## 19.1 – Volatility Types

The last few chapters have laid a foundation of sorts to help us understand Volatility better. We now know what it means, how to calculate the same, and use the volatility information for building trading strategies. It is now time to steer back to the main topic – Option Greek and in particular the 4^{th} Option Greek “Vega”. Before we start digging deeper into Vega, we have to discuss one important topic – Quentin Tarantino ☺.

I’m huge fan of Quentin Tarantino and his movies. For people not familiar with Quentin Tarantino let me tell you, he is one of the most talented directors in Hollywood. He is the man behind super cult flicks such as Pulp Fiction, Kill Bill, Reservoir Dogs, Django Unchained etc. If you’ve not watched his movies, I’d suggest you do, you may just love these movies as much as I do.

It is a known fact that when Quentin Tarantino directs a movie, he keeps all the production details under wraps until the movies trailer hits the market. Only after the trailer is out people get to know the name of movie, star cast details, brief story line, movie location etc. However, this is not the case with the movie he is directing these days, titled “The Hateful Eight”, due to be released in December 2015. Somehow everything about ‘The Hateful Eight’ – the star cast, storyline, location etc is leaked, hence people already know what to expect from Tarantino. Now given that most of the information about the movie is already known, there are wild speculations about the box office success of his upcoming movie.

We could do some analysis on this –

**Past movies**– We know almost all of Tarantino’s previous movies were successful. Based on his past directorial performance we can be reasonably certain that ‘The Hateful Eight’ is likely to be a box office hit**Movie Analyst’s forecast**– There are these professional Hollywood movie analysts, who understand the business of cinema very well. Some of these analysts are forecasting that ‘The Hateful Eight’ may not do well (unlike his previous flicks) as most of the details pertaining to the movie is already, failing to enthuse the audience**Social Media**– If you look at the discussions on ‘The Hateful Eight’ on social media sites such as Twitter and Facebook, you’d realize that a lot of people are indeed excited about the movie, despite knowing what to expect from the movie. Going by the reactions on Social Media, ‘The Hateful Eight’ is likely to be a hit.**The actual outcome**– Irrespective of what really is being expected, once the movie is released we would know if the movie is a hit or a flop. Of course this is the final verdict for which we have to wait till the movie is released.

Tracking the eventual fate of the movie is not really our concern, although I’m certainly going to watch the movie ☺.

Given this, you may be wondering why we are even discussing Quentin Tarantino in a chapter concerning Options and Volatility! Well this is just my attempt (hopefully not lame) to explain the different types of volatility that exist – Historical Volatility, Forecasted Volatility, and Implied Volatility. So let’s get going.

**Historical Volatility** is similar to us judging the box office success of ‘The Hateful Eight’ based on Tarantino’s past directorial ventures. In the stock market world, we take the past closing prices of the stock/index and calculate the historical volatility. Do recall, we discussed the technique of calculating the historical volatility in Chapter 16. Historical volatility is very easy to calculate and helps us with most of the day to day requirements – for instance historical volatility can ‘somewhat’ be used in the options calculator to get a ‘quick and dirty’ option price (more on this in the subsequent chapters).

**Forecasted Volatility **is similar to the movie analyst attempting to forecast the fate of ‘The Hateful Eight’. In the stock market world, analysts forecast the volatility. Forecasting the volatility refers to the act of predicting the volatility over the desired time frame.

However, why would you need to predict the volatility? Well, there are many option strategies, the profitability of which solely depends on your expectation of volatility. If you have a view of volatility – for example you expect volatility to increase by 12.34% over the next 7 trading sessions, then you can set up option strategies which can profit this view, provided the view is right.

Also, at this stage you should realize – to make money in the stock markets it is NOT necessary to have a view on the direction on the markets. The view can be on volatility as well. Most of the professional options traders trade based on volatility and not really the market direction. I have to mention this – many traders find forecasting volatility is far more efficient than forecasting market direction.

Now clearly having a mathematical/statistical model to predict volatility is much better than arbitrarily declaring “I think the volatility is going to shoot up”. There are a few good statistical models such as ‘Generalized AutoRegressive Conditional Heteroskedasticity (GARCH) Process’. I know it sounds spooky, but that’s what it’s called. There are several GARCH processes to forecast volatility, if you are venturing into this arena, I can straightaway tell you that GARCH (1,1) or GARCH (1,2) are better suited processes for forecasting volatility.

**Implied Volatility (IV) **is like the people’s perception on social media. It does not matter what the historical data suggests or what the movie analyst is forecasting about ‘The Hateful Eight’. People seem to be excited about the movie, and that is an indicator of how the movie is likely to fare. Likewise the implied volatility represents the market participant’s expectation on volatility. So on one hand we have the historical and forecasted volatility, both of which are sort of ‘manufactured’ while on the other hand we have implied volatility which is in a sense ‘consensual’. Implied volatility can be thought of as consensus volatility arrived amongst all the market participants with respect to the expected amount of underlying price fluctuation over the remaining life of an option. Implied volatility is reflected in the price of the premium.

For this reason amongst the three different types of volatility, the IV is usually more valued.

You may have heard or noticed India VIX on NSE website, India VIX is the official ‘Implied Volatility’ index that one can track. India VIX is computed based on a mathematical formula, here is a **whitepaper** which explains how India VIX is calculated –

If you find the computation a bit overwhelming, then here is a quick wrap on what you need to know about India VIX (*I have reproduced some of these points from the NSE’s whitepaper*) –

- NSE computes India VIX based on the order book of Nifty Options
- The best bid-ask rates for near month and next-month Nifty options contracts are used for computation of India VIX
- India VIX indicates the investor’s perception of the market’s volatility in the near term (next 30 calendar days)
- Higher the India VIX values, higher the expected volatility and vice-versa
- When the markets are highly volatile, market tends to move steeply and during such time the volatility index tends to rise
- Volatility index declines when the markets become less volatile. Volatility indices such as India VIX are sometimes also referred to as the ‘Fear Index’, because as the volatility index rises, one should become careful, as the markets can move steeply into any direction. Investors use volatility indices to gauge the market volatility and make their investment decisions
- Volatility Index is different from a market index like NIFTY. NIFTY measures the direction of the market and is computed using the price movement of the underlying stocks whereas India VIX measures the expected volatility and is computed using the order book of the underlying NIFTY options. While Nifty is a number, India VIX is denoted as an annualized percentage

Further, NSE publishes the implied volatility for various strike prices for all the options that get traded. You can track these implied volatilities by checking the option chain. For example here is the option chain of Cipla, with all the IV’s marked out.

