Option premium Understanding Fluctuations and Profit Potential in Options Trading

  1. Trading for professionals: Options trading
    1. Call Option Basics learn the basic Definition with Examples
    2. Call option and put option understanding types of options
    3. What Is Call Option and How to Use It With Example
    4. Options Terminology The Master List of Options Trading Terminology
    5. Options Terms Key Options Trading Definitions
    6. Buy call option A Beginner’s Guide to Call Buying
    7. How to Calculate Profit on Call Option
    8. Selling Call Option What is Writing/Sell Call Options in Share Market?
    9. Call Option Payoff Exploring the Seller’s Perspective
    10. American vs European Options What is the Difference?
    11. Put Option A Guide for Traders
    12. put option example: Analysis of Bank Nifty and the Bearish Outlook
    13. Put option profit formula: P&L Analysis and Break-Even Point
    14. Put Option Selling strategies and Techniques for Profitable Trading
    15. Call and put option Summary Guide
    16. Option premium Understanding Fluctuations and Profit Potential in Options Trading
    17. Option Contract moneyness What It Is and How It Works
    18. option moneyness Understanding itm and otm
    19. option delta in option trading strategies
    20. delta in call and put Option Trading Strategies
    21. Option Greeks Delta vs spot price
    22. Delta Acceleration in option trading strategies
    23. Secrets of Option Greeks Delta in option trading strategies
    24. Delta as a Probability Tool: Assessing Option Profitability
    25. Gamma in option trading What Is Gamma in Investing and How Is It Used
    26. Derivatives: Exploring Delta and Gamma in Options Trading
    27. Option Gamma in options Greek
    28. Managing Risk in Options Trading: Exploring Delta, Gamma, and Position Sizing
    29. Understanding Gamma in Options Trading: Reactivity to Underlying Shifts and Strike Prices
    30. Mastering Option Greeks
    31. Time decay in options: Observing the Effect of Theta
    32. Put Option Selling: Strategies and Techniques for Profitable Trading
    33. How To Calculate Volatility on Excel
    34. Normal distribution in share market
    35. Volatility for practical trading applications
    36. Types of Volatility
    37. Vega in Option Greeks: The 4th Factors to Measure Risk
    38. Options Trading Greek Interactions
    39. Mastering Options Trading with the Greek Calculator
    40. Call and Put Option Guide
    41. Option Trading Strategies with example
    42. Physical Settlement in Option Trading
    43. Mark to Market (MTM) and Profit/Loss Calculation
Marketopedia / Trading for professionals: Options trading / Option premium Understanding Fluctuations and Profit Potential in Options Trading

A quick note on Premiums

This snapshot depicts the intraday behaviour of a BHEL 230 European Call Option (CE) premium on April 30th 2015. The data is in the red box and below that I have pointed out its price info. It began at Rs.2.25, went up to Rs.8/- and finished at Rs.4.05/- by day’s end.

Ponder this: the premium on the day soared by 350%, from Rs.2.25/- to Rs.8/-, and it closed up at a comparatively modest 180%, from Rs.2.25/- to Rs.4.05/-. Such fluctuations are not uncommon in options trading, so don’t be shocked.

Assuming you have managed to capture just 2 points when trading this particular option intraday, this will generate an attractive Rs.2000/- in profits as each lot is worth 1000 (highlighted by the green arrow). This is very common when it comes to trading premiums as traders generally do not hold onto their option contracts until expiry, but they try and take advantage of short-term movements in premiums by initiating and closing trades quickly (intraday or within a few days).

It is not unusual to experience returns of 100% or more through options trading, but be mindful that such consistent gains can only be made with a thorough understanding of this instrument.

This is IDEA Cellular Limited’s option contract. It has a strike price of 190 that expires on 30th April 2015, and the type is a European Call Option, noted in the blue box. Below this lies the OHLC data, which is highly intriguing.

If you had sold the 190-call option intraday at an opening price of Rs. 8.25/- and managed to capture a minimum low of Rs. 0.30/-, you could have gained a profit of Rs. 4000/- with a lot size of 2000. This significant profit would be enough to treat your partner to a dinner at Marriot.

I am emphasising that most traders trade options to benefit from the changing premiums. They usually don’t hold until expiry. There are rare cases where I do, normally option writers tend to keep the contracts running until expiry rather than purchasers. This is because if you have sold an option for Rs. 8/- then you will get the whole premium received that is Rs. 8/- only on expiration.

Having said that traders like to trade just the premiums, you may have some questions about it. Why does the premium vary? What is the cause for the change in premium? Can we forecast the future movement of the premium? Who determines the valuation of a specific option?

Questions about options form the basis of option trading. If you’re able to fully understand these fundamental components, it can be a stepping-stone to becoming a proficient trader in this area.

You can think of the option’s premium as a ship sailing in the sea. Its speed is determined by a number of forces, such as wind speed, water density, pressure, and its own power. Some of these forces increase or reduce the speed and it eventually finds an optimal rate. To understand why the premiums, vary so much, you need to consider all four forces acting on them.

The ‘Option Greeks’ are responsible for the variation in the option premium. Some can boost it while others bring it down. These opposing forces are factored into the ‘Black & Scholes Option Pricing Formula’, which subsequently yields the premium of the option.

Envision this – the Option Greeks sway the option premium yet are regulated by the markets. Since markets shift moment by moment, the Option Greeks also alter, thus altering the option premiums in turn!

In this course, we will learn to identify the various forces that drive pricing of options, how these forces are affected by market conditions and how Option Greeks further modify the option premium.

So, the end objective here would be to be –

  1. To gain an understanding of how Option Greeks impact premium pricing 
  2. To understand how premiums are determined by considering Option Greeks’ influence
  3. Finally, keeping the Greeks and pricing in perspective, we need to select strike prices to trade smartly

Before attempting to learn the option Greeks, we must first understand the concept of “Moneyness of an Option”. We will cover this in detail in the upcoming chapter.

We anticipate that the topics to come may be more complicated, however we will strive to keep them simple. In order for you to be successful, it is essential that you understand everything we have worked on already.


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