## 20.1 – Volatility Smile

We had briefly looked at inter Greek interactions in the previous chapter and how they manifest themselves on the options premium. This is an area we need to explore in more detail, as it will help us select the right strikes to trade. However before we do that we will touch upon two topics related to volatility called ‘Volatility Smile’ and ‘Volatility Cone’.

Volatility Smile is an interesting concept, something that I consider ‘good to know’ kind of concept. For this reason I will just touch upon this and not really dig deeper into it.

Theoretically speaking, all options of the same underlying, expiring on the same expiry day should display similar ‘Implied Volatilities’ (IV). However in reality this does not happen.

Have a look at this image –

This is the option chain of SBI as of 4^{th} September 2015. SBI is trading around 225, hence the 225 strike becomes ‘At the money’ option, and the same is highlighted with a blue band. The two green bands highlight the implied volatilities of all the other strikes. Notice this – as you go away from the ATM option (for both Calls and Puts) the implied volatilities increase, in fact further you move from ATM, the higher is the IV. You can notice this pattern across all the different stocks/indices. Further you will also observe that the implied volatility of the ATM option is the lowest. If you plot a graph of all the options strikes versus their respective implied volatility you will get to see a graph similar to the one below –

The graph appears like a pleasing smile; hence the name ‘Volatility Smile’ ☺

## 20.2 – Volatility Cone

(*All the graphs in this chapter and in this section on Volatility Cone has been authored by Prakash Lekkala)*

So far we have not touched upon an option strategy called ‘Bull Call Spread’, but for the sake of this discussion I will make an assumption that you are familiar with this strategy.

For an options trader, implied volatility of the options greatly affects the profitability. Consider this – you are bullish on stock and want to initiate an option strategy such as a Bull Call Spread. If you initiate the trade when the implied volatility of options is high, then you will have to incur high upfront costs and lower profitability potential. However if you initiate the position when the option implied volatility is low, your trading position will incur lower costs and higher potential profit.

For instance as of today, Nifty is trading at 7789. Suppose the current implied volatility of option positions is 20%, then a 7800 CE and 8000 CE bull call spread would cost 72 with a potential profit of 128. However if the implied volatility is 35% instead of 20%, the same position would cost 82 with potential profit of 118. Notice with higher volatility a bull call spread not only costs higher but the profitability greatly reduces.

So the point is for option traders , it becomes extremely crucial to assess the level of volatility in order to time the trade accordingly. Another problem an option trader has to deal with is, the selection of the underlying and the strike (particularly true if your strategies are volatility based).

For example – Nifty ATM options currently have an IV of ~25%, whereas SBI ATM options have an IV of ~52%, given this should you choose to trade Nifty options because IV is low or should you go with SBI options?

This is where the Volatility cone comes handy – it addresses these sorts of questions for Option traders. Volatility Cone helps the trader to evaluate the costliness of an option i.e. identify options which are trading costly/cheap. The good news is, you can do it not only across different strikes of a security but also across different securities as well.

Let’s figure out how to use the Volatility Cone.

Below is a Nifty chart for the last 15 months. The vertical lines mark the expiry dates of the derivative contracts, and the boxes prior to the vertical lines mark the price movement of Nifty 10 days prior to expiry.

If you calculate the Nifty’s realized volatility in each of the boxes, you will get the following table –

Expiry Date | Annualized realized volatility |
---|---|

Jun-14 | 41% |

Jul-14 | 38% |

Aug-14 | 33% |

Sep-14 | 28% |

Oct-14 | 28% |

Nov-14 | 41% |

Dec-14 | 26% |

Jan-15 | 22% |

Feb-15 | 56% |

Mar-15 | 19% |

Apr-15 | 13% |

May-15 | 34% |

Jun-15 | 17% |

Jul-15 | 41% |

Aug-15 | 21% |

From the above table we can observe that Nifty’s realized volatility has ranged from a maximum of 56% (Feb 2015) to a minimum of 13% (April 2015).

We can also calculate mean and variance of the realized volatility, as shown below –

Particulars | Details |
---|---|

Maximum Volatility | 56% |

+2 Standard Deviation (SD) | 54% |

+1 Standard Deviation (SD) | 42% |

Mean/ Average Volatility | 31% |

-1 Standard Deviation (SD) | 19% |

-2 Standard Deviation (SD) | 7% |

Minimum Volatility | 13% |

If we repeat this exercise for 10, 20, 30, 45, 60 & 90 day windows, we would get a table as follows –

Days to Expiry | 10 | 20 | 30 | 45 | 60 | 90 |
---|---|---|---|---|---|---|

Max | 56% | 49% | 41% | 40% | 37% | 35% |

+2 SD | 54% | 46% | 42% | 41% | 40% | 38% |

+1 SD | 42% | 38% | 36% | 36% | 35% | 33% |

Mean/Average | 30% | 29% | 30% | 30% | 30% | 29% |

-1 SD | 19% | 21% | 23% | 24% | 24% | 24% |

-2 SD | 7% | 13% | 17% | 19% | 19% | 19% |

Min | 13% | 16% | 21% | 22% | 21% | 20% |

The graphical representation of the table above would look like a cone as shown below, hence the name ‘Volatility Cone’ –

The way to read the graph would be to first identify the ‘Number of days to Expiry’ and then look at all the data points that are plotted right above it. For example if the number of days to expiry is 30, then observe the data points (representing realized volatility) right above it to figure out the ‘Minimum, -2SD, -1 SD, Average implied volatility etc’. Also, do bear in mind; the ‘Volatility Cone’ is a graphical representation on the ‘historical realized volatility’.

Now that we have built the volatility cone, we can plot the current day’s implied volatility on it. The graph below shows the plot of Nifty’s near month (September 2015) and next month (October 2015) implied volatility on the volatility cone.

Each dot represents the implied volatility for an option contract – blue are for call options and black for put options.

For example starting from left, look at the first set of dots – there are 3 blue and black dots. Each dot represents an implied volatility of an option contract – so the first blue dot from bottom could be the implied volatility of 7800 CE, above that it could be the implied volatility of 8000 CE and above that it could be the implied volatility of 8100 PE etc.

Do note the first set of dots (starting form left) represent near month options (September 2015) and are plotted at 12 on x-axis, i.e. these options will expire 12 days from today. The next set of dots is for middle month (October 2015) plotted at 43, i.e. these options will expire 43 days from today.

__Interpretation__

Look at the 2nd set of dots from left. We can notice a blue dot above the +2SD line (top most line, colored in maroon) for middle month option. Suppose this dot is for option 8200 CE, expiring 29-Oct-2015, then it means that today 8200 CE is experiencing an implied volatility, which is higher (by +2SD) than the volatility experienced in this stock whenever there are “43 days to expiry” over the last 15 months [remember we have considered data for 15 months]. Therefore this option has a high IV, hence the premiums would be high and one can consider designing a trade to short the ‘volatility’ with an expectation that the volatility will cool off.

Similarly a black dot near -2 SD line on the graph, is for a Put option. It suggests that, this particular put option has very low IV, hence low premium and therefore it could be trading cheap. One can consider designing a trade so as to buy this put option.

A trader can plot volatility cone for stocks and overlap it with the option’s current IV. In a sense, the volatility cone helps us develop an insight about the state of current implied volatility with respect to the past realized volatility.

Those options which are close to + 2SD line are trading costly and options near -2 SD line are considered to be trading cheap. Trader can design trades to take advantage of ‘mispriced’ IV. In general, try to short options which are costlier and go long on options which are trading cheap.

Please note: Use the plot only for options which are liquid.

With this discussion on Volatility Smile and Volatility Cone, hopefully our understanding on Volatility has come to a solid ground.

## 20.3 – Gamma vs Time

Over the next two sections let us focus our attention to inter greek interactions.

Let us now focus a bit on greek interactions, and to begin with we will look into the behavior of Gamma with respect to time. Here are a few points that will help refresh your memory on Gamma –

- Gamma measures the rate of change of delta
- Gamma is always a positive number for both Calls and Puts
- Large Gamma can translate to large gamma risk (directional risk)
- When you buy options (Calls or Puts) you are long Gamma
- When you short options (Calls or Puts) you are short Gamma
- Avoid shorting options which have a large gamma

The last point says – avoid shorting options which have a large gamma. Fair enough, however imagine this – you are at a stage where you plan to short an option which has a small gamma value. The idea being you short the low gamma option and hold the position till expiry so that you get to keep the entire option premium. The question however is, how do we ensure the gamma is likely to remain low throughout the life of the trade?