The Implied Volatilities can be calculated using a standard options calculator. We will discuss more about calculating IV, and using IV for setting up trades in the subsequent chapters. For now we will now move over to understand Vega.

**Realized Volatility** is pretty much similar to the eventual outcome of the movie, which we would get to know only after the movie is released. Likewise the realized volatility is looking back in time and figuring out the actual volatility that occurred during the expiry series. Realized volatility matters especially if you want to compare today’s implied volatility with respect to the historical implied volatility. We will explore this angle in detail when we take up “Option Trading Strategies”.

## 19.2 – Vega

Have you noticed this – whenever there are heavy winds and thunderstorms, the electrical voltage in your house starts fluctuating violently, and with the increase in voltage fluctuations, there is a chance of a voltage surge and therefore the electronic equipments at house may get damaged.

Similarly, when volatility increases, the stock/index price starts swinging heavily. To put this in perspective, imagine a stock is trading at Rs.100, with increase in volatility, the stock can start moving anywhere between 90 and 110. So when the stock hits 90, all PUT option writers start sweating as the Put options now stand a good chance of expiring in the money. Similarly, when the stock hits 110, all CALL option writers would start panicking as all the Call options now stand a good chance of expiring in the money.

Therefore irrespective of Calls or Puts when volatility increases, the option premiums have a higher chance to expire in the money. Now, think about this – imagine you want to write 500 CE options when the spot is trading at 475 and 10 days to expire. Clearly there is no intrinsic value but there is some time value. Hence assume the option is trading at Rs.20. Would you mind writing the option? You may write the options and pocket the premium of Rs.20/- I suppose. However, what if the volatility over the 10 day period is likely to increase – maybe election results or corporate results are scheduled at the same time. Will you still go ahead and write the option for Rs.20? Maybe not, as you know with the increase in volatility, the option can easily expire ‘in the money’ hence you may lose all the premium money you have collected. If all option writers start fearing the volatility, then what would compel them to write options? Clearly, a higher premium amount would. Therefore instead of Rs.20, if the premium was 30 or 40, you may just think about writing the option I suppose.

In fact this is exactly what goes on when volatility increases (or is expected to increase) – option writers start fearing that they could be caught writing options that can potentially transition to ‘in the money’. But nonetheless, fear too can be overcome for a price, hence option writers expect higher premiums for writing options, and therefore the premiums of call and put options go up when volatility is expected to increase.

The graphs below emphasizes the same point –

X axis represents Volatility (in %) and Y axis represents the premium value in Rupees. Clearly, as we can see, when the volatility increases, the premiums also increase. This holds true for both call and put options. The graphs here go a bit further, it shows you the behavior of option premium with respect to change in volatility and the number of days to expiry.

Have a look at the first chart (CE), the blue line represents the change in premium with respect to change in volatility when there is 30 days left for expiry, likewise the green and red line represents the change in premium with respect to change in volatility when there is 15 days left and 5 days left for expiry respectively.

Keeping this in perspective, here are a few observations (observations are common for both Call and Put options) –

- Referring to the Blue line – when there are 30 days left for expiry (start of the series) and the volatility increases from 15% to 30%, the premium increases from 97 to 190, representing about 95.5% change in premium
- Referring to the Green line – when there are 15 days left for expiry (mid series) and the volatility increases from 15% to 30%, the premium increases from 67 to 100, representing about 50% change in premium
- Referring to the Red line – when there are 5 days left for expiry (towards the end of series) and the volatility increases from 15% to 30%, the premium increases from 38 to 56, representing about 47% change in premium

Keeping the above observations in perspective, we can make few deductions –

- The graphs above considers a 100% increase of volatility from 15% to 30% and its effect on the premiums. The idea is to capture and understand the behavior of increase in volatility with respect to premium and time. Please be aware that observations hold true even if the volatility moves by smaller amounts like maybe 20% or 30%, its just that the respective move in the premium will be proportional
- The effect of Increase in volatility is maximum when there are more days to expiry – this means if you are at the start of series, and the volatility is high then you know premiums are plum. Maybe a good idea to write these options and collect the premiums – invariably when volatility cools off, the premiums also cool off and you could pocket the differential in premium
- When there are few days to expiry and the volatility shoots up the premiums also goes up, but not as much as it would when there are more days left for expiry. So if you are a wondering why your long options are not working favorably in a highly volatile environment, make sure you look at the time to expiry

So at this point one thing is clear – with increase in volatility, the premiums increase, but the question is ‘by how much?’. This is exactly what the Vega tells us.

The Vega of an option measures the rate of change of option’s value (premium) with every percentage change in volatility. Since options gain value with increase in volatility, the vega is a positive number, for both calls and puts. For example – if the option has a vega of 0.15, then for each % change in volatility, the option will gain or lose 0.15 in its theoretical value.

## 19.3 – Taking things forward

It is now perhaps time to revisit the path this module on Option Trading has taken and will take going forward (over the next few chapters).

We started with the basic understanding of the options structure and then proceeded to understand the Call and Put options from both the buyer and sellers perspective. We then moved forward to understand the moneyness of options and few basic technicalities with respect to options.

We further understood option Greeks such as the Delta, Gamma, Theta, and Vega along with a mini series of Normal Distribution and Volatility.

At this stage, our understanding on Greeks is one dimensional. For example we know that as and when the market moves the option premiums move owing to delta. But in reality, there are several factors that works simultaneously – on one hand we can have the markets moving heavily, at the same time volatility could be going crazy, liquidity of the options getting sucked in and out, and all of this while the clock keeps ticking. In fact this is exactly what happens on an everyday basis in markets. This can be a bit overwhelming for newbie traders. It can be so overwhelming that they quickly rebrand the markets as ‘Casino’. So the next time you hear someone say such a thing about the markets, make sure you point them to Varsity ☺.

Anyway, the point that I wanted to make is that all these Greeks manifest itself on the premiums and therefore the premiums vary on a second by second basis. So it becomes extremely important for the trader to fully understand these ‘inter Greek’ interactions of sorts. This is exactly what we will do in the next chapter. We will also have a basic understanding of the Black & Scholes options pricing formula and how to use the same.

## 19.4 – Flavors of Inter Greek Interactions

(The following article was featured in **Business Line** dated 31st August 2015)

Here is something that happened very recently. By now everyone remotely connected with the stock market would know that on 24^{th} August 2015, the Indian markets declined close to 5.92% making it one of the worse single day declines in the history of Indian stock markets. None of the front line stocks survived the onslaught and they all declined by 8-10%. Panic days such as these are a common occurrence in the equity markets.

