Option Volatility & Pricing: Advanced Trading Strategies and Techniques

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This classification helps the trader to decide which strike to trade, given a particular circumstance in the market. However before we get into the details, I guess it makes sense to look through the concept of intrinsic value again. The intrinsic value of an option is the money the option buyer makes from an options contract provided he has the right to exercise that option on the given day.

Intrinsic Value is always a positive value and can never go below 0. Consider this example —. Given this, assume you bought the CE and instead of waiting for 15 days to expiry you had the right to exercise the option today.

Now my question to you is — How much money would you stand to make provided you exercised the contract today? Abcs option volatility trading strategies with sheldon natenberg remember when you exercise a long option, the money you make is equivalent to the intrinsic value of an option minus the premium paid.

Hence to answer the above question we need to calculate the intrinsic value of an option, for which we need to pull up the call option intrinsic value formula from Chapter 3. So, if you were to exercise this option today, you are entitled to make 20 points ignoring the premium paid. Here is a table which calculates the intrinsic value for various options strike these are just random values that I have used to drive across the concept —.

With this, I hope you are clear about the intrinsic value calculation for a given option strike. Let me summarize a few important points —. Before we wrap up this discussion, here is a question for you — Why do you think the intrinsic value cannot be a negative value? To answer this, let us pick an example from the above table — Strike isspot isand option type is long abcs option volatility trading strategies with sheldon natenberg.

Let us assume the premium for the Call option is Rs. Hopefully this should give you some insights into why the intrinsic value of an option can never go negative. With our discussions on the intrinsic value of an option, the concept of moneyness should be quite easy to comprehend.

Moneyness of an option is a classification method which classifies each option strike based on how much money a trader is likely to make if he were to exercise his option contract today. There are 3 broad classifications —. Understanding these option strike classification is very easy. All you need to do is figure out the intrinsic value. Let us take up an example to abcs option volatility trading strategies with sheldon natenberg this well. As you can notice from the image above, the available strike prices trade starts from all the way upto From the definition of ATM option that we posted abcs option volatility trading strategies with sheldon natenberg we know, ATM option is that option strike which is closest to the spot price.

Considering the spot is atthe closest strike is probably If there was strike, then clearly would be the ATM option. But in the absence of strike the next closest strike becomes ATM. Hence we classify as, the ATM option. In order to do this we will pick few strikes and calculate the intrinsic value. Do remember the spot price iskeeping this in perspective the intrinsic value for the strikes above would be —.

We know this is the ATM option as strike is closest to the spot price of So we will not bother to calculate its intrinsic value. Negative intrinsic value, therefore the intrinsic value is 0. You may have already sensed the generalizations for call options that exists here, however allow me to restate the same again. Now let us look at 2 ITM options — and The intrinsic value works out to be and 60 abcs option volatility trading strategies with sheldon natenberg considering the spot is at Higher the intrinsic value, deeper the moneyness of the option.

I would encourage you to observe the premiums for all these strike prices highlighted in green box. Do you sense a pattern here? Here is the snapshot of various strikes available for a Put option. The strike prices on the left are highlighted in a blue box. As you can see there are many strike prices available right from to Since the spot is atthe nearest strike to spot should be the ATM option. As we can see from the snapshot above there is a strike at which is trading at Rs.

This obviously becomes the ATM option. Let us go with the following strikes and evaluate their respective intrinsic value also called the moneyness —. And as you can see from the snapshot, the premiums for ITM options are much higher than the premiums for the OTM options. I hope you have got a clear understanding of how option strikes are classified based on their moneyness. However you may still be wondering about the need to classify options based on their moneyness.

As you briefly know by now, Option Greeks are the market forces which act upon options strikes and therefore affect the premium associated with these strikes. So a certain market force will have a certain effect on ITM option while at the same time it will have a different effect on an OTM option. Hence classifying the option strikes will help us in understanding the Option Greeks and their impact on the premiums better.

The Option chain is abcs option volatility trading strategies with sheldon natenberg common feature on most of the exchanges and trading platforms. The option chain is a ready reckoner of sorts that helps you identify all the strikes that are available for a particular underlying and also classifies the strikes based abcs option volatility trading strategies with sheldon natenberg their moneyness.

Besides, the option chain also provides information such as the premium price LTPbid —ask price, volumes, open interest etc for each of the option strikes. Here is the link to check the option chain for Nifty Options. Having understood the basics of the call and put options both from the buyers and sellers perspective and also having understood the concept of ITM, OTM, and ATM I suppose we are all set to dwell deeper into options.

The next couple of chapters will be dedicated to understand Option Greeks and the kind of impact they have on option premiums. Based on the Option Greeks impact on the premiums, we will figure out a way to select the best possible strike to trade for a given circumstance in the market.

I hope you are as excited to learn about all these topics as we are to write about the same. Abcs option volatility trading strategies with sheldon natenberg please stay tuned. Hi kartik, Thanks for new chapter. You have magical writing power which makes the learning so interesting and easy. I completely understood the concept of this chapter and very excited for next chapter.

Thanks for the kind words and we are really glad you were able to understand the chapter: Will put up the next chapter as soon as we can. Are you facing any problems with this? Hi kartik If I place an order to buy niftyCE at premium of with a trailing stop loss of points. After sometime premium iscan I modify my trailing stop loss to 80 points or 60 points or can I square off my position at current price.

Hi Karthik, Varsity is the great effort of you and Zerodha. I do not have words to appreciate, thanks a lot…. We will try our best Keshav.

In fact that is our aim as well. But nevertheless we will do our best. Hi kartik, I have rs in my trading account. So for every 1 point up or down move you can make or lose Rs. For trading options please look into the charts of the spot market and not really the chart of the Options. You should look at the spot charts.

The index is made up of these 50 stocks, check this http: The volume of Nifty spot is cumulative volumes of all abcs option volatility trading strategies with sheldon natenberg 50 stocks. Check this — http: For intraday it may not be possible Narsimha. I will get back to you on this soon, meanwhile you can certainly use the Nifty futures chart. Hi Karthik, the bid-ask spread for the Nifty is quite close; and when I square off an order at market price, there are no major surprises.

So while trading larger volumes, is it safer to trade Nifty? The spread is tight when liquidity is abundant. In simpler words — when there are more people trading a particular contract liquidity improves and therefore the spreads get better it gets tighter.

Tighter spreads imply lesser damage when you place market orders lesser surprise. Karthik, I was asking about the spread in absolute terms not percentage. With Bank Nifty options, I abcs option volatility trading strategies with sheldon natenberg a difference of over 10 rupees between the bid price and the ask price onscreen.

Yes in absolute terms the difference is kind of bigger on Bank Nifty. It makes sense to trade Nifty especially when you know that you will use market orders. Thanks a lot for this information. The lot of 25 is fixed for both futures and options. I think came about because one of the comments posted earlier. Also, it may not be safe to assume point abcs option volatility trading strategies with sheldon natenberg moment in Nifty.

The change in premium based on the change is underlying is captured by delta…which is the focus in chapter 9. Hi Jose, request you not to use caps lock.

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