The answer to this lies in understanding the behavior of Gamma versus time to expiry/maturity. Have a look at the graph below –

The graph above shows how the gamma of ITM, ATM, and OTM options behave as the ‘time to expiry’ starts to reduce. The Y axis represents gamma and the X axis represents time to expiry. However unlike other graphs, don’t look at the X – axis from left to right, instead look at the X axis from right to left. At extreme right, the value reads 1, which suggests that there is ample time to expiry. The value at the left end reads 0, meaning there is no time to expiry. The time lapse between 1 and 0 can be thought of as any time period – 30 days to expiry, 60 days to expiry, or 365 days to expiry. Irrespective of the time to expiry, the behavior of gamma remains the same.

The graph above drives across these points –

- When there is ample time to expiry, all three options ITM, ATM, OTM have low Gamma values. ITM option’s Gamma tends to be lower compared to ATM or OTM options
- The gamma values for all three strikes (ATM, OTM, ITM) remain fairly constant till they are half way through the expiry
- ITM and OTM options race towards zero gamma as we approach expiry
- The gamma value of ATM options shoot up drastically as we approach expiry

From these points it is quite clear that, you really do not want to be shorting “ATM” options, especially close to expiry as ATM Gamma tends to be very high.

In fact if you realize we are simultaneously talking about 3 variables here – Gamma, Time to expiry, and Option strike. Hence visualizing the change in one variable with respect to change in another makes sense. Have a look at the image below –

The graph above is called a ‘Surface Plot’, this is quite useful to observe the behavior of 3 or more variables. The X-axis contains ‘Time to Expiry’ and the ‘Y axis’ contains the gamma value. There is another axis which contains ‘Strike’.

There are a few red arrows plotted on the surface plot. These arrows are placed to indicate that each line that the arrow is pointing to, refers to different strikes. The outermost line (on either side) indicates OTM and ITM strikes, and the line at the center corresponds to ATM option. From these lines it is very clear that as we approach expiry, the gamma values of all strikes except ATM tends to move towards zero. The ATM and few strikes around ATM have non zero gamma values. In fact Gamma is highest for the line at the center – which represents ATM option.

We can look at it from the perspective of the strike price –

This is the same graph but shown from a different angle, keeping the strike in perspective. As we can see, the gamma of ATM options shoot up while the Gamma of other option strikes don’t.

In fact here is a 3D rendering of Gamma versus Strike versus Time to Expiry. The graph below is a GIF, in case it refuses to render properly, please do click on it to see it in action.

Hopefully the animated version of the surface plot gives you a sense of how gamma, strikes, and time to expiry behave in tandem.

## 20.4 – Delta versus implied volatility

These are interesting times for options traders, have a look at the image below –

The snapshot was taken on 11^{th} September when Nifty was trading at 7,794. The snapshot is that of 6800 PE which is currently trading at Rs.8.3/-.

Figure this, 6800 is a good 1100 points way from the current Nifty level of 7794. The fact that 6800 PE is trading at 5.5 implies there are a bunch of traders who expect the market to move 1100 points lower within 11 trading sessions (do note there are also 2 trading holidays from now to expiry).

Given the odds of Nifty moving 1100 (14% lower from present level) in 11 trading sessions are low, why is the 6800 PE trading at 8.3? Is there something else driving the options prices higher besides pure expectations? Well, the following graph may just have the answer for you –

The graph represents the movement of Delta with respect to strike price. Here is what you need to know about the graph above –

- The blue line represents the delta of a call option, when the implied volatility is 20%
- The red line represents the delta of a call option, when the implied volatility is 40%
- The green line represents the delta of a Put option, when the implied volatility is 20%
- The purple line represents the delta of a Put option, when the implied volatility is 40%
- The call option Delta varies from 0 to 1
- The Put option Delta varies from 0 to -1
- Assume the current stock price is 175, hence 175 becomes ATM option

With the above points in mind, let us now understand how these deltas behave –

- Starting from left – observe the blue line (CE delta when IV is 20%), considering 175 is the ATM option, strikes such as 135, 145 etc are all Deep ITM. Clearly Deep ITM options have a delta of 1
- When IV is low (20%), the delta gets flattened at the ends (deep OTM and ITM options). This implies that the rate at which Delta moves (further implying the rate at which the option premium moves) is low. In other words deep ITM options tends to behave exactly like a futures contract (when volatility is low) and OTM option prices will be close to zero.
- You can observe similar behavior for Put option with low volatility (observe the green line)
- Look at the red line (delta of CE when volatility is 40%) – we can notice that the end (ITM/OTM) is not flattened, in fact the line appears to be more reactive to underlying price movement. In other words, the rate at which the option’s premium change with respect to change in underlying is high, when volatility is high. In other words, a large range of options around ATM are sensitive to spot price changes, when volatility is high.
- Similar observation can be made for the Put options when volatility is high (purple line)
- Interestingly when the volatility is low (look at the blue and green line) the delta of OTM options goes to almost zero. However when the volatility is high, the delta of OTM never really goes to zero and it maintains a small non zero value.

Now, going back to the initial thought – why is the 6800 PE, which is 1100 points away trading at Rs.8.3/-?

Well that’s because 6800 PE is a deep OTM option, and as the delta graph above suggests, when the volatility is high (see image below), deep OTM options have non zero delta value.

I would suggest you draw your attention to the Delta versus IV graph and in particular look at the Call Option delta when implied volatility is high (maroon line). As we can see the delta does not really collapse to zero (like the blue line – CE delta when IV is low). This should explain why the premium is not really low. Further add to this the fact that there is sufficient time value, the OTM option tends to have a ‘respectable’ premium.

**Download** the Volatility Cone excel.

### Key takeaways from this chapter

- Volatility smile helps you visualize the fact that the OTM options usually have high IVs
- With the help of a ‘Volatility Cone’ you can visualize today’s implied volatility with respect to past realized volatility
- Gamma is high for ATM option especially towards the end of expiry
- Gamma for ITM and OTM options goes to zero when we approach expiry
- Delta has an effect on lower range of options around ATM when IV is low and its influence increases when volatility is high.
- When the volatility is high, the far OTM options do tend to have a non zero delta value

This one is tough to understand….Need to read 2/3 times.

This is indeed a tricky concept Sir, but not tough :).

Please do let me know which part you are finding difficult…I will be happy to take you through it.

Gamma Variation with Time Graph.

On this graph, due to the introduction of Surface Line, I m not able to plot the actual line of OTM, ITM and ATM exactly,

And as I am stuck on this I am not able to read those followed graphs. Could you please help me with it.

This can be a quite challenging, Ravindra. How are you generating this graph? You need a 3D surface plot for this. I took my friend’s help in rendering this in Matlab.

So Sir can we assume that as of the above stated graph of “Gamma vs Time to Maturity” can we mash-up that with “Gamma Variation with time” to help myself read the graph ignoring those mentioned Red Arrows ?

Will that be a good attempt to start reading 3D graphs ?

Hmm, sort of. If I’m not wrong, I think the Gamma vs Maturity represents that of an OTM.

Dear Mr. Karthik Rangappa,

Can you please explain as to how you arrive at 1 SD and 2 SD under volatility cone?

Thanking you,

P.K.Ramakrishnan

Sir, its explained in the chapter.

Dear Sir,

Thank yor for your valuable contribution. Can we have topic on how to read option chain?

Check this, Abhay – https://zerodha.com/varsity/chapter/moneyness-of-an-option-contract/

Sorry Karthik,

But I too can not understand how you arrived at 1SD and 2SD under volatility cone.

Thanks.

Where exactly is the problem, Ram?

this was really educative and very informative. but where can we find volatility cone live for nifty options? Also need some help to select proper strike. where can i find high volumes, with delta and implied volatility values in table form but live during market hours? thanx for ur help

Suresh – you need to comprehend all the Greeks to identify the best possible strikes. However towards the end of this module, I will share few pointers on this. For all other variables you can use a standard B&S options calculator, which is the focus of the next chapter (chapter 21).

Volatility cone is a very interesting concept – I cant guarantee, but we will try and develop a web based tool for this sometime soon.

Sir, I am doing option trading, till date i had not write any option, just doing buy & square off both call & put option. You are explaining the things quiet easily. But i want to know from where we can plot this graph & find the right time to enter as you know for trading the option is fast process. Thanks in advance.