However something unusual happened in the options markets on 24^{th} August 2015, here are some data points from that day –

Nifty declined by 4.92% or about 490 points –

India VIX shot up by 64% –

But Call option Premiums shot up!

Traders familiar with options would know that the call option premiums decline when market declines. In fact most of the call option premiums (strikes below 8600) did decline in value but option strikes above 8650 behaved differently – their premium as opposed to the general expectation did not decline, rather increased by 50-80%. This move has perplexed many traders, with many of the traders attributing this move to random theories such as rate rigging, market manipulation, technological inefficiency, liquidity issues etc. But I suspect any of this is true; in fact this can be explained based on the option theory logic.

We know that option premiums are influenced by sensitivity factors aka the Option Greeks. Delta as we know captures the sensitivity of options premium with respect to the movement of the underlying. Here is a quick recap – if the Delta of a particular call option is 0.75, then for every 1 point increase/decrease in the underlying the premium is expected to increase/decrease by 0.75 points. On 24^{th} August, Nifty declined by 490 points, so all call options which had ‘noticeable Delta’ (like 0.2, 0.3, 0.6 etc) declined. Typically ‘in the money’ options (as on 24^{th} Aug, all strike below 8600) tend to have noticeable Delta, therefore all their premiums declined with the decline in the underlying.

‘Out of the money’ options usually have a very low delta like 0.1 or lower. This means, irrespective of the move in the underlying the moment in the option premium will be very restrictive. As on August 24^{th}, all options above 8600 were ‘out of the money’ options with low delta values. Hence irrespective of the massive fall in the market, these call options did not lose much premium value.

The above explains why certain call options did not lose value, but why did the premiums go up? The answer to this is lies in Vega – the option Greek which captures the sensitivity of market volatility on options premiums.

With increase in volatility, the Vega of an option increases (irrespective of calls and puts), and with increase in Vega, the option premium tends to increase. On 24^{th} August the volatility of Indian markets shot up by 64%. This increase in volatility was totally unexpected by the market participants. With the increase in volatility, the Vega of all options increases, thereby their respective premiums also increased. The effect of Vega is particularly high for ‘Out of the money’ options. So on one hand the low delta value of ‘out of the money’ call options prevented the option premiums from declining while on the other hand, high Vega value increased the option premium for these out of the money options.

Hence on 24^{th} August 2015 we got to witness the unusual – call option premium increasing 50 – 80% on a day when markets crashed 5.92%.

### Key takeaways from this chapter

- Historical Volatility is measured by the closing prices of the stock/index
- Forecasted Volatility is forecasted by volatility forecasting models
- Implied Volatility represents the market participants expectation of volatility
- India VIX represents the implied volatility over the next 30 days period
- Vega measures the rate of change of premium with respect to change in volatility
- All options increase in premium when volatility increases
- The effect of volatility is highest when there are more days left for expiry

Do you plan to have a module/chapter on mathematical/statistical models in trading?

On the same note, do you use VAR,GARCH,ARIMA etc. and different time series models using a forecasting software like EVIEWS for trading.

Is it a good idea to combine statistical models with technical analysis for trading or are they chalk and cheese?

Rajdeep – a module on Statistical models will be an awesome! Will probably do that sometime in future.

Yes, I’ve used GARCH models earlier…but these were built from scratch on R and Excel. Have not used any software for this. Also, I’m not sure if its a good idea to combine TA and stats…never done that before so cant really comment.

Does Vega won’t have negative value

Nope.

Dear Karthik,

Today, for the 1st time, I made a profit of more than Rs.1000/- on Zerodha website since I am client of Zerodha client. Previously, I mistakenly made a loss of Rs. 270/-. The full credit for this goes to u, because of u I was able to understand options very well. God bless and continue this valuable service to us and the society in whole.

I’m so glad to hear this, hope this is the start of something bigger for you. By the way you need to attribute your success to your hard work and nothing else 🙂

Good luck!

Awesomeness !!!! Wish I had read this before 16th May 2014 the election results day, I was long and in handsome virtual profit but suddenly the market went down (now I know the volatility dried up) :-).

I wish vega of brining the newer lessons go high and we don’t have to wait long for next chapter . 🙂

The beauty of markets is that there are always opportunities….it upto you to figure out where it lies!

Will try our best to upload chapter soon 🙂

very true W.R.T markets opportunities knocks everyday 🙂

Thanks again for your hard and wonderful work.

Stay profitable!

hi Karthik, so what does a vega of say 12 and the price of a particular underlying moving by INR 10 signify?

Raj – thanks for bringing this point. I seem to have missed this concept all together. I will work on this this right away…

could not get it.

Vega corresponds to which volatility?

Implied Volatility.

hi karthik, awaiting your views on the above query i had raised. was keenly expecting it to be addressed in the recent module. thanks.

My query was: so what does a vega of say 12 and the price of a particular underlying moving by INR 10 signify?

Raj – I did update section 19.2. You will find the answer towards the end of the section..please do check. Thanks.

Dear Karthik,

Can u please let me know the website wherein we can see the candlestick formation as the market is on. It was somewhere during the Options module or Technical analysis module. Can u please let me know. Regards.

Have you seen chartink.com ?

Totally speechless. Wonderful chapter. So one should not go long when volatility is high. Can you please explain the safe volatility value for going long on options.

I assume that change in vega will come in the next chapter.

Can you please give examples w.r.t. the event happening every three months, company results and volatility.

I have noticed last week at the end, option value declined even though there was increase in the stock value, due to volatility came down to normal value. e.g. relcap CE340.

Can you please also give us the list of remaining chapter in this module to know how much we do not know and how much time we shall wait to really restart option trading.

Thanks a lot.

Glad you liked the chapter. Here are the answers –

1) For each instrument the volatility value varies. For example 12-15% volatility for Nifty could be considered low…but Infy 20-25% could be considered low.

2) Have discussed change in vega in this chapter only, the upcoming chapter will contain details on Gamma vs Time, Gamma vs Strike etc.

3) Corporate results and RBI monetary policy are two regular events that drive up volatility

4) Possible – decrease in volatility reduces the price of option premiums

5) The modules is almost coming to end…maybe 2 or 3 chapters more.

hi, Karthik, in the chapter above, you have said -” The effect of Vega is particularly high for ‘Out of the money’ options.” does that mean Vega is higher for deep OTM options compared to OTM options? as, when i calculate using the option calculator vega is higher for OTM compared to deep OTM.

