option Greek

Intrinsic Value

How does the option Greek intrinsic value effect the option price.

Intrinsic Value

Intrinsic Value (Current Stock price– Strike price)

Call Option:

A call option is the right to buy that asset, you agree to buy the asset at a price which is called the strike price, if the market price is above the strike price then the call option has a positive intrinsic value, if the market price is below the strike price then the call option has zero intrinsic value.

Formula

Intrinsic value=Underlying stock’s current price-call strike price.
Time Value=Call premium-intrinsic value.


Put Option:

A put optionis the right to sell an asset without obligation to sell that asset, you agree to sell the asset at a price which is called the strike price, if the market price below the strike price then the put option has a positive intrinsic value, if the market price is above the strike price then the put option has zero intrinsic value.

Formula:

Intrinsic value=Call strike price-Underlying stock’s current price.
Time value=Put premium-intrinsic value.





Option Greeks


  1. Delta- The hedge ratio.
  2. Gamma - The rate of change of Delta.
  3. Theta - Time decay.
  4. Vega – Sensitivity to volatility.
  5. Rho- Sensitivity to interest rates.

1.Delta- The hedge ratio

Call options

  • Have a positive Delta that can range from zero to 1.00.
  • At-the-money options usually have a Delta near .50.
  • The Delta will increase (and approach 1.00) as the option gets deeper in the money.
  • The Delta of in-the-money call options will get closer to 1.00 as expiration approaches.
  • The Delta of out-of-the-money call options will get closer to zero as expiration approaches.

    Put options

    • Have a negative Delta that can range from zero to -1.00.
    • At-the-money options usually have a Delta near -.50.
    • The Delta will decrease (and approach -1.00) as the option gets deeper in the money.
    • The Delta of in-the-money put options will get closer to -1.00 as expiration approaches.
    • The Delta of out-of-the-money put options will get closer to zero as expiration approaches.
    • You also might think of Delta, as the percent chance (or probability) that a given option will expire in the money.
    Example:

    A delta of 0.40 means the option has about a 40% chance of being in the money at expiration. This doesn’t mean your trade will be profitable,

    A delta of 0.40 also means that given a $1 move in the underlying stock, the option will likely gain or lose about the same amount of money as 40 shares of the stock.

    2.Gamma: The rate of change of Delta

    • Gamma measures the rate of change in an option's Delta per ₹1 change in the price of the underlying stock.
    • Gamma measures the rate of change in the underlying stock price by ₹ 1 per option delta. Gamma tells us how much the option's delta should change after the price of the underlying stock or index increases or decreases.

    Relationship between Delta and Gamma:
    • Delta is only accurate at a certain price and time. In the Delta example above, once the stock has moved ₹1 and the option has subsequently moved ₹.40, the Delta is no longer 0.40.
    • As we stated, this ₹1 move would cause a call option to be deeper in the money, and therefore the Delta will move closer to 1.00. Let's assume the Delta is now 0.55.
    • This change in Delta from 0.40 to 0.55 is 0.15—this is the option's Gamma.
    • Because Delta can't exceed 1.00, Gamma decreases as an option gets further in the money and Delta approaches 1.00.

    3.Theta: time decay

    • Theta measures the change in the price of an option for a one-day decrease in its time to expiration. Simply put.
    • Theta tells you how much the price of an option should decrease as the option nears expiration.
    • Since options lose value as expiration approaches, Theta estimates how much value the option will lose, each day, if all other factors remain the same.
    • Because of time-value erosion is not linear, Theta of at-the-money (ATM), just slightly out-of-the-money and in-the-money (ITM) options generally increase as expiration approaches, while Theta of far out-of-the-money (OTM) options generally decreases as expiration approaches.

    4.Vega: Sensitivity to volatility

    The rate of change in an option's price per 1% change in the implied volatility of the underlying stock, While Vega is not a real Greek letter, it is intended to tell you how much an option's price should move when the volatility of the underlying security or index increases or decreases.

    More about Vega's sensitivity to interest rates: Vega measures how the implied volatility of a stock affects the premium of the options on that stock. Volatility is one of the most important factors affecting the value of the options premium.
    Neglecting Vega can cause you to overpay when buying options. Remember, All other factors being equal, when determining strategy, consider buying options when Vega is below normal levels and selling options when Vega is above normal levels. When dropping Vega value will typically cause both calls and puts to lose value. When The increase in Vega will typically cause both calls and puts to gain value.

    5.Rho:

    • Rho measures, the expected change in an option's premium per 1% change in interest rates.
    • It tells you how much the price of an option should rise or fall if the risk-free interest rate increases or decreases.

    More about Rho:
    • When Call option interest rates increase, the value of call options will generally increase, the value of put options will usually decrease.
    • The main reason for these changes is positive RHO in call options and negative RHO in Put options.
    • Rho is generally not a huge factor in the price of an option but should be considered if prevailing interest rates are expected to change, such as any positive news or announcement.
    • Rho is far more sensitive to changes in interest rates for short-term options.
    • If the stock is trading at ₹25, the ₹25 calls and the ₹25 puts would both be exactly at the money.
    • You might see the calls trading at a price of ₹0.60, while the puts may trade at a price of ₹0.50.
    • When option interest rates are low, the difference will be relatively small. As interest rates increase, this difference between puts and calls whose strikes are equidistant from the underlying stock will get wider.
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