Deval – unfortunately Options cant be traded based on charts. As you can see there are many dimensions for Options trading which goes beyond simple charting. For successful options trading you need to develop a deeper understanding of Greeks and associated theory…which is the focus of this entire module.

hi karthik, how do we plot the volatility cone? what platform do we use for the same? secondly, how is the annualized realized volatility and hence its mean and variance calculated? thanks.

You can plot the Volatility cone on excel, although the logic could be a bit tricky. For the calculations, I will try and put up an excel sometime soon.

Although Karthik has already answered this, but may I still suggest that if you are familiar with MATLAB; plotting of volatility cone using MATLAB is lot easier.

Oh yes, MATLAB is good…in fact even ‘R’ is good.

Well thanks karthik/sunil. is there a way to learn how to plot the cone on MATLAB or R….i am not aware of either of them. secondly when you calculate option greeks, the inputs that are dynamic are spot price and IV. both of them change constantly. when you keep changing them on the calculator, you can see the delta and vega go up with an increase in IV. the gamma remains constant. this was for an OTM call option of bank nifty… i need to know, if we have to constantly calculate the same as the price and IV change or just decide the underlying will move by X and calculate the premium( based on delta and gamma)? i mean summing all and taking the correct strike is proving difficult. thanks.

Not sure about learning MATLAB, R etc. Maybe you should try Coursera, they may have a course there for free.

Yes, the greeks are dynamic. On a normal day when the volatility is not much I dont really calculate the greeks constantly…once a day before initiating my trade usually works for me.

hi karthik, following is the calculation of Infosys CE1160 september 2015. : life of option – 2 days (calculated today)

interest rate @ 7 %

security price @ 1128

strike @ 1160

volatility @35.95

option price @2.413 ( as per calculator)

[email protected] 0.1548

gamma @0.0079

theta @ -1.7231

vega @ 0.2002

with this information, if underlying moves by x, we know the movement of premium thanks to delta and gamma. what else can we infer? apart from the fact that the option will lose value due to theta and the impact of volatility on the premium due to vega. do comment. thanks.

Well, it is just about that 🙂 Most of the times you end up using Delta, Gamma, and IV data…the rest of the numbers helps you quantify. For example if all else stays the same I know the premium will drop by 1.7231 points t’row (thanks to Theta).

Today initially NIFTY traveled Northward and turned South and around 1 PM collapsed about 140 points within a hour. Can we calculate/predict it from IV, Gamma. Theta, Delta, smile and cone etc.

No sir..predicting the direction is quite a tough task. You can attempt to do so with some candlestick pattern….but the Greeks will not help (as far as I know).

The materials provided is very concise and very useful. Thanks a lot.

When can we see Zerodha pi having features like thinkorswim platform , where trading options are much more simpler

Hopefully very soon 🙂

the gamma of ATM option shoots up near expiry. the gamma is also the highest for an ATM option otherwise too. the delta of an ATM is influential when the volatility is low and even more sensitive when it’s high. in fact, when it’s high the delta of strikes around the ATM is influenced too. i guess, it means buy an ATM option closer to expiry and watch it shoot up ( i.e if your directional call is right). does all this mean trading in ATM is a safer bet? thanks.

Yes – trading ATM, especially near the expiry always makes sense. OTM options can be most dangerous around expiry.

First of all, thank you to the entire team of Zerodha for initiating Varsity. I have been through the entire module of options and waiting for the rest of it. I have a request can you please throw some light on put-call ratio and how to apply it in trading.

Thanks Yogita. PCR will be covered in the next module which is on Options Trading Strategies.

The option chain of SBI shows different implied volatility for different strike prices. In last chapter you taught that volatility is same as standard divination. What is the reason for different IV. Is it that IV depend on other parameters as well ?

This is exactly the reason why we have Volatility smile! One reason for this is that the option prices also factors in ‘demand supply’ situation in market which is not really captured by other greeks.

what is option equilibrium and what is difference from delta neutral, please explain

Not sure about option equilibrium price. Can you please elaborate a bit?

For delta neutral check this chapter – http://zerodha.com/varsity/chapter/delta-part-3/, section 11.1, Case 4.

what is put-call parity? what does it significance

Put Call Parity talks the relationship between the Call and Put option premiums and the arbitrate opportunity arising out of it. Will talk about it shortly in subsequent chapters.

I have seen a few charts and searched on net regarding profit and loss. All say one Standard thing ” ON THE DAY OF EXPIRY “. In the previous chapters I found the BULL CALL mentioned by you . I looked for that on internet.

My question is:

1. Will the profit and loss be equal OR be the same if I decide to square off before expiry?

2. Can we make any Excel sheet for calculating Profit loss before the date of Expiry?

1) The P&L for on the day of the expiry will be different from the P&L before the expiry

2) This would be difficult as there are multiple factors that weigh on the P&L.

Dear Karthik, Can you pl. elaborate the calculation done for Mean, 1SD , 2 SD for 15 Months Nifty Volatility & for 10, 20, 30 .. Days calculation.

Its very confusing, thoough i read previous chapters many times? Can you pl. simplify.

Ashwin – will put up the excel sheet soon, that should clear the confusion.

Waiting for your sheet sir, Please posit it ASAP. It will help lot of us… As of now i am using options oracle but the IV value differ a bit as compared with IV shown in option chain shown in NSEindia website.

Will upload as soon as possible. Thanks.

waiting for ur excel sheet v good work u hv done to trade options

t & R

Sure, will post it soon.

Sir, in the interpretation you mentioned that “option 8200 CE, expiring 29-Oct-2015, then it means that today 8200 CE is experiencing an implied volatility, which is higher (by +2SD) than the volatility experienced in this stock whenever there are “43 days to expiry” over the last 15 months [remember we have considered data for 15 months]. Therefore this option has a high IV, hence the premiums would be high and one can consider designing a trade to short the ‘volatility’ with an expectation that the volatility will cool off.” but on checking the historical data of 8200CE for past one month in NSE website (http://www.nseindia.com/live_market/dynaContent/live_watch/get_quote/GetQuoteFO.jsp?underlying=NIFTY&instrument=OPTIDX&expiry=29OCT2015&type=CE&strike=8200.00#) the premium price never came down. Could you please explain the reason?

The premium has comes down.

On 24 sept option premium opened at 49 at achieved a intraday high of 61 and on 9 oct it was trading at 153 (current month high) so, if i had shorted the option on 24 sept i would have been in loss

Yes.

” ITM options behave same as underlying ” —— don’t they tend to loose value faster than the underlying ?

what about DEEP ITM options ?

Deep ITM has a delta of 1, which means to say that for every 1 point movement in the underlying the option also move by 1 point. Hence same as the underlying.

Hi Karthik, Can you please explain your historical volatility calculation in little more detail for 10/20/…day periods. I have tried doing this calculation with the data from NSE website, but my calculation are not matching with the numbers given by you in volatility cone. Thanks.

Historical Volatility calculation is explained here – http://zerodha.com/varsity/chapter/volatility-calculation-historical/

I have already followed your calculation and the corresponding excel sheet used by you. What I am reporting here is,

for example, the calculation for volatility cone, for 10 days windows, annualized realized volatility seems to be incorrect, eg. you reported 26% for Dec. 2014 in the table, but the correct number is 18%. Could you please provide excel sheet that you used for your realized and annualized volatility calculation for 10 day window size. Thanks for your good work.

Vijay – I will put up the excel sheet soon. Sorry for the inconvenience.

Hi Karthik

1) For drawing Volatility Cone how can I get the data of Annualized Realized Volatility specific to x no. of days till expiry for different months?

2) In the last Delta vs IV graph how did you come to the curve with IV of 20% and 40%? (Since IV for different Strike will be different always)

Thanks

I’m supposed to be putting up the excel sheet (I know its over delayed)…will put it up shortly and it should sort out many of your queries regarding the calculations.

Hey Karthik, waiting for the excel sheet. 😛

It will happen only by next Month Vivek. The guy who authored that section is getting married this week 🙂

hi karthik i have one doubt , how did u calculate sd ,mean , for different days to expire to plot, and how did u get annualised return of each month, thanks in advance

Its explained in the excel Nithin…can you please check once?

I understood how to calculate daily returns and annualized returns and SD and Mean, but thing i didnt get is how to calculate mean , SD for different windows (10 day, 20,30, etc like u caluclated and tabulated the values) ..thanks

Nithin, will be putting up the excel shortly!

A gentle reminder please for Volatility cone excel sheet. Thank you.

Option Greek value table

Karthik, Can you please give me the link of your excel sheet?

All excel sheets are uploaded except for the Volatility Cone. Will do that soon.

