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  • AIMS MMS - Derivatives & RM Lecture 7 THETA

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    Vishal Bhojani
    26 Ansichten9 Seiten
    The document discusses the concept of delta and theta as it relates to options risk management. It notes that a deep out-of-the-money call option with two days to expiry has only a 10% chance of expiring in-the-money, based on its low delta of 0.1. It recommends selling, rather than buying, such an option to benefit from the high probability it will expire out-of-the-money. The document also explains that theta, which represents the time decay of an option, benefits option sellers as time passes and premiums decline each day as expiration nears.

    Originalbeschreibung:

    Learn Basic of THETA

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    The document discusses the concept of delta and theta as it relates to options risk management. It notes that a deep out-of-the-money call option with two days to expiry has only a 10% chance of expiring in-the-money, based on its low delta of 0.1. It recommends selling, rather than buying, such an option to benefit from the high probability it will expire out-of-the-money. The document also explains that theta, which represents the time decay of an option, benefits option sellers as time passes and premiums decline each day as expiration nears.

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    © All Rights Reserved
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    26 Ansichten9 Seiten

    AIMS MMS - Derivatives & RM Lecture 7 THETA

    Hochgeladen von

    Vishal Bhojani
    The document discusses the concept of delta and theta as it relates to options risk management. It notes that a deep out-of-the-money call option with two days to expiry has only a 10% chance of expiring in-the-money, based on its low delta of 0.1. It recommends selling, rather than buying, such an option to benefit from the high probability it will expire out-of-the-money. The document also explains that theta, which represents the time decay of an option, benefits option sellers as time passes and premiums decline each day as expiration nears.

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    © All Rights Reserved
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    von 9

    Derivatives & Risk

    Management
    Vishal Bhojani
    Delta as a probability
    • 8400 CE is trading at Rs.4/-
    • Spot is trading at 8275
    • There are two day left for expiry – would you buy this option?

    • Well, a typical trader would think that this is a low cost trade, after all the premium is just Rs.4/- hence
    there is nothing much to lose. In fact the trader could even convince himself thinking that if the trade
    works in his favour, he stands a chance to make a huge profit
    • 8400 CE is deep OTM call option considering spot is at 8275
    • The delta of this option could be around 0.1
    • Delta suggests that there is only 10% chance for the option to expire ITM
    • Add to this the fact that there are only 2 more days to expiry – the case selling this option becomes
    stronger
    • A prudent trader would never buy this option. However don’t you think it makes perfect sense to sell
    this option and pocket the premium? Think about it – there is just 10% chance for the option to expire
    ITM or in other words there is 90% chance for the option to expire as an OTM option
    Theta

    Number of days for


    Likelihood of passing
    preparation
    30 days Very high
    20 days High
    15 days Moderate
    10 days Low
    5 days Very low
    1 day Ultra low
    Theta
    Option sellers are always compensated for the time risk

    Premium = Intrinsic Value + Time Value

    All else equal, options lose money on a daily basis owing to Theta

    Time moves in a single direction hence Theta is a positive number


    Theta is a friendly Greek to option sellers

    When you short naked options at the start of the series you can pocket
    a large time value but the fall in premium owing to time is low

    When you short option close to expiry the premium is low (thanks to
    time value) but the fall in premium is rapid
    Theta
    Theta Examples
    •Spot Value = 8514.5
    •Strike = 8450 CE
    •Status = ITM
    •Premium = 160
    •Today’s date = 7th July 2015
    •Expiry = 30th July 2015
    Intrinsic value of call option – Spot Price – Strike
    Price i.e. 8514.5 – 8450 = 64.5
    Premium = 160
    Time Value = Premium – Intrinsic Value
    Time value = 160 – 64.5 = 95.5

    Hence out of the total premium of Rs.160,


    traders are paying 64.5 towards intrinsic value
    and 95.5 towards the time value.
    Theta Examples

    Date = 29th April


    Expiry Date = 30th April
    Time to expiry = 1 day
    Strike = 190
    Spot = 179.6
    Premium = 30 Paisa
    Intrinsic Value = 179.6 – 190 = 0 since it’s a
    negative value
    Hence time value should be 30 paisa which
    equals the premium

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