Nifty options trading basics
Most of the traders lose money by trading in options because they start trading in options without understanding basics of options. Options are not just about buying put and calls there are lot of things that works behind option pricing.
You need to understand those crucial things for success in options trading. Here I am discussion some mathematical factors that decides option pricing. In the money ITM options have intrinsic value. If Nifty is currently trading at then ITM call option has intrinsic value of The put option has 0 intrinsic value technically it should be negative but we take what we get which is 0.
Hope you understood what is intrinsic value. So ITM options has positive intrinsic value and OTM has zero intrinsic value.
OTM call have extrinsic value which is actually a non existent value. If Nifty is at then call option has points of extrinsic value. It is non existent value because its just the value of hope, anyone buying call option when Nifty is at is only buying on hope that Nifty can cross The premium of options keep on decreasing as we move towards the expiry, this decrease with time is called as time decay and is also known as premium decay.
Time decay is more in OTM options than ITM options. There is no exact formula to calculate time decay or theta value it is calculated theoretically. Based on this theory we can calculate time decay.
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Assume Nifty currently trading at and strike price call option is at OTM call has no intrinsic valuethe premium value is everything. If Nifty call option is at 90 then its value will decay to. Deltas value ranges from 0 to 1.
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If Nifty moves up by points and if the delta value is 0. The exact delta value is calculated by options pricing model such as the Black-Scholes Model. The typical values for delta are given below you can use them they also works fine. You can observe that delta for ATM option is 0.
Volatility measures the amount of uncertainty. The effect of IV can generally be seen during infosys results when both put and call options price increases simultaneously as there is very high uncertainty on whether the result will be good or bad.
Both the put and call options value decreases simultaneously after the results are out because uncertainty is gone. This special effect of IV is also visible during various events like budget, election results etc.
If IV is high movement in option price will be more and movement will be less if IV is low. I am not going to discuss how to calculate IV as NSE display it for every derivative equity. You can find the IV column that displays the vega factor of options chain at NSE website. This is the cost of money factor as you are blocking money to hold an option. For all practical purposes, rate of interest does not change in the short term and can be ignored for trading purposes.
Hope this clears the mathematical terms that works behind option pricing. In the coming posts I will discuss some more detailed aspects of options. News Stocks Analysis Fundamental Analysis Technical Analysis Investment Fixed Deposits Mutual Fund NCD Books Exams.
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