Madhu – yes, deep OTM options do react to change in volatility – but do bear in mind this has to be a massive change in volatility, like what happened on 24th August. However, such events are not very frequent.

Dear Karthik Sir,

I just virtually take position – long call and long put of slightly OTM strike and difference between two strikes is 100,

Put IV is more than Call IV – Nifty was down by almost 200 points, put premium increased drastically and call premium decreases slowly.

buy sell Qty p n l / no Total profit / loss

Long NIFTY SEP15 7850 PE 175.16 289.95 100.00 114.79 11479.00

Long NIFTY SEP15 7950 CE 181.98 143.25 100.00 -38.73 -3873.00

Net profit 7,606

Call IV is more than put IV – Nifty going up by 100 points, but call premium increasing slowly but put premium decreasing very fast

buy sell Qty p n l / no Total profit / loss

Long NIFTY SEP15 7700 PE 160.20 125.45 100.00 -34.75 -3475.00

Long NIFTY SEP15 7800 CE 180.00 202.80 100.00 22.80 2280.00

Net profit -1195

Kindly let me know what exactly is happening because of IV?

See for IV to have any effect on premiums, the change in IV should be quite large. I suppose the premiums here are moving, largely attributable to delta (directional move).

ok..but when Nifty is going up why not call premium is going up? like u said about OTM strikes, suppose delta is 0.5 and if Nifty moves up by 2 points premium should move by 1 point, and also put premium falling sharply.

I also observed that even if Nifty is moving in upward direction call premium is falling and put premium is increasing, is it because of participants expecting reversal?

Also kindly let me if any virtual trading platform available in India to test options strategies, I think that would be better to test options strategies without actually investing hard earned money.

Thank you

Firstly, OTM deltas cant be 0.5…it has to be a value far lesser than 0.5. Change in premium is dependent on delta, time to expiry, and volatility. If the volatility is high then even if markets are dropping, CE premiums can increase.

No, I’m not sure of any option trading virtual platforms.

May be volcu.be are the place where we can test our skills…

Sir, Regarding my above query kindly refer below image

Dear karthik

can u pls… tells us in how much time we can expect a full proof module on option topic.

Working towards winding up ‘Options Theory’ by this month end.

Hi Karthik, Premium value provide by B&S calculator provided by Zerodha is different from what is posted on option chain in NSE site. Please check and confirm if I m doing something wrong.

Well, the B&S calculator tells you what should be the fair value given the inputs you have fed in. This could be very different from the market value.

B&S cal

i tried calculating details for 7900CE

As I said…B&S just gives you the fair value based on the inputs you feed it with.

Hi Karthik,

Today I bought 8000Ce @55 and now eod reach to @75 when I check with zerodha using Black & Scholes option calculator it shows 48.71.

Should I assume this CE is overvalued? or something missing from me.

Mukul – volatility is around 25%, I would suggest you take India ViX values for this.

hi karthik . i trade options on the basis of the underlying Stock price movement, by tracking volume and RSI divergences , ADX . and mostly buy naked calls and put options dependent on the stock movement on the b/o for the 2-3 % move. I have studied the greeks on the varsity and this has given me an all new persective on the Price movement, thanks for making it so interesting and easy for anyone to understand, i think you are doing a great job here. Plz request you to also throw some light on LIQUIDITY in stock options and how to check that on any website….cheers

Aks

Glad to hear this Amit – liquidity is an important aspect of trading options, will try and include it in the ongoing series. Thanks.

What is Series while downloading historical data. I’m trying to download SBIN data.

The series would be ‘EQ’ for stocks (including SBIN). The reason why you see so many series for SBIN is because SBIN is a Bank and besides stocks, most of SBIN’s debentures and bonds are listed as well.

Thank you so much! And yes your writings are precious. Very eagerly waiting to read Options Strategies. You won’t believe I’ve bookmarked it & check daily if it is there.

Sanket – thanks for the kind words, this is encouraging to all of us!

Another 2 or more chapter and we will be done with Options Theory…onwards to strategies then!

Hi Karthik,

When can we read on Option Strategies ???

Very soon Sir. Another 2 or more chapters in Options Theory and we are good to start Options Strategies.

Thank you for all these useful and concise materials.

Today(18/9/2015) nifty closed up around 83 points @7981, but Sep 24 CE8200 lost 53% closing @8.25

Can u tell me why this happened.

Few reasons –

1) Volatility cracked around 17%…check India Vix

2) Time value (Theta) is starting to act on options premiums

3) OTM option’s Gamma starts tending towards zero as we approach expiry (although we have another 6-8 days for expiry)..hence the impact of delta (further implies impact of directional movement of underlying) is low.

In Chapter 5 :

I find the below content…

—————————————————

Important note – The calculation of the intrinsic value, P&L, and Breakeven point are all with respect to the expiry. So far in this module, we have assumed that you as an option buyer or seller would set up the option trade with an intention to hold the same till expiry.

But soon you will realize that that more often than not, you will initiate an options trade only to close it much earlier than expiry. Under such a situation the calculations of breakeven point may not matter much, however the calculation of the P&L and intrinsic value does matter and there is a different formula to do the same.

To put this more clearly let me assume two situations on the Bank Nifty Trade, we know the trade has been initiated on 7th April 2015 and the expiry is on 30th April 2015–

1.What would be the P&L assuming spot is at 17000 on 30th April 2015?

2.What would be the P&L assuming spot is at 17000 on 15th April 2015 (or for that matter any other date apart from the expiry date)

Answer to the first question is fairly simple, we can straight way apply the P&L formula –

= Max (0, 18400 – 17000) – 315

= Max (0, 1400) – 315

= 1400 – 315

= 1085

Going on to the 2nd question, if the spot is at 17000 on any other date apart from the expiry date, the P&L is not going to be 1085, it will be higher. We will discuss why this will be higher at an appropriate stage, but for now just keep this point in the back of your mind.

——————————————————————————————————————–

TO BE PRECISE,

My Question is : If I am PUT or CALL Seller do I need to wait till end of EXPIRY to execute ( Square Off ) My Position?

HOW is the PROFIT LOSS calculated in case of Selling CALL and PUT.

In case of an options seller, the profit is limited to the extent of the premium received. However the loss as you may know can be unlimited. Also you need not have to hold the options till expiry, you can choose to square-off whenever you want.

So, if one thinks that there will be an increase in volatility, the prudent option would be to buy an OTM option because-a) the effect of Vega is higher on OTM options and b) since they have a low delta. Also, it would be better to buy an option which has more time left till expiry as the effect of theta will be minimal. Is that right?