Also wanted to ask, it is ok to choose options(Security as well as strike) by checking IV column (if selection to be made by checking IVs)from nseindia.com option chain?

Yes it does. Simple rule – buy options when the IV is low and you expect it to go high. Or Sell options when IVs are high and you expect it to go down.

Sorry to say, but either there is some typo in Volatility cone or my full concept is wrong, i.e. In AUG 2015 Nifty dipped from 8466 — 7809 — 7945 in last 10 days before expiry, but volatility in your figure is very less. Please upload excel sheet.

Anurag – Volatility cone bit has been authored by someone else. Will try and get the excel soon.

Dear Karthik,

I started reading the options theory 10 days back and read all the modules twice during this period.

Today I decided to execute a virtual trade in F&O. Options calculator is available on my online trading portal.

I was slightly bullish today morning as world markets were suggesting, I decided to buy 1 lot of NIFTY Futures JAN28 @7346/-. Since the market has been highly volatile I decided to hedge the trade at the same time by buying 2 lots of options [email protected]/- at 9:51 am.( The DLETA at that level was 0.4, combined DELTA 0.8)

In the event of NIFTY going up,from your teachings I could calculate that for every point gained in NIFTY (ie for every 1 Delta earned I would lose approx 0.6 delta ie the combined delta of 2 lots of 7300PE, after taking into account the reduction in delta as the Nifty moves up 80-90 points .

The trade worked exactly that way and by EOD NIFTY futures were at 7466. ie 90 points up and the 7300PE was trading @22/- ie 26/- down and as calculated for a 90 point profit in NIFTY I lost 0.6 DELTA X 90 on the put options ie 54(in actual 52 points) point loss combined. Net profit for the trade was 90-52= 38 points it remained that at EOD.(Profit 0.4 DELTA X 90 =36 points almost correct calculations)

I was feeling FANTASTIC and thought I can now be confident about this kind of trade and trade it regularly, UNTIL tonite when I sat to review my trade I was Shaken.

What Surprised me was when I tried to apply the similar trade on FEBRUAY contract the results were bad and it was disturbing. The strikes were exactly similar ie 7300PE but I lost , for the same 90 point upmove in NIFTY I lost a total of 80 points by EOD on the combined PUT position, compared to the 52 point loss in JAN trade. The NET profit turned out to be only 10 points (90-80).

The IV were almost similar at EOD 7300 JAN was 22.4 , FEB 20.29.

Can you please explain what went wrong , why did the results vary for FEB and what would be a better trade for FEB if executed today.

My question is too long , your answer will be appreciated and will help me improve the next trade.

Sorry Typing mistake, BY EOD NIFTY futures were 7436 not 7466 as mentioned earlier.

Avinash – I’m a bit confused about your calculation, 2 Put options each with 0.4 Delta adds up to a total delta of 0.8. So for every 1 point up move your position losses 0.8 Deltas…so for 90 points up move you are likely to lose 72 points from the total premium i.e 98. So by EOD the premium value is likely to be ard 26…i.e 98 – 73 . How did 0.6 delta feature here?

Anyway, before you understand why this does not work well for Feb, you need to understand why this worked for Jan.

It worked because we are close to Expiry, theta is peaking (remember theta acceleration), and as we approach expiry Volatility has a lesser impact on positions ass compared to the effect on premiums at the start of the series.

Since Feb is too far and there is ample time to expiry, Volatility has a far greater impact. So besides Delta, the Vega is also playing a drag on premiums.

Also, the next chapter in Options module includes a simple arbitrage example, you may want to check that for Feb!

Dear Karthik,

What is your view on my JAN NIFTY Futures Hedged trade, what would be a better hedged trade in this scenario.

Posted a reply.

Dear Karthik,

Thanks for the quick reply.

The reason why I calculated the combined DELTA as 0.6 is like this.

NIFTY at 7346 ,DELTA of 7300PE is 0.4, as NIFTY moves to 7400 DELTA becomes 0.3, further up 36 points it would be less than 0.3 , so instead of calculating DELTA for every 50 points change in NIFTY I took an average of 0.3 per lot X 2 lots = 0.6. So 90 points X 0.6 = 54 points drop in PE combined premium. The profit worked out to be diff of DELTA ie 0.4 X 90 =36 points, 1-2 points here and there.

But this thing about VOLATILITY having a greater impact on long duration options I was not aware of.

I do not know whether I am correct, but the results at EOD worked out that way. Kindly advise.

FOR Yesterday what would be a better HEDGE trade for FEB series I would like an example.

Volatility does make a big difference. What you did is a classic hedge i.e buy Fut and Sell options. Suggest you try out call ratio back spread or bear call ladder? These are all hedged option strategies.

First of all it would be a great sin if I don’t thank you for what you are doing. Thanks sir for teaching every minute topic with great details leaving no point to wonder or ponder.

my doubt: If i bought deep OTM CE long nifty index at very low price, let say Rs2, if some big event happens (though rare) and premium goes to Rs20. Then sir will there be buyers to purchase my contract? [i feel those who had shorted earlier will be in great loss and would be looking to square off and hence will buy my contract]. I must sell the contract to avoid high STT. sir, what would be the liquidity situation in such case. Are there times when such situation land long call person in trouble or is it ok with nifty no matter what the situation is??

Thanks for the kind words, Harsh!

Nifty, in particular, has abundant liquidity, so transacting in this contract should not be a problem.

Addendum to previous post:

AT around closing ie NIFTY 7436 I checked the DELTA of 7300PE in the portal calculator it showed 0.28xx , only thing I didn’t to take a picture of the same.

Addendum to DELTA calculation:

I would like to be very transparent about my calculation as I have gained knowledge only from your portal.

At NIFTY 7346 , 7300PE DELTA : 0.4 Gamma: 0.002, GAMMA measures the rate of change of DELTA.So for an approx 100 point move, 100 x 0.002 = 0.2 Since I did not want to calculate the change for every 50 points , I took the average of 0.2 (ie 0.1) and applied it to the range and subtracted 0.1 from 0. 4 and arrived at the new DELTA of 0.3. I know It may sound crazy but hat is the way I did it.Somehow the results co- incided with the calculation pretty accurately. Boss You have to tell me wether this is correct or a mere coincidence. Based on your reply I would be able to take more rational decisions going forward

Avinash – not sure if you can take averages here. Can I suggest something? Please try this calculation over and over again for few options…you will get a sense of this.

Typically this is how it works, and I’m sure you already know this –

Delta – x

Gamma – g

Premium – p

This means for every 1 point change, premium changes by x units.

Also after every point change you need to reset the delta value based on gamma. Measning for every 1 point change, old Delta would change from x to (x-g).

@karthik : could you please explain ” Volatility Cone” in excel Step by step ?

Vaibhav – This week for sure I will get the excel up and running. This has been long overdue.

@KARTHIK : waiting for excel sheet.

Yes Anurag, I’m trying my best 🙂

Thank You.

I’ll try some combinations and take your vies on them.

Sure, please do!

Thanks a lot karthik.

Welcome!

Too tedious and very exhaustive. Good for those who want to do PHD in options. In order to trade in options, one has to have understanding option geeks(Basic), OI, Max Pain. Lastly, few good option strategies.As its time for quaterly results, strangle and straddle option strategies turns out to be profitable. If one has to trade options on Intra Day basis, select liquid stocks and strike price whose detla is between 0.5 to 1 which is ITM.

Hmm, learning options is certainly time consuming. Wont happen in a hurry, but it certainly is worth the efforts!

Hi Karthik,

Could you kindly address the queries in the attached picture?

Looks like some confusion, thanks for pointing this. Will correct the same.

Where can I find the excel for cone and SD

How could you find the historical volatility of individual NSE stocks for each month like nifty? i was searching it in the nse only i could find the historical data of stocks but not the volatility at different time periods. we could calculate it like you showed in previous chapters.

Yes, you will have to calculate the historical volatility numbers…its not available online. I’ve explained this in Chapter 16 I guess.

Yes you have explained it perfectly in the last chapter. very easy to follow. thank you.

Welcome!

Sir, can you provide an excel sheet showing the volatility cone calculation and plotting.

Sure, will do.

Hi Karthik,

Can you pls post that sheet for volatility cone?

Also, one question. May not be related to above though .. Who actually trades during pre-market hours between 9-9.15 am on nSE?

Will upload it positively this week!

Anyone can place orders in the pre market session.

Whenever I try to buy shares in that window system debars me. Are those orders over night orders which get settled in that window?

Not sure what you mean? Which window are you referring to?

Window means that 9 am to 915 am window.

