST CHANGE? How to effectively interpret the Open Interest Change, OI gainers and OI losers list for trading? What does these values signify?
Which of the following combination in the table is recommended in Call and put Option for Index and stocks based on option greeks.
WHAT IS OPEN INTEREST -
Basics of OPTIONS
Open Interest - A option contract has both a buyer and a seller, so the two market players combine to make one contract. The open interest position that is reported each day represents the increase or decrease in the number of contracts for that day, and it is shown as a positive or negative number.
The total number of futures or options contracts of a given stock or index that have not yet been offset by an opposite futures or options transaction or fulfilled by delivery of the option exercise. Each open transaction has a buyer and a seller, but for calculation of open interest, only one side of the contract is counted.
Rise in OI & Rise in Price - An increase in open interest along with an increase in price mostly indicates long positions being built up, except for very weak stocks where some traders may short the stock on a rally.
Rise in OI &Fall in Price - An increase in open interest along with a decrease in price mostly indicates short positions being built up, except for very strong stocks where some traders may buy the stock on declines.
Fall in OI & Rise in Price -Decrease in open interest along with an increase in price mostly indicates short covering, except for weak stocks where traders may decide to book profits/cut losses at higher levels. It may also indicate delivery based buying by institutions which pushes up the price and speculators use it to unwind.
Fall in OI &Fall in Price - Decrease in open interest along with a decrease in price mostly indicates long unwinding
SUMMARY - An increase in open interest along with an increase in price is said to confirm an upward trend. Similarly, an increase in open interest along with a decrease in price confirms a downward trend. An increase or decrease in prices while open interest remains flat or declining may indicate a possible trend reversal.
There is a simple logic to understand the above big concept. It took long time to understand . So I wish to share it so that it will be useful to all. ALWAYS ask two questions -- 1. When price changes who WILL BENEFIT / gain ? 2. What the BENEFICIARIES / GAINERS think ? When Price rises, Who will gain ? Buyers will gain.. What sellers will think ? Now Buyers may think in two ways... 1. Buyers think that Price will increase further and they may gain more - so the buyers will start buying more contracts and the open interest will increase . This is called LONG BUILDUP, (Rise in Price & Rise in OI). it is a bullish indication. Market is Strong. Market is in Upward Trend. 2. Buyers think that Price may not increase further and let us book the profit to avoid loss. So the buyers will start to square off / exit / unwind their long (buy) positions /contracts thus the open interest will decrease . This is called LONG UNWINDING, (Rise in Price & Fall in OI). it is a sign of PROFIT BOOKING by BULLS. Market is Weakening. Trend Reversal is about to happen When Price fall (decrease) , Who will gain ? Sellers will gain.. What sellers will think ? Now Sellers may think in two ways... 1. Seller think that Price will decrease further and they may gain more - so the Sellers will start selling more contracts and the open interest will increase . This is called SHORT BUILDUP, (Fall in Price & Rise in OI). it is a bullish indication. Market is Weak. Market is in Downward Trend. 2. Seller think that Price may not decrease further and let us book the profit to avoid loss. So the Sellers will start to square off / exit / cover their short (Sell positions /contracts thus the open interest will decrease This is called Short Covering, (Fall in Price & Fall in OI). It is a short covering by bears.Market is Strengthening. Trend Reversal is about to happen
The following is the summary of reply by the broker for the query asked by the client .
Query 1 by client
if buyers and sellers enter the bid and ask price for controlling the option premium, then How is the option premium formula like black scholes formula control the price. Does the price adjustment happen at the end of the day after market hours or only in the open price. please clarify. which governs ? Bid spread or Black scholes model.
Reply to query 1 by IIFL
Option price is dependent on the market demand and supply based on the expectation of the traders. Traders follow black scholes method as in India we have European style option. Black scholes is based on 5 option greeks i.e delta,gamma,vega,theta and rho which helps options traders determine an expected price of an option based on the assumptions of an implied volatility. But basically, the bid-ask spread is based on demand and supply of trades so the current market price of options will be majorly governed by the bid and ask spreads and the price adjustment would happen during the live market hours.
Query 1 continued against reply
CLARIFICATION 1 on ON REPLY TO QUERY 1
1. Let us take the same example
Now let us take an example. The Option premium is rs 12 for OTM option and there are two days to expiry. Now the option premium should decrease atleast rs 6 per day approx.
Now on the on day before the expriy the open price is Rs12. By end of day it must become around Rs 4 (Option premium decays more faster when it is close to exprry.) Now assume that around 11 pm the OTM option is trading around Rs 8.
Let the bid price by Rs.7.95 and Ask price is Rs8.9 and LTP is Rs8.
Bid Price is under the ccontrol of the buyer like us.
Seller Price is under the ccontrol of the buyer like us.
LTP is obviously under the control of bidders and sellers at a fixed price. When all the three parameters are under our control.
HOW IS THE RATE ADJUSTMENT DONE....?
The exchange cannot MANIPULATE THE BIDDER PRICE or THE BROKER CANNOT MANIPULATE THE ASK PRICE.
Kindly clarify how the PRICE ADJUSTMENT IS TAKING PLACE...
QUERY 2
The theta value decreases the option premium. correct .. Now let us take an example. The Option premium is rs 12 for OTM option and there are two days to expiry. Now the option premium should decrease atleast rs 6 per day approx. This price change must happen every 1 hour or 1 min or once in a day. At what intervals does the option premium gets adjusted during the market hours?
Reply to query 2 by IIFL
Query 2: Theta measures the per day erosion of the option premium. It has a negative value for both call and put. Theta is measured on per day basis assuming the other the option greeks are constant.
Call Theta = -((UnderlyingPrice * Volatility * NdOne()) / (2 * Sqr(Time)) - Interest * ExercisePrice * Exp(-Interest * (Time)) * NdTwo()) / 365
Put Theta = -((UnderlyingPrice * Volatility * NdOne()) / (2 * Sqr(Time)) + Interest * ExercisePrice * Exp(-Interest * (Time)) * (1 - NdTwo())) / 365
CLARIFICATION 2 on REPLY TO QUERY 2
CLARIFICATION 3 on REPLY TO QUERY 2
As per the Reply to Query 1 ,
" so the current market price of options will be majorly governed by the bid and ask spreads and the price adjustment would happen during the live market hours".
What is the unit of time . is is hours or minutes or days,
But in the formula Let us assume Time indicates the number of days to expiry..
Now if theta value remains constant throughout the day as it is calculated only once in a day. If price gets adjusted during the market hours it means theta value is also changing during the market hours. please clarity.