Right – when buying options it is important to evaluate the situation based on time and volatility. There has to be more time for expiry, and the volatility should be expected to increases.

Dear Sir,

(1)Likewise 12-15% Nifty IV can be considered as LOW, I would request you to kindly advise from where Nifty can be considered as HIGH for guidence purpose. ( 2 )Also can I consider above 17% of India VIX as HIGH. Thanking you very much Sir. R.V.N.Sastry

17-18% is the average…anything below is low and above this is high.

How to conclude that the present IV for a particular stock is high or low? Is it based on vega?

For this you need to calculate daily historical volatility and convert it to annual volatility and get a “quick” perspective.

dear sir, instead pof calculation ……. can we simply compate the strike rate IV to annual volatility mentioned on NSE website and draw our conclusion ?

Of course you can.

Hi Karthik,

Few Queries..

1. What value of vega is considered as high and low for stocks or indices?

2. what values of IV’s are considered as high and low for Bank Nifty?

For indices – take ViX value. About 17-18% for Nifty is average.

For Stocks and Bank Nifty – you need calculate the daily volatility and convert it to annual volatility to get a quick perspective.

1) can you please explain more about VIX india ?

2) vega is always positive …. volatility be always positive or it can be negetive as well ?

3) vega intereacts with volatility or change in volatility ?

4) vega always appreciates the value or it may depreciate the value as well ?

5) can be consider vega and OPTION-BUYERs friend ,if it always increases the value ?

1) Check this – http://zerodha.com/z-connect/queries/stock-and-fo-queries/trading-india-vix-simplified

2) Volatility is always positive

3) Vega represents the sensitivity of the premium wrt to change in the volatility

4) Increase in volatility (and hence vega) always tends to increase the premium

5) Low vega is buyer’s friend, high vega is seller’s friend 🙂

thank you sir ,

continuing question to point 4 .

1) what happens when volatility decreases after we have bought the option ?

2) there are several technical & fundamental analysis methods to predict directional movement …… how the same the be done to predict increase or decrease in volatility ?

3) is it possible to create to vega neutral option pairs ? i assume no, as vega is always positive .but pls do elaborate .

4) kindly elaborate more on “Low vega is buyer’s friend, high vega is seller’s friend” .

5) IN THE OPTION CHAIN SHOWN IN THIS CHAPTER ….. CERTAIN STRIKE PRICES HAVE A ( – ) in the IV , means IV not available ….. what exactly does it mean ?

thank you

1) The premiums tend to go lower due to lower volatility. But then the direction also matters…if the underlying is moving quickly then on one hand premiums would go up (due to the speed at which underlying is moving) and on the other, the premium would tend to go lower (due to lower volatility). Finally which ever greek has more significance (in that particular scenario) would dominate the play.

2) You need to be aware of both, check chapter 23, section 23.5.

3) Should be – I will get back to you on this at a later stage

4) Low vega means low premium value…so good for buyers and vice versa

5) I guess so.

Hi Karthik

Sorry for clobbering you with questions but I really am unable to sort these doubts of mine.

1) I am facing trouble as to when to use India VIX, Annualized volatility given for the Nifty as such and the different Implied Volatility for different strikes in the Option chain. Please clarify

2) Some strikes don’t have any IV given. What does this imply?

3) As mentioned by you most of the trading in Options is done with Volatility concept as the fulcrum, how to go about it? I googled GARCh as mentioned by you but couldn’t find anything fruitful.

That would be all as of now 😛

Vivek, keep them coming – its always a pleasure to help!

1) I would suggest you take the annualized volatility and not really the strike specific volatility

2) Not sure why the data goes missing for few strikes

3) Check this for GARCH – http://cims.nyu.edu/~almgren/timeseries/Vol_Forecast1.pdf

Karthik,

I have tried looking on internet for GARCH and Volatility forecasting stuff. I went through the pdf you shared as well but to tell you frankly I didn’t understand a single sentence. All sounded French to me. Can you please let me know what am I missing or if you could suggest some more basic literature. The best option would be your easy-to-understand lesson on Statistical analysis but gauging limited time availability to you if you could share with me some literature I will be obliged to you. 🙂

The PDFs are best source. The topic itself is quite mathematics/statistics heavy…simplifying it would be a herculean task!

Karthik, Would it be a fair comment if i said that IVs tend to work more in your favor when you have bought puts rather than when you have bought calls. I say that based on the following understanding.

1. IVs are represented by the VIX index which is also known as the fear index.

2. Markets fall on fear and Vix generally rises in a fearful market. On the other hand, when there is less fear and more confidence/greed, Vix is generally lower.

3. We buy puts when markets are falling and by corollary from the above 2, Vix works in our favor because it is likely to rise…..

Most of the opposite happens in case of calls. So in a call, we generally dont get help from the IV…..

Would you agree or Have i understood something incorrectly?

Wish you a very happy new year!

I know whatever you said sounds very intuitive…however Volatility has similar effect on option premium irrespective of calls or puts. I would suggest you read this – http://www.thehindubusinessline.com/portfolio/technically/when-options-strike/article7596687.ece

Hi,

I found the article very interesting and I thought I should leave a comment for a few reasons.

First of all, I am a big fan of Tarantino. Pulp fiction, Reservoir Dogs, Django Unchained are my favourites. I can recite a number of dialogues from the movie. I love them

secondly, I can’t forget 24th August as that’s the date the market so spectacularly taught me that I was wrong. I lost over 1.5lac in less than 30 mins of opening 🙂

my 4 months of hard work, crushed by the steam roller in less than 30 mins. In all other times that i had made loss in the past, i had exactly known what I did wrong. Some of the time it was greed, fear in some other or mere sloppiness. But this time I had stuck to the plan, did all the right things, but I had a spectacular fall. It left me confused and questioning my strategy. I haven’t quite found a method to tweak my strategy to withstand such a fall and therefore haven’t been trading lot since.

And thirdly, I can relate to the OTM calls refusing to give up value on the day of the crash. I wanted to square off the CALL side to free up capital to repair the PUT side. But the CALL side gaining value instead had greatly annoyed me 🙂

It was Vega in play. Another lesson learnt, humbly.

Market is probably the best teacher! It has unusual ways to teach simple lessons 🙂

I love Tarantino as well 🙂

Good luck for all your future trades – learn & evolve!

how to use vega in calculation premium. you have explained use of delta and gamma in calculating option premium.

but how to use vega value that we get from B&S calculator?

Well, vega can be used pretty much the same way as delta..I guess you got the math right in your previous comment with Delta & Theta.