Eagerly waiting for Volatility cone excel sheet………….

Sure, I will try and upload it by this week.

When can the Volatility cone sheet be uploaded? Appreciate your input.

Hopefully over the next few hours.

Kindly put a link of volatility cone excel sheet for downloading. Thanks

Its there already I guess.

Hi Karthik,

In the above graph (delta vs implied volatility) why is that ITM of put option has delta > -1 when volatility is 40% (blue line) ?? When the volatility is more, premium increases for put option acc to http://zerodha.com/z-connect/wp-content/uploads/2014/08/put-vs-vega_v1.jpg . Then why is it that here, the delta is > -1. According to above graph (put vs vega) the delta with volatility should be better than without volatility. Correct me if I am wrong. Eagerly waiting for your response.

The put delta is capped to -1, and cannot be greater than -1…and -1 is the maximum delta a put option can gain….which is what happens when the put option is deep ITM. When Volatility increases the rate at which delta changes increases…which is what the graph is trying to convey.

@above, I mean with increase in volatility, the delta of put should also increase. The put options has best delta of -1.

With increase in Volatility, the rate at which the delta changes increases.

Hi Karthik, kindly answer the following questions.

1) If the volatility increases, (i) delta increases (or) (ii) rate of change of delta ?

2) Isnt the rate of change of delta = gamma ?? Then, if the volatility increases gamma increases ?

3) The above graph (delta vs implied volatility) shows that, for a deep ITM call/put options with the increase in volatility, the delta plotted is 0.9/-0.9 (approx) i.e not 1/-1. How can delta at high volatilty (40%) be less than delta at low volatilty (20%) ??

4) vega talks about change in premium w.r.t change in volatility. Does vega (volatilty) effects delta as well a part from premium. Please clarify, vega vs delta;

1) Rate of change of Delta

2) Yes,but do note that the gamma peaks at ATM…which also explains why Delta is upper and lower bound

3) Think about it non mathematical terms – when Volatility increases the chance of stock moving haywire is greater…hence deep ITM options also get reactive…this is exactly why delta is not strictly 1 when volatility increases

4) Yes

@above, when the volatility is high the Deep ITM calls/puts doesnt hit 1/-1 ??

Nope, for reasons explained earlier.

Hi Karthik,

Consider the article below http://www.theoptionsguide.com/delta.aspx. They said

“As volatility rises, the time value of the option goes up and this causes the delta of out-of-the-money options to increase and the delta of in-the-money options to decrease.”

From the graph in the article, the delta of ITM comes down (from 1 to 0.95) with increase in volatility.

Doesnt delta and volatility linearly related ? From the graph, ITM options delta is not linearly related to volatility. pls clarify

No, there is no linearity when it comes to options.

Could you add option geeks on Kite real time charts?

We would probably do this sometime in the near future.

Hello Karthik,

Could you please provide any web based tool or exel for Volatility Cone calculation as you had mentioned earlier. Thanks in advance.

I’ve not found anything reliable that I think is worth recommending. Will keep you posted when I find something interesting.

Hi Karthik,

Could you please explain about this =SQRT(1/B$5*SUM(OFFSET(Sheet1!$E$2,MATCH(Sheet1!$N5,Sheet1!$A$2:$A$504,1)-1,0,-B$5)))*SQRT(252) ….. Calculation?

I tried to understand but getting confused.

Thanks & Regard’s,

Naidu.

=SQRT(1/B$5*SUM(OFFSET(Sheet1!$E$2,MATCH(Sheet1!$N5,Sheet1!$A$2:$A$504,1)-1,0,-B$5)))*SQRT(252)

C

Hi Karthik,

Could you explain about the below points those are getting confused and taken from Volatility Cone excel file?

1. xi-x1

2. (xi-x1)^2

3. =SQRT(1/B$5*SUM(OFFSET(Sheet1!$E$2,MATCH(Sheet1!$N5,Sheet1!$A$2:$A$504,1)-1,0,-B$5)))*SQRT(252)

Thanks & Regards,

Naidu.

These are excel formulas used for the Volatility cone calculation. This section is authored by someone else, will try and get you an answer for this soon.

I got the explanation from an excel expert(excel forum), about excel formulas used for Vitality cone calculation , please find the information below.

For example, is it the use of MATCH and OFFSET? Is it the multplication of SQRT(252)?

The formula calculates the annualized standard deviation of daily (natural) log returns, which are the values in column Sheet1!E. It is a measure of volatility.

The MATCH expression returns the row index (relative to row 2) of the closest date in column Sheet1!A before or equal to the date in Sheet1!N3.

The notation $N3 means that we use N3, N4, N5 etc as we move down each column of formulas.

In contrast, the notation $A$2:$A$504 means that we always use A2:A504 in each formula.

The OFFSET expression returns the cell range of values (log returns) from column Sheet1!E corresponding to the last B5 (number of) dates ending with the relative row index returned by MATCH.

The notation B$5 means that we use B5, C5, D5 etc as we move across each row of formulas.

In contrast, the notation $E$2 means that we always use E2 in each formula.

The expression SUM(…)/B$5 calculates the (population or exact) variance of the daily log returns referenced by OFFSET.

The expression SQRT(SUM(…)/B$5) calculates the standard deviation of the daily log returns.

The daily standard deviation is annualized by multiplying by SQRT(252) according to the “square root of time” rule, assuming 252 trade days per year (on average).

—–

The (population or exact) variance of a set of data is Sigma((x[i]-xhat)^2) / n, where x[i] is each of n data points, and xhat is the mean of the data. (The operation ^2 is the square of the calculation. Sigma is the sum of the calculations.)

Ostensibly, the values (x[i]-xhat)^2 are calculated in column Sheet1!E, based on the calculation of x[i]-xhat in column Sheet1!D.

However, the calculation in column Sheet1!D seems to be incorrect.

At a minimum, the reference to J4 in Sheet1!D3 should probably be written $J$4, so that J4 is referenced in each formula down the column.

Also, Sheet1!J4 should probably contain the formula =AVERAGE(C3:C510). [Errata]

I’m going to share this with the guy who created the Volatility Cone and wait for his feedback 🙂

Hi Karthik,

Any update on why the volatility cone excel provided is having a reference to “J4” in sheet1 formulae.

Also i understand, it is important to understand if volatility might increase or decrease to decide on weather to go long or short on option. And we may use Volatility cone to determine if the volatility might increase or decrease. Request to confirm my understanding.

In addition, is there any other way apart from volatility cone to determine if volatility might increase or decrease.

Thanks again for the write up. Very useful.

That’s absolutely correct. Volatility cone helps you develop this perspective. There are other volatility models like GARCH and ARCH volatility models. These can get quite complicated.

Thank You Karthik.

Googled about realized volatility and found http://www.realvol.com/VolFormula.htm which explains why mean ( “J4” ) is zero as follows. Request to review and confirm.

————————–Extract from website ———————————————-

Mean Set to Zero

The RealVol Daily Formula starts with the traditional formula for standard deviation and modifies it in a few key ways. First, we set the mean to zero in order to provide “movement regardless of direction” instead of “movement about a mean or trend.” Doing so makes hedging easier for options traders and corresponds to the formula used for variance swaps and volatility swaps in the over-the-counter market.

————————–Extract from website ends ———————————————-

Will do try and do that when possible. Thanks.

Friend could you match the calculations for volatility cone for atleast the 10 days for one month.

Eshwar

HI Karthik,

Thanks a lot for teaching these concepts.

My query is:

1) From delta v/s IV, can we infer that in case of high IV, gamma of OTM & ITM would not approach 0.

2) In excel sheet, in bin width why did you divide the range by 50 ?

Not sure about your 1st query. Divided the bin width by 50 to contain all the data within 50 bins. You can choose to have any number of bins you want.

can you please give details of calculation of volatility cone that is described in above figure ,like how do you calculate for 10 days,20,days 120 ays .All details are for calculation of standard deviation or volatility but no calculation is shown for volatility cone so kindly provide details and formula .or is there any website where we can see different-2 days historical volatility so can draw the cone and applied IV ?

You can download the excel which is put up at the end of the chapter.

Hi Karthik

Where is the excel sheet for the V cone calculations??

sorry it is there overlooked

Cheers!

While thanks for the excel sheet for volatiatlity cone but am not able to match the calculations as in sheet. I tried for 10 days for the month of dec but am not able to match the stdev atleast although followed the process as described in earleir chapters. It would be nice if the person who has done calculations takes the pain to explain atleast for a month. This would be a great learning to all of us.

