Options- Lesson 1: Basic concepts, Black & Schultz model and implied volatility
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I am here to help you with Currency, and Commodities hedge, as well as choosing between options.
In the previous article we learned about futures contracts -enter the link: https://www.dhirubhai.net/pulse/all-you-need-know-forwards-futures-english-boaz-eilon/
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In this article we will learn what Calls and Puts are, basic terms regarding options, Black & Schultz model and the implied volatility
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This is the link to the explanatory video https://www.theta1.co.il/basic-terms-in-options-and-price-determination/
Options parameters
Delta - the change in the option price caused by a change of one point of asset price.
Delta measures the change in the price option that will result from a change of one point in price asset. To get the delta in number, multiply the delta in percentage of the base asset multiplier.
Delta is larger or equal to minus 1 and small or equal to plus 1 multiply by asset multiplier. In options on the Tel Aviv 35 index, the multiplier is 100, so the delta of?options on that Index ?is large or equal to minus 100 and small or equal to plus 100.
The delta of buying a 'call' options is positive and of buying 'put' options is negative.
In the money, options have a delta of 0.5 (50%) times the base asset multiplier - in absolute value
As an option goes into the money, its delta will aspire in absolute value to 1. As the option moves away from the money, the delta will move towards 0.
Explanation - Buying an asset has a Delta of 100. The deeper in money the 'call' option is, the more it will behave like buying the asset itself, so its delta will grow. Similarly, a 'put' option when deep in the money will behave like an asset sale, so that its delta will aspire to minus 100.
The shorter the time it takes for the exaction day the Call Delta's will move away from 50 and the Put's delta will move away from minus 50 (and vice versa).
An increase in standard deviation will cause the delta to move to 50 its absolute value (and vice versa).
The shorter the expiration date is and / or the smaller the standard deviation is, the closer the delta of options within the money will be closer to 1 and the delta of an option outside the money will approach 0. (In absolute value and vice versa).
Row - the change in option price caused by a change of one percent in the risk-free interest rate.
How does a change in interest rates affect option prices? To understand the effect of the interest rate change on the prices of a 'Call' option, we will remember that buying a 'Call' option is an alternative to purchasing the asset. Suppose there is a price of a 'call' option where investors are indifferent between buying the asset and buying a 'call' option. Now suppose that the interest rate goes up, since in the purchase of the asset there is a loss of an alternative interest rate the relative viability of buying a ‘call’ option will increase. Investors will therefore be willing to pay a higher premium for a 'call' option and it's price will go up.
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Conversely, buying a 'put' option is an alternative to a short sale of the underlying asset.
Suppose there is a price of a 'put' option where investors are indifferent between selling the asset and buying a 'put' option. Now suppose that the interest rate goes up, because in the sale of the asset there is now more interest rate the relative profitability of the sale of the asset will increase. Investors will therefore be willing to pay a lower premium for the 'Put' option and its price will reduce.
Therefore, the Row of buying a 'call' is positive and of buying, a 'put' is a negative.
Theta - The change in option price (NIS) caused by a change of one day in the time left for expiration.
Negative theta means that each passing day, when the rest of the parameters remain unchanged, will lower the value of the option to the buyer.
The shorter the time to maturity, the greater the theta of at the money option is. The theta of options that are far from the money will usually also increase as the expiration time shortens, but close enough to the end of the option's life, the theta will decrease, as the premium level will be low and its erosion will diminish.
Vega - the change in price option caused by a change of one percent in the standard deviation.
Changes in standard deviation will affect the prices of 'call' and 'put' options in the same direction. An increase in the implied volatility deviations will increase the prices of a 'call' options as well as the prices of a 'put' options.
When buying options Vega is always positive
The Vega of a longer option will be higher than the Vega of a similar option for a shorter expiration date
Gamma - the change in the delta that will be caused by a change of one point in the asset price.
Gamma is a special sensitivity index in that it measures the rate of change of another sensitivity index (the delta). In terms of derivative, while Delta, Theta, Row and Vega are the first derivative of the Black & Schultz formula, the gamma is the derivative of the delta, i.e. a second derivative.
The gamma of buying 'call' or 'put' options is positive and of writing 'call' or 'put' options is negative.
Gamma and theta always have the opposite sign and have a similar power, meaning that negative theta means positive gamma, the shorter the time to expiration, the erosion of time will increase and so will the gamma.
At the money option will have a higher theta and gamma in absolute value than in or out of the money options.
When writing options all the parameters change direction. Therefore, a writing of a 'Call' will have a negative Vega Delta and Gamma, and a positive Theta. A 'Put's writing will have a positive Delta, and a negative Vega and Gamma and usually, but not always, a negative Theta as well.