Hi bro,

From your experience, do you think greek (other than delta) really affects for interday trading?

Thank you 🙂

For intraday Vega and Delta matters the most.

Vega?? lets say I buy now and sell within few minutes to max 2 hours. will that have any affect?

Thanks bro

Volatility can vary at a blink of an eye 🙂

oh I see. Thaks bro 🙂

Welcome!

Volatility changes based on the orderflow… Does it mean that increase in OI in NIfty options a reason for increase in IV of respective options?

Not sure – I;ve never really studied the correlation between OI and IV, so cant really comment.

Sir, today on 12/02/2016 IOC declared its results for Q3. From the options chain, it is observed that there is a +ve change in the premium of its CE 360 to CE 410 but at the same time there is +ve change in the premium of its PE 340 to PE 420 ……… Can you please explain the reasons for this +ve change in both CE as well as PE when the underlying security shows a decline of 2.06% in spot? …….. Is it because of the liquidity due to very low volume in IOC options or is it because the Q3 results were declared by IOC at the fag end almost after the trading hours of today?

SEE THE CHART IOC OPTION CHAIN

Yup, as I said it’s because of increase in volatility!

This is because of increase in volatility! Check the chapter on vega for a detailed explanation.

Dear Karthik – I read this somewhere “Usually out of the money options have a higher IV, the trade typically could be if it is much above the MEAN IV, it could be a good time to sell them and much below the MEAN time to buy.” My question is what is MEAN in the sentence. Request if you can please explain ? Thanks.

Mean = average. So if the historical average volatility is 20% but today the volatility is 30% then you can sell volatility by employing a suitable strategy. Likewise if the volatility is lesser than average, then you can buy it.

Thanks for the detailed explanation. 🙂

Welcome!

Karthik,

How do the Greeks automatically keep changing the price of an option? Is there a market maker? Also, about the news article you mentioned, did the premiums automatically adjust or there were people who bought or sold to affect the price?

There is no concept of market making in India. However there is a fairly good arbitrage environment, mainly driven by HTF algos. I suppose they are responsible for getting these greeks and premium aligned and on track.

Hi Karthik ,

Can You please help me in getting the source of the data mentioned in your Volatility Cone excel sheet.

Thanks and Regards

Devenndra

Guess NSE India has all the data you’d need. Check this – https://www.nseindia.com/products/content/derivatives/equities/historical_fo.htm

Dear kartik sir

If u don’t mind Can u please give a clear example of how to calculate vega as i didn’t understand clearly from the above example given by you…i mean vega should be calculated on daily implied volatility or what?? Still confused… please give one more example in detail…sorry for giving you trouble??

Vega as such is derived from the B&S model, check this post to understand the framework – http://zerodha.com/z-connect/queries/stock-and-fo-queries/option-greeks/how-to-use-the-option-calculator

In chapter 19.2 you have mentioned that vega will be calculated on change of each % of volatility..so here volatility is implied volatility or india vix???

India ViX is the implied volatility of Nifty. Yes, one needs to look at the IVs to derive the Vega.

If is it so then INDIAVIX data should match with IV in the Option Chain data of NIFTY(For ATM case). Tell me if I am wrong here .

Actually I also want to know that how implied volatility is calculated using the order book of Option data.

Hmm, it should I suppose. Although I’ve never really checked this. The calculation is quite complex, you can find some insights here – https://www.nseindia.com/content/indices/white_paper_IndiaVIX.pdf

Dear Karthik, IS the following comment addressed in your new articles ! Can you direct through a llink . Thanks ….Realized volatility matters especially if you want to compare today’s implied volatility with respect to the historical implied volatility. We will explore this angle in detail when we take up “Option Trading Strategies”.

I’ve addressed this is in various bits across the modules. However the most concrete way of dealing with this is by setting up volatility arbitrage trades, which is still not explained in Varsity.

I’ve read all the chapters of this module and made a strong conception upon Option. But got trapped in Vega section. Here I’m not able to relate vega with volatility. Can Vega relate with volatility and time as in the link – http://www.theoptionsguide.com/vega.aspx

Please correct me where I’m wrong!

Vega captures the change in premium for the given change in volatility! This is quite straightforward. Is there any particular part which you found confusing?

Yes. On 15/07/2016 Infy had down a 1000 point. A huge volatility. Can you please elaborate each greek change with the volatility depending upon ITM , ATM and OTM option. I have

I’ve done that already! Please start from this chapter – http://zerodha.com/varsity/chapter/the-option-greeks-delta-part-1/

Sorry, Karthik to bother you. I was thinking from only one side perspective which jumbled me.

And thanks for you quick reply.

Welcome!

Hello Sir, I just wanted to clarify is my approach right. If I want to buy a Call Option, I will first check Volatility Cone of a given underlying and if the volatility is near -2SD and if GARCH model predicts the future volatility to increase in next few days before the expiry.

Bingo! That is exactly how one should go about before buying naked options 🙂

Thank you very much sir 🙂 I would be really grateful if you could share GARCH process excel sheet or R programming file, I tried making it myself but it was really difficult to understand. I wanted to know one more thing, Sir as you had said in Future Trading module to predict movements of NIFTY, one should have knowledge about general Indian Economic activities so from where can I gain this knowledge.

Will try and upload the GARCH models, but cannot really commit a timeline for this.

To keep tab on general macro economic events, the best source is your daily news paper!

Thank you very much sir 🙂

Welcome!

Hello Karthik Sir,First of all Thank you for sharing your trading experience with us.its really very helpful for us.Still i m trying to learn Option so please help me and do needful..

I have some doubt related to volatility…Please do needful…I got the volatility data of CEAT of September series 2016.

CALL 30.31

PUT 35.12

HV 41.29

From these data, there would be any help to take decision before initiate trade if so please share your knowledge..

You are welcome Avinash.

Just with these many data points it is not possible to identify a trade. You will have to dig deeper, for example identify if the historical volatility is higher or lower compared to the current volatility…if its higher, maybe you want to sell an option..or if its lesser, maybe you want to consider buying an option. So this thing needs more digging up.

why vega is common for PE&CE at same strike?,despite of having different IV at same strike price.what must be low vega value and high vega value for identifying the trade .

IV for the given strike is same for both CE & PE, else you will have an arbitrage opportunity.

I can’t understand IV same for CE and PE for given strike. But on the Option chain chart it shows different

can you elaborate ?

