Option Graph Content

Last modified 11:24, 5 Nov 2012

Option Graph Components

The following paragraphs contain descriptions and explanations of the contents of each of the four panes in the Option Graph work page.

For information on changing the appearance of the charts that appear in each of these panes, go to the Individual Graph Appearance Controls topic.

For information on changing the data used by all four panes, or about the Function bar viewing tools that affect all charts simultaneously, go to the Option Page Controls topic.

Close Price/Model Price

optngraf_pricmodelpanel.png

This graphic compares the actual Close price to the price calculated by the pricing Model.

The Model price gives users an indication of whether the particular option being analysed is over or under valued. For example, if the analysis is to Buy a Call option and the Last Traded price is below the Model price, then the option is under valued and considered 'cheap'.

Note - Currently, only the Black Scholes with a Historical Volatility setting is used to calculate the Model price on this page. Therefore, changing the Model settings will not have an impact on the Model price in this screen. However, changes made to the Model settings will affect all the other Model prices throughout Your SOFTWARE.

Volatility

Four related volatility calculations are plotted for the option.

optngraf_impvolpanel.png

Historical Volatility

Historical Volatility is the volatility of the underlying asset, in this case IBM.

By default, the historical volatility is calculated as a 20 period, but this can be adjusted to your preferred period.

The user can change the Historical Volatility calculation settings.

Volatility of All Options in a Class

The IVAG chart plots an average of the implied volatility of all options for the underlying asset in the same class (i.e. all have the same strike price across all expiries) as compared to the particular option that is being analysed.

Volatility of All Options in a Class of the Same Type

The IVC chart plots and average of the implied volatility of all options for the underlying asset in the same class (i.e. all have the same strike price across all expiries) as the option and of the same type (Put or Call) as the option, in this case IV for Call.

If the option was a Put, the chart would be called IVP.

Implied Volatility of the Option

The Implied Volatility of the option itself is plotted. The option's symbol is included in the chart's label.

Underlying Asset Price Chart

optngraf_pricchartpanel.png

The daily price chart of the underlying security can graphically demonstrate how the underlying asset's price can affect the option's value and volatility.

This relationship is particularly apparent when the Function Bar's Synchronize Spacing tool is applied.

The default display is a bar chart. The chart type, as well as many other aspects of its display, can be changed in the Chart Parameters dialog box, available from the chart's pop-up menu.

For more details on changing the price chart's appearance, go to the Individual Graph Appearance Controls topic.

The Greeks

Option prices do not move mechanically in conjunction with the price of the underlying asset, therefore it is important to understand what factors contribute to an option's price movements, and how those factors are inter-related.

To understand the probability of an option or trade making money, it is essential to be able to determine a variety of risk-exposure measurements. The Greeks help measure an option position's risks and potential rewards.

Greeks provide traders with a means of determining how sensitive a specific trade is to quantifiable factors such as price fluctuations, volatility fluctuations, and the passage of time.

The Greeks are displayed in the bottom right of the Option Graphs window and can be viewed one at a time by navigating through the tabs. The following graphic shows the tab for Delta displayed.

optngraf_greekspanel.png

There are five Greeks calculated for the option.

Delta

Delta is the change in the price of an option relative to the change in price of the underlying security. The basic formula is as follows:

deltaFormula.png

In addition to the actual prices of the option and its underlying asset, the software uses other factors in its Delta equation, for example the current Price Model settings will have an effect on the Delta value.

Call options will have positive Deltas, while Put options will have negative Deltas, however the theory behind the Delta calculation, and the ranges that result, are otherwise the same.

Options that are very far "in the money" will often have price changes that are practically the same as the underlying asset. Often ITM options have Deltas of between 0.8 and 1.0. A Delta of 1.0 means that the option price change is 1 to 1 for the change in the underlying asset's price.

"At the Money" options are likely to have Deltas at around the 0.5 level, meaning that the price of a call option will increase by $0.50 for each $1.00 move upward in the underlying price. Conversely an ATM Put option is likely to have a Delta of around -0.5, implying that the put's price will increase by $0.50 for each $1.00 move downward by the underlying price.

"Out of the Money" option prices do not move very much in relation to the underlying asset's price movements. This is reflected in Delta levels of around 0.35 to 0.20 or less.

deltaRangeTable.png

The display of the Delta chart, in common with all the Greek charts, can be adjusted by the user. For more information, go to the Individual Graph Appearance Controls topic.Some traders regard the Delta as a statistical indication of an option's chances of being "in the money" by expiry. An OTM option with a Delta of .30 is viewed as having only a 30% chance of becoming ITM, while an ITM option with a Delta of 0.75 has a 75% chance of being ITM at expiry.

Gamma

Gamma indicates the rate of change in the Delta for each one-point movement in the price of the underlying asset.

By plotting the Gamma, changes in the Delta can be easier to forecast.

Gamma measures the rate of change, not the direction. For example, a call option with a Gamma of 0.03 indicates the option will gain 0.03 Deltas for each point increase in the underlying asset price. A put option with a Gamma of 0.03 indicates the option will gain 0.03 negative Deltas. The Gamma level is the same, but the Delta result is different depending on the option type.

Gamma is often used as a risk profile, particularly for large, complex option positions with many strikes or many expiry dates. Gamma is highest for ATM options indicating that the Deltas of ATM options are more sensitive to price moves in the underlying stock.

When the Gamma is negative, it indicates that the option's Delta is moving relatively faster than the underlying asset's price movements. This can often occur as an option nears its expiry and time decay has an increasing effect on the option price, the underlying asset of course is unaffected. Typically, negative gamma implies positive theta, meaning time decay is working in favor of the position.

Rho

Rho measures an option's change in value in relation to a change in interest rates.

Increasing interest rates will decrease the value of Rho for put options and increase the value of Rho for call options.

Rho is greater in long-term options and is negligible for most near term options.

Theta

Theta is a measure of the time decay of an option, the dollar amount that an option will lose each day due to the passage of time. The Theta value of an option normally decreases as the expiry date approaches.

Theta is higher for short-term options and lower for long-term options.

Some trading strategies attempt to profit from time decay. The ability to plot and analyze the option's Theta is critical when using these strategies.

Vega

Vega is used to measure an option's change in value in relation to changes in the underlying asset's price volatility. Normally, as the volatility of the underlying asset increases, so will the premiums for its options, the theory being that increased volatility will create greater chances that the option will expire ITM.

Long-term options have a higher Vega value, as they are more sensitive to changes in volatility. When volatility decreases, Vega typically also decreases.

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