Thanks for good work

As I’ve mentioned earlier, this bit is authored by someone else. I’ll try and get an explanation soon. Thanks.

Hi Karthik

I could crack finally. Took some time but am through. Has given good insight.

Thanks

Eshwar

Cheers! Why don’t you explain what you’ve understood on a word doc, maybe I’ll include it in the main article…will benefit many 🙂

SURE WILL DO IN A SHORT TIME

Cheers!

Hi Eshwar,

Can you pls post the correct sheet

Hello, i have tried tinkering with the volatility cone model in excel but seems there is an error. I see that you have cracked it , so can you please post the same for my and others benefit? Also, i would be requiring the same for Bank nifty , so it would require fresh data inputs

This bit is developed by someone else. We have the excel uploaded which you should be able to download, hopefully that should help.

helllo karthik sir its really a superb information you have providing with easy to understand language. I am also doing my research on options and facing certain difficulties regarding it, how can we plot date vs implied volatility chart (irrespective of strike) ?? How this after some study i found that india vix does this for nifty but i am looking same for individual FnO stocks. Tried backsolving from black scholes but it gives IV for particular strike. India vix formula is bit complex plus it needs bid and ask rates to backtest it, historical bid ask rates are not available please let me know regarding this thanx a ton!!

This is not an easy task for the exact reason you’ve mentioned. ViX computation is highly complex and data intensive. Without the historical order book and knowledge on cubic spline it is difficult to do this.

yes cublic spline calculation i understood only problem is the historical orderbook of bid and ask. Do you know any alternative ? Thanx for replay

Why dont you touch base with data vendors? They may just have a solution for you.

Hi Karthik

Is there any significance of volatality smile in option premium.

No direct connection between the two.

Hi Karthik

Why implied volatality of ATM is low compared to ITM & OTM.

True, this is exactly what the ‘Volatility Smile’ suggests. Volatility should be the same across all strikes, but this is only in theory. The variation in IV’s can mathematically attributed to something called ‘Jump diffusion’.

Hi Team Zerodaha,

I want a way so that I can get the expiry dates of an option contract for the last 12 months.?

Is there anythibng on NSE site.

Cant find a proper format.

Check this – https://www.nseindia.com/products/content/derivatives/equities/historical_fo.htm

Thanks Kartik for your reply.

In the Volatility Cone excel, frank I could not decipher anything from the sheet.

But I went for a much much longer process.

With the expiration dates for the last 15 months(Is it necessary to take 15 months .??), I calculated the Annualized Volatility 10,20,30,45,60,90 days from the expiry separately for each 15 months.

Very long and tedious, but kind of the concept is same. ( Correct.. ??)

After that with that data one can construct the Cone.

But please it would be of much help if one can give the details of the Calculations in the Zerodha VC excel.

One user gave it, but still it is not making any sense to me.

Thanks and Regards.

Promit Banerjee

Yes, that is the process and I understand it is a tedious work. We will soon try and find a solution for this 🙂

Hi Karthik,

Thanks a ton for your constant support.

Well, I have deciphered the values for the current Nifty series.

The values look quite good to me, but I am not an expert in charts and can not plot this table hence.

I request you to plot the below values for yourself and see if the Cone is coming.

If it is a success kindly do let me know the process also.

Thanks again.

Days 10 20 30 45 60 90

Max 5.19% 6.26% 6.87% 9.22% 9.80% 10.83%

2 sd 4.66% 5.88% 6.79% 8.94% 10.19% 11.96%

1 sd 3.76% 4.86% 5.75% 7.57% 8.71% 10.49%

mean 2.86% 3.84% 4.71% 6.20% 7.24% 9.02%

1sd 1.96% 2.81% 3.67% 4.83% 5.76% 7.54%

2 sd 1.05% 1.79% 2.63% 3.47% 4.29% 6.07%

min 1.72% 2.55% 3.20% 4.66% 5.20% 7.08%

Promit – I’m not sure if I can do that. However, glancing at these numbers, I do get a sense that they could be right.

Thanks Karthik for the reply..

Anyone if they can just plot the graph from the data.

I can also send you the data via mail if you want.

Regrads,

Promit Banerjee.

Hopefully, someone in the community here can help you. I’m sure it will be a great learning experience for them as well.

Hi Mr. PROMIT BANERJEE

Exact cone, as shown above is not coming. But, something similar to cone is coming with the data given by you.

Regards

Hi Promit I tried to plot the graph and it does not looks like cone

I am not able to attach the file here

Hi Dear Karthik,

Do we have to draw Volatility cone for each and every strike price.

I suppose, one cone will not give clarity on IV, for all the strike prices of the same underlying.

Could you please help me on this.

Regards

True, you plot it and connect the points to get the volatility cone.

Hi Karthik,

I am thankful that you created such a content as it helps new users like me and others, please continue the good work. I looked for a tool and found Options Oracle tool is capable of creating a volatility cone. I am yet to check the accuracy of it but others here could also check and feedback if they feel it is plotting the call and puts IV properly.

http://www.pasitechnologies.com/2015/11/optionsoracle-nse-plugin-v-185.html

Thanks for sharing the link Gokul, will look through this.

Hi Karthik

A layman’s question.. how to understand how much liquid is a call or a put of a particular strike?

A scrip is considered liquid if you can easily buy or sell the contract when you place a market order. Do note, the price at which you get the contract should be around the same price as the last traded price in the market.

Hi Karthik

Based on your Volatility Excel, I have put in 15 months data for Nifty to get the volatility cone for the last 12 months. From the volatility cone, a 30 days-to-expiry option with + 2 SD variance would be at an IV of 18.37%. Now from the Nifty Option chain, as on today (28th Mar), the 27-Apr 10000 PE has an IV of 20.47%. The option also has a good liquidity at the moment, going by the Volume and OI figures. Is it feasible to go short on this 10000 PE which is presently trading at 835 ?

The difference in volatility is not much to build a case for short (with high conviction), but yeah, the thought process and approach is spot on. Good luck.

Thanks for the feedback. Another Question.. For plotting the volatility cone, the days to expiry (x axis) used was 10-20-30-45-60-90. Is this fixed or can it be changed/expanded to, say 10-15-20-25-30-35-45-60-75-90?

Can be changed to suite your requirement.

Hi karthik,

I have two queries

Kindly guide.

1) most of the time i have seen that the direction of nifty is highly dependent on the global markets and some major indian news. In that case how relevant is the nifty chart by itself ?

2) can you provide the opening time of major global markets( which affects indian markets ) w.r.t. IST ?

Thanks in advance.

1) It is still very necessary. Not all the time is Nifty dependent on global mkts.

2) Please track the Hang Seng and FTSE, and DOW futures which trades all the time.

i am trying my level best to understand this formula =SQRT(1/B$5*SUM(OFFSET(Sheet1!$E$2,MATCH(Sheet1!$N5,Sheet1!$A$2:$A$504,1)-1,0,-B$5)))*SQRT(252), so as to obtain the value for x days for given month. but cant able to achieve so far. i tried the formula you explained in chapter 16. but not getting this value as shown in excel sheet. If you can shown how to obtain relative volatility , it will really helpful. please explain here or mail me. i will really appreciate

This particular section is not written by me, so I will have to check this with the guy who created this.

This is really good info. Is there any broker in India who gives this IV rank info inside the trading platform? Also if i just have to calculate the IV rank using the formula “100*(Current IV – 52 week Low IV)/(52 week High IV – 52 week low IV), how do i do that. I guess it will be very difficult to calculate the daily voltaility for last 364 days and then figure the high and low values..

If you know coding, then I guess it is fairly easy to do it. I dont think there is any broker giving you this info.

Amazing tutorial. At a time when people hold back information and tricks of the trade for selfish reasons, there is an interesting and knowledgeable teacher like Karthik who loves to share. Learnt a lot. Thanks. Off I go to the next module!

Hey..thanks for the kind words Anish. At Zerodha we believe in good karma 🙂

Hi Karthik, can you please provide the excel sheet of volatility cone, please. Thanks

I suppose its available at the end of the chapter, you can download it.

U got HV from june 2014 to august 2015.

Where can I get this data from?

NSE India provides historical data, please check this – https://www.nseindia.com/products/content/equities/equities/eq_security.htm

I did not get the monthwise historic data anywhere on NSE website, secondly u said “If we repeat this exercise for 10, 20, 30, 45, 60 & 90 day windows, we would get a table as follows” where to get such precise data?

Ah, these are derived data Vignesh.

hi ,

I am very new in trading …thanks for so easy to comprehend lectures. But from where can I get delta,gamma and theta values.