All else equal the Implied Volatility for both Call and Put option for the same strike is supposed to be the same. Think about it, implied volatility is the volatility that the market expects on an overall basis. Market does not differentiate and allot different implied vol’s for call and puts. Hence IV is the same for both CE & PE. However, markets are not efficient as we think – the discrepancies in demand / supply, sentiments factors etc act upon the IVs and therefore they tend to be different for different strikes.

Hi kArthik,

Many congratulation for winning Bootstrap startup award.As always i loved your every chapter and contentiously reading your module and yes this help me a lot while doing trading and it always provide me a confidence of thinking in a technical way rather then following instinct.Thanks for such a hard effort.You are doing something out of the box.I always suggest people to follow varsity.

I have certain inquiry.

1: Can i operate multiple brokerage account as i am trading with sasonline but i aslo want to taste your platform.

2.If NO, then what i have to do in order to register with zerodha.

Thanks for the kind words Madhusudan 🙂

Click on the “Open Zerodha Account” on the Varsity homepage (you will find it at right bottom) and enter your details. Someone from the sales team will pick up your lead and help you open your account.

Yes, you can choose to trade with multiple brokers…but frankly, you just need one good broker and that would be Zerodha 🙂

Dear Sirji, is my observation right? on 14th dec nifty index closing price was 8182.45, and nifty 8100dec pe was 68.70 and volatility around 18%. so theta was 2.86 delta 0.342, vega 6. and the next day nifty close 28 point down 8153. but 8100dec pe was also don by 7 point around 61.35. and volatility around 15%. so my question is why the pe was also down.due to volatility? volatility was down by 3% so loss of 6*3=18 points and theta loss was 3 point. so total loss of long option 21 point aprox. and due to delta around 0.35 the profit was 28*.035 was 10 point resulting to the net loss of 21-10=11 point which worked to 68.70-11=57.70, and it is closw to 57.35 which LTP on 15 dec 2016

Check this – http://www.thehindubusinessline.com/portfolio/technically/when-options-strike/article7596687.ece

Thanks Sirji

Welcome!

Sir I m trying to open the link but it’s not opening can you provide the link if it is in Trading Q&A.

Which link are you talking about? If its the HBL one, then it is working fine.

sir,

is there any software that give live option greeks ..?

Thanks

Sarath

Not sure Sarath!

Hy sir,

Thanks for the reply, one more doubt . Implied volatility means expected volatility in future .If 8300 ce has IV of 11.94.

1. IV of 11.94 means volatility in particular strike or spot?

2. IV of 11.94 means future expected volatility then how we get the current volatility..?

3. IV of 11.94 is high or low?

Thanks

sarath

IV means the expected volatility as of today.

1) It is the IV of that strike

2) As I said, it is future vol as of today

3) Compare this with past historical volatility to get a quick idea. This is not the best method but helps you with a give and dirty view.

Thanks karthik….

Welcome!

Hi Karthik,

Is there any website where we can get CHARTS of historical data of volatility of various stocks/index and also screeners where I can screen options based on volatility, say I want to get list of stocks where implied volatility is greater than its highest volatility etc etc

I’m not sure of any such websites. However, we are thinking about this and may come up something in the near future.

Hi karthik,

I have one doubt

Kindly clarify

You have mentioned above that ” imagine you want to write 500 CE option where spot is at 475″

Here

Spot – 475

Strike – 500

CE – call option & writing CE means i am bearish

So.when i m waiting for 500 CE to drop further how could i sell it when it is already at 475 ?

Thanks in advance

Mehul, 500 is the strike, and 475 is the spot. I’d suggest you start reading from the beginning of this module to get a clear idea.

Hello karthik,

Thanks for the reply.

I have gone through the chapter 4 again and this is what i understood :

Irrespective of the spot price i can choose the appropriate strike price and in the above case i wish the spot remains at 475 or below strike i.e 500 only then i make money.

But I have a small cofusion…

Please guide

Suppose

Strike – 500CE

Spot – 475

Position – short

If i do not exercise, and square off my position then, what amount of premium received will i be able to keep ?

Can i square off the very next moment ?

Sorry to bother you karthik again.

Thanks in advance.

If you are shorting a 500CE at lets say Rs.15 premium…and the spot expired at 475, then 500CE will have no intrinsic value and hence you can retain the entire premium. If you are short and the option is expiring OTM, then you can let it go without squaring off. However, on the other hand, if you are long and the option is ITM upon expiry…then you are better off squaring off. This is because of the STT, read this – http://zerodha.com/z-connect/queries/stock-and-fo-queries/stt-options-nse-bse-mcx-sx

Karthik,

I know and remember the day 24 AUG 2015. A doubt popped up giving this a second read. How did the settlement happen on this unusual day? I mean since the option premium increased did the long gained money and shorts lose? Ignore if it is a foolish question. Just out of curiosity.

Settlement would have happened on the expiry day, remember, there is no M2M in options.

Respected Sir,

Gratitude for your last guidance regarding the portfolio optimization & beta values.

And thanks for simplifying such advance trading topics for us for laying strong foundation of Model Thinking. Have a few general doubts –

1) When we talk about ‘volatility’ (informally) in day-to-day trading practice, in general, which volatility are we exactly talking about (IV, Historical, Forecasted, …) ?

2) Which volatility has more significance/priority for traders in practical world?

3) What is considered a normal range of India VIX? For example – Nifty50 ranges between 16x to 20x P/E with average of 18x (as per Module 3 Chapter 11). However, now I think its range has practically shifted up.

4) Volatility is high = Vega is high. Does that mean India VIX is high = Vega is high?

5) Is there any defined method/model/process which converts market triggers/news into numerical values for utilization in any sort of formula/model to quantify their impact on price movements? If yes, please provide any relevant link.

6) Does Zerodha offer any programming platform/facility where traders can code their trading models to automate buy/sell using terminal tools & data and market triggers/news, also test and modify it, if necessary?

Regards

James

1) We are generally talk about the current state of volatility which is the Implied Volatility

2) IV

3) Yes, it has. India Vix around sub 15 seems to be the norm these days

4) Yes. But remember, ViX is for Nifty….may not be applicable to stocks.

5) Yes, check for the concept of ‘Principle Component Analysis’. It is a statistical technique, traders use it in markets for the exactly the same purpose that you have mentioned. I have very little knowledge about it

6) You may want to check out Kite Connect APIs – kite.trade

Thanks a lot for your guidance.

Welcome.

Respected Sir,

Getting few cracks in core concepts, please clarify –

1) The IV of option near 9300CE Nifty (Spot-9119.40) is 10.16%. You told it is IV of strike price (not spot price) – not got this point? How can strike price be volatile, it is fixed at regular price intervals to form an option chain and does not move, it is spot price of underlying that moves, right? So, is it IV of premium of that strike price?? Please help.