You can get it from the Options calculator here – https://zerodha.com/tools/black-scholes/

Hi Karthik……Your articles are really striking the point with ease understand. You know how much force need to applied for each stone(topic) to make a right shape(knowledge).

Thanks for the kind words, Srinivas 🙂

In the Volatility Cone sheet, from where will I get the data of Implied Volatility, and what was the purpose of column D in sheet 1(=C4-J5) when there is no values in J column?

Thank You.

Ah, this section is authored by someone else, Abhilash. Let me check with him.

Thanks a lot!! Eagerly waiting for that.

Cheers!

Hi Karthik,

I have following questions.

1. If I want to use volatility cone to find trading opportunities, do I have to calculate this cone for each underlying in which I’m interested or these values are readily available? I know IndiaVIX is volatility index of all the stocks but I feel it won’t depict correct conditions of any particular stock.

2. I know you told there is no particular checklist while trading options, but I was hoping if you can give some steps to do before starting a trade. I read all the chapters and have understood all the concepts but when it comes to trade I still feel I might miss something since there are many factors to look at.

So not a strong checklist like you mentioned in TA but just a few steps for newbies.

Something like this I have in mind for naked trades-

Step1 – find your view on underlying ofc

Step2 – choose a expiry based on liquidity and trading time

Step3 – pick put/call strikes based on time to expiry and check premiums

Step4 – check volatility, buy when volatility is low, short when volatility is high

Thanks.

One more question

3. What are bid/ask price and quantity?

I don’t think you’ve mentioned them anywhere in this module.

Check section 9.6 – https://zerodha.com/varsity/chapter/the-trading-terminal/

1) You will have to develop the Cone for each underlying. True that on ViX

2) There is a high possibility that each time you trade options, the circumstance is different. Hence difficult to generalize a checklist. Go ahead and take a trade, a low risk one…your learning curve will accelerate once you have a trade live in the market.

you have explained the concept of implied volatility very nicely in easy way. Thanks you for your hard labour. Please tell name of 10 multibagger stocks for 2017.

Happy learning, Shyam!

Hi Karthik,

Once again thanks for sharing all these. I have done the Volatility Cone calculations myself, and as many others mentioned in earlier comments, I think there is some problem in the Volatility Cone excel sheet shared by you (as well as in the example used). I have done all the calculation in a Google spreadsheet with real-time data grabbed from Google finance (https://goo.gl/wUsgBd). Anybody can use this to get Volatility Cone for current date without requiring to do any change (also for any previous date by changing start date).

Anyway, as per my calculation, the mean line in Volatility Cone for the period used by you guys (Jan 11 – Feb 12) lies around 22-24. This matches with India VIX data for that period. However, in the shared excel sheet, this lies around 30 which is around the maximum India VIX level in that period. You do not need to go through either of these calculations to verify what I’m saying, but do you think the way I’m thinking is correct, i.e. mean volatility in Volatility Cone should be around the same level as India VIX average for the same period?

Moving on to my second question, in my calculation as well as in your examples, the MIN line in volatility cone is always greater than -2SD line (this is not the case with MAX and +2SD). Does this indicate anything? I was thinking may be this is a proof of what you mentioned in several chapters – “fear spreads faster than greed”. So, Nifty volatility always shoots up more from the average, than it goes down.

Nachiketa, I’m forwarding this query to my person who developed the Volatility Cone. I’ll probably ask him to reply here directly.

Thanks Karthik. That’ll be great.

Cheers!

Vix average need not be same as avg volatility of volatility cone, but it should be close enough.

Calculation for vix is different from volatility cone. Volatility cone uses spot data, ViX uses IV of near month and next month options, so they need not match.

The mathematical reason for why highest value vix is higher than 2 sd, but lowest value is not below -2 sd is that the Volatility cone assumes a normal distribution for nifty, which is only an approximation. Think of it, volatility can never be zero or negative, whereas it has no upper limit. This is not the case with the normal distribution, it will swing on both sides with equal chance. That’s the reason for this pattern.

Thanks Karthik for the reply below (can’t reply to that for some reason).

Also wanted to mention that last week was the first time I tried Option trading after going through all these material. It has been a exciting practical hands-on with Gujarat election going on. I could relate as well as predict and check all the volatility caveats you have mentioned in these articles. For example, Thursday (the day before exit poll was out), premiums of almost all 3-4 strikes on either side of ATM for both PE and CE increased although Nifty was down by some 0.4~0.5%. The reason being Volatility increased to almost 17% (highest in last 11 months). And although Nifty went up, premiums of some deep OTM CE dropped next day with exit poll bringing down the volatility to normal levels.

Absolutely, this is one of the most common setups to trade. Hope you made a profit 🙂

Good luck and stay profitable!

Why we can’t see implide volatility of bank nifty in options chains.

Further what does (-) sign refer to in IV in nse option chain.

Ah, I’m not sure why. Maybe you should check with NSE for this. Its not a -ve sign, it just means the IV is not available 🙂

Okay. Can you advice any other tool for IV as without it is not possible to use black and schols calculator.

Have you checked this? – https://zerodha.com/z-connect/queries/stock-and-fo-queries/option-greeks/how-to-use-the-option-calculator

https://drive.google.com/file/d/1xIxPL8GEPujTRU69pIUcO7r_9snYH3om/view?usp=sharing

can a Volatility Cone look like this?

Yes, that kind of looks like a Vol Cone.

Hello sir,

as you explained volatility cone to measure costliness of an option by using chart above having colorfull lines of sd1,sd2 etc. it was very easy to understand that which option is costly and which is cheap for buyers perspective.BUT if am doing same exercise at my pc at home i am facing problems:-

1. How to make same chart

2. how to plot dots on that chart

yeah i can understand i can use excel for that exercise. but i wanna use same type of graphical interpretation of things that makes things easy to understand

Thank you sir.

Warm regards

Ankit

I guess you can download the excel sheet and run through the steps, Ankit.

Could you please explain what exactly do you mean is 680PE is trading at 5.5? In delta vs IV example.

It means the strike of 680, Put option is trading at a premium of Rs.5.5.

Where can I get data for realized volatility?

You can calculate that – historical volatility is realized vol.

Hello Sir,

Sorry for troubling you with many questions.

In the graph, Delta vs IV, I am confused about few things.

When the delta increases, premium increases; when the volatility increases, the premium increases. But for the ITM options, when the volatility increases, delta seems to decrease (at the ends). So, for the increase in volatility, if delta decreases, does the premium tend to increase or decrease.

Thanks in advance Sir

Aishwarya

Not sure if I understood the question correctly, but Yes, the if the IV increases so would the premium. Remember, the end of the Delta line (representing OTM and ITM) tends to stand elevated levels – this also implies the option premiums are more reactive under higher IVs.

1) While I do understand the concept of selling an option before a major event and pocketing the difference in premium later on, but wouldn’t the risk be very huge? Like I remember an example in an earlier module where one of your associates made big money when the election results were announced for 2009 on May 18th. My concern is what if someone had sold a CE option then? Wouldn’t the rise of the market be so huge that it would overpower the drop in volatility? I know that was probably an extreme case but the risk of market rising by 200-300 after an event and overpowering the volatility drop can never be ruled out, can it? How to overcome this?

2) If the implied volatility of ATM options are less compared to ITM/OTM options, then if one is looking to short an option strike before a major event, would it make more sense to short an OTM or ITM option? But I also read somewhere that one should never short ITM options?

Thanks in advance!

1) Yes, I do agree. Hence you need to evaluate the possible outcome of each event and its impact on option prices. Also, remember, you are writing both CE and PE and not just CE or PE.

2) Ideally, it’s best if you short ATM for event-based trades. But its absolutely important to ensure the premiums are very high enough to consider writing these options.

1) Writing both CE and PE as a hedging technique or to collect premium from both of them?

2) Considering Karnataka elections are on 12th May, would it make sense-

a) to buy a CE option on 1st or 2nd May, thought process being that premium would rise due to volatility.

b) conversely, selling option around 10th May and collecting premium when results are announced?

Yes, both make sense. Although I think, the options have already incorporated the higher volatility bit.

Once again hello sir,

I am not able to plot volatility cone of other stocks using the excel sheet provided by you. Value error is coming on all sheets other than the first. I am not able to understand a few things regarding the same:

1.) Column J (x1) is empty while the values in column D (xi-x1) are based on column J only.

2.) Column F (implied volatility) is empty till row 200 and than some values are pre-filled from row 201 onwards. Do we have to fill those values manually, if yes than how can we get those ?

3) 2 years data has been taken to calculate different volatility cones. If i want to plot a cone for April 2018, do i need to put data from April 2016 to April 2018 or just one year data will be sufficient ?

4) To find out if the current IV is high or low for a strike price, do i need to plot volatility cones for all past months like its done in excel sheet or just current month (April 2018) cone will be enough ?

I am having lots of doubts in this and i know you can’t personally explain me everything but i would be grateful if you could spare some time to help me out a bit. Thanks.

Rishab, the volatility cone was plotted by someone else. I will try passing this query to the right person and get you a response.

Ok Sir, Thanks!

Good luck, Rishab.

Hi Karthik,

In the 3 dots example i.e. blue and black dots you have taken this current data from NSE’s option chain Implied Volatility given in IV column of index or stock?

In our own calculations also we have to consider NSE’s option chain Implied volatility (i.e IV column) for analysis?

Yes, you can your own calculation for IVs, but this is not easy.

Hi Karthik,

I didn’t got exactly what you are trying to explain. Can you please clarify.

Thanks.

Can you please help me understand which part you are stuck with?

Hi Karthik,

From where i can get the data for 3 dots plotting?

Ah, that is just superficially plotted.

how to calculate Annualized realized volatility for past nifty data?

Calculate the daily return and multiply this with the square root of time, have explained this in the chapter.

How to calculate realized volatility?

Please explain.

Historical Volatility is nothing but the realized volatility.

But how to find the data before 10 days of expairy realized volatility of last 1 year?

Khurshid, you can run a historical volatility calculation on excel. “=Stdev()” on the return series will give you this value.

Please share the link of volatility cone excell sheet.

Its available in the chapter itsefl, please scroll down.

Dear Karthik

Is there any hindi version of varsity?

Nothing yet, Khurshid.

Sir I have a doubt regarding volatility cone calculations,

10 days before expiry means, for 29-jun-2018 expiry I have to take data from 22-may-2018 to 31-may-2018 to calculate annual volatility, likewise for 20 days 12-may-2018 to 31-may-2018 data am I correct sir?

It just means 10 days before the expiry date…so you will have to go back 10 days before 29th June.

thanks sir, that is what I am asking, little confusion, was sleepy while typing☺️

Good luck 🙂

Dear Karthik

How to get 10 days annualized realised volatility before expiry date from the downloaded nse closing price data?

You can convert the daily volatility to 10-day volatility by multiplying daily volatility with Square Root of 10. For example, if the daily vol is 1.2%, then 10 day vol is = 1.2%*Sqrt(10) = 3.79%.

I understood this ” how to convert annualized volatility to required time period or one day volatility to required time period” but my question is how to find annualized realized volatility of “last 10 days or 20 or 30 days before expiry period? Please explain

Extracting the volatility before a certain number of days is quite tricky, needs a lot of computation. Not really easy, Khurshid.

How do we calculate realized volatility?

Historically volatility is the realized volatility.

Sir,

I DOWNLOADED THE VOLATILITY CONE EXCEL SHEET BUT COULD NOT UNDERSTAND HOW THE EXCEL SHEET IS DESIGNED AND HOW THE DATA HAS BEEN PUT INTO. WOULD YOU PLEASE EXPLAIN IT STEP BY STEP ABOUT IT. (LIKE YOU DID FOR EXCEL SHEET FOR HISTORICAL VOLATILITY CALCULATION)

PLEASE!

THANK YOU SIR.

Saugatha, the excel sheet is prepared by someone else, will try and see if I can get an explanation. Thanks.

Yeah can you explain whhat data are supposed to be put in that.

Sure, will reach out and check. Thanks.

Dear karthik

At volatility cone chapter, the nifty data of 15 month is hypothetical or actual? Downloaded the 15 these moth of data, they are not maching.

Actual data, Khurshid.

Sir you have mentioned many a times about liquidity,

but how to find whether an option is liquid or not?

what is the max diff between bid-ask spread for liquid contracts?

Mani, if the option premium is around 10 or 12 and the difference is say around 1 or 1.5, then clearly this is a large spread. Likewise, if the option 100 and the difference is around 1 or 1.5, then its still not so great but alright. End of the day, you will have to quickly measure this spread as a % of the premium. Higher the %, lower the liquidity and otherwise.

K sir

Where can I get the implied volatility values that are mentioned in the excel column F of the volatility cone sheet?

Siddhant, you can check https://sensibull.com/.

1. For using the volatility cone Excel sheet, I have to paste the date & closing price (for last two years) of any F&O stock and also change the dates (i.e. monthly expiry dates). Remaining all calculations will be done by the excel sheet itself?

2. If Currently October-2018 series is ending , then i can take IV for for next 30days from October sheet and compare with NOV series NSE data IV.. Right?

1) Yes, please give that a try

2) Yup, you can.

What shall be the starting date in the volatality cone i.e. first entry date in the excel sheet. What is the ideal date for calculating the volatality cone for next month. Example: i want to calculate the volatality cone for NOV-2018 month, what shall be my starting date (i.e. first entry) .. i can simply take last two years data on any day( may be 1st or 3rd or 6th NOV ..etc) in NOV-2018 and just paste the data in excel sheet or else there is any particular starting date? Please give me clartiy on it.

I’d suggest you take at least 6 months data.

1. is it sensible to buy options with 20 days to expiry and the IV is trading just below mean ( by seeing volatality cone of that particular stock or index) ?

2. Also sometimes Deep ITM call option IV is low(for a particular strike price) , is it sensible to buy deep itm option if IV is really low? for example, i am thinking to buy banknifty NOV series call option(29 NOV expiry) today. CMP is 25771 and IV of ATM(25700) is 14% & premium is 445 , whereas 25200CE is ITM option and trading at 745 & IV is just 10.20% (which is near SD-1 level), so is it good to buy 25200 instead of buying OTM option i.e. 26000CE , premium is 284 & IV is 13.51%(which is mean level as per volatality cone)?

3. Can we short weekly banknifty expiry series call options ( which is SD1 above) also based on the volatality calculation sheet which you shown us i.e. SD1 and SD2 levels.?

1) Yes, but you need to have a view on the IV here. Makes sense to buy only if you expect the IV to increase over the next 20 days

2) Same answer as above. If the answer is yes, then you certainly can buy the option with an expectation that the low IV will support your long position

3) Yes, you can. Make sure you calculate weekly SDs.

>as you go away from the ATM option (for both Calls and Puts) the implied volatilities increase, in fact further you move from ATM, the higher is the IV.

However,

IV of strike 230(slightly OTM) is 51.18

IV of strike 225(ATM) is 51.53

Could you pls clarify?

Well, this is a generic statement. Markets, as you know is all about mispricing 🙂

>Similarly a black dot near -2 SD line on the graph, is for a Put option. It suggests that, this particular put option has very low IV, hence low premium and therefore it could be trading cheap. One can consider designing a trade so as to buy this put option.

When IV is low, then premiums are low and hence logically we could buy PUT, however when volatility is low it also means

that market might be bullish and bulls might get control right , then how could we justify our PUT buying and rule out bullish doubts?

IV and volatility are used interchangeably here, Bharath. The idea here is to convey that when IVs crack, the options become cheaper and hence builds a case to buy. However, the other factors should also justify the trade. You need to look at factors such as Delta, theta, and of course momentum.

This Chart Please…

Particulars Details

Maximum Volatility *56%

+2 Standard Deviation (SD) 54%

+1 Standard Deviation (SD) 42%

Mean/ Average Volatility 31%

-1 Standard Deviation (SD) 19%

-2 Standard Deviation (SD) 7%

Minimum Volatility 13%

I didn’t get it how did you get to 42% as 1SD and 54% as 2SD

By the way sorry, for not being able to understand it.

Thanks.

Ah, I get your point. I will check this and get back, Ram.

OK.

Hi Karthik,

Is it possible to connect with you to understand how to draw volatility cone. I downloaded the excel, but did not understand much looking at excel.

Thanks

Abdul

Ah, the cone was actually developed by someone else. But do let me know which part you are stuck with, will try my best to help. Thanks.

Sir, I thought I need to just replace the values in Sheet 1 and rest will auto calculate. Need help in creating cone for some other stock so that I understand from base.

Technically yes, thats all you need to do. Let me check this again. Thanks. Meanwhile, please do check Sensibull – https://sensibull.com/

IV and volatility we calculated in previous chapter is different? If yes, how?

Mayank, can you kindly suggest how they are different?