Regards

James

When I say strike, I’m talking about that strike’s premium. Every strike has its own IV.

Ohh! Thanks a lot Sir!

That was very confusing for me when I used to look at nifty option chain taking the concept of Vega into account. Also, it has become understandable why IV is minimum for ATM strikes & rises as I traversed towards OTM strikes.

No one clear trading concept doubts as efficiently as you do.

Thanks again, Sir.

Welcome, James. Good luck and happy learning.

As per superb explanation of change in Vega across time, it is clear that as time passes vega decreases. But what about change in vega across option chain of same expiry. I am not able to clearly deduce that from the text.

However, as per my understanding, Vega of ATM must be higher as compared to ITM or OTM, somewhat forming Bell Curve like Gamma. Am i right?? If not, please correct me.

Thanks in advance.

Absolutely, Vega for ATM is the highest. It is quite natural, as ATM options sit on the fence. It can swing either ways…so its kind of fickle and volatile. However, OTM and ITM have already taken sides and therefore the volatility is lower for these options.

Respected Sir,

My question is general, but I find it relevant to post it in this chapter. I searched but found confusing unstructured answers, please help.

1) Just like India VIX, is there any single volatility index for overall Global Markets? If yes, please provide reference.

2) In addition, please list the few important Volatility Indexes of the major Markets (US, UK, European, Asian & others) in the world for overall volatility heat-map.

[I find your guidance highly helpful, for traders like me, to understand/track the extant/effects of (global) events better, like recent French Elections.]

Regards

James

1) You will find ViX for all major markets, but there is no Vix index that aggregates this as a whole. Or maybe its just that I’m not aware of this. D

2) Do check this – http://www.cboe.com/products/vix-index-volatility/volatility-indexes

Good luck.

Should we compare IV of strike price directly with annualized HV or Daily volatility * SQRT(no of days left to expiry) ?

How to guage volatility is cooling off?

You need to compare across similar time frames. For example daily with daily, and annual with annual. When volatility decreases, it suggests a cool off in Vol.

Dear Karthik Sir,

Thank you and your team for amazing explanations.

One query outside of this topic. With COIN being introduced, can you and your team please share knowledge on how to study Mutual Fund.

Thanks Tanmay, that is high on priority. We will take it up next.

Thank you again for quick response to the queries and explaining complex terms with superb examples. It is very helpful with the kind of examples you give. I do have few more to ask kindly review it.

1.) Banknifty has a daily movement 200-300 points (usually or in most days), so does more volatility signify that it is more prone to black swan event?

2.) The futures of banknifty are trading at a discount of 33 rs. does it have a slight bearish significance though the technical indicate a strong buy or why is it trading lower than the spot?

Since you have provided with so much valuable information and also good recommendations (fooled by randomness, I like I like).

1)I wanted to add few: Vega isn’t greek, kappa is( vega is more common though, stumbled upon this on mit openware)

2) What we cannot know by marcus du satoy is also a very good read giving an insight on randomness and other factors.

1) Kind of, higher volatility favors black swan events

2) Not really. Discount/premium cannot be used to estimate the sentiment in the market

3) Vega is a 2nd order derivative – so as far as I know, it falls under the Óption Geeks umbrella. Kappa is 3rd order I guess…and it is also an option geek

Hi sir,

On july 14,infosys stock price was down by 5.00(0.51%) even though stock went down all put options(every strike price) lost premium why? and also some of ITM call options gained value….how?

With the drop in volatility, the premiums can lose value.

sir, i am confused in nifty example;

The INDIA VIX (volatility) was 64% up & as you said there will be increase in premium with increase in volatility,

so why there was decrease in premium of ITM, ATM, OTM options and it went down?

Sir, where am i wrong. please correct me

It really depends on the strike you are dealing with. If the option is far OTM, then volatility does not have much impact on premium.

when volatility increases, the vega also increases and the premium will also increase.

OR

when volatility increases, vega will also increase and the premium can fluctuate in any direction (high or low).

sir, where am i wrong,

Vege increases when volatility increases, and therefore the option premiums.

How can we use particular strike price IV for analysis?

1. Will we have to compare with it annual Historical volatility.

2. Or we have to compare it with India vix (but India vix is only for nifty ).

You can compare it with historical IV and assess if the volatility is high or low, based on which you can decide to go long or short on the premium.

where will i get historical iv data?

Unfortunately, its not available on the internet I guess.

what if option underlying is falling continuously assume by 30% and volatility increased by 40%

1. how will CE and PE option premium react?

This also depends on the time to expiry. If there is ample time to expiry, then the fall in price has a greater impact on premiums compared to volatility. On the other hand, if the time to expiry is less…then volatility has a tad bit higher impact on premiums.

HI Karthik ,

On 02-10-2017 I HAVE CHECKED THE NSE SITE FOR STRIKE @ 9700 (CE) THE IV IS 6.39,and the under lying is trading @ 9786(Nifty Spot Price) . My question is what would be the IV for the same strike price if nifty trade @ 9746 and 9796 ?. If you have a solution please let me know the calculation process .

Thank you for the efforts !

It is hard to estimate the Vega versus spot price. Vega increases when panic on the street increases.

Is there any mechanism available to estimate the Vega ? .

and (IV = Vega) ?

You can use this for both – https://zerodha.com/tools/black-scholes/

Hello sir

1.How could we know if implied volatiliy of a stock is low or high?

2. How could we know if the implied volatility of a stock is going to increase or decrease?

3. Does a naked option buying is mere a speculation and not a trading?

thanks

1) By comparing it with the historical volatility

2) That is your trading call

3) Again depends on your trading logic.

There are 2 stocks A and B.

The IV of A for its ATM strike for particular expiry is 23.

Similarly the IV of B for its ATM strike for the same expiry is 35. Can we say that B is more volatile than A?

Thank you

Yes, you can.

Thanks sir

Can we conclude that the volatility of stock has increased from nse option chain IV. Suppose IV on 13 dec. Is 33% and on 15dec for same strike it is showing 50%.Will this implies that volatility of stock has increased from 33 to 50.

Yes, this is exactly what it means.

Thank You very much.

One more doubt suppose currently implide volatility of sbi for 310 strike is 30% and it’s annualised volatility is near about 44% does it means that volatility of sbi is low than it’s historical volatility and one should look at buying the premium (after considering theta)

Yes, this is true purely from a volatility perspective. However, you may want to consider other forces at play before you buy the option.

Thank you very much

is it proper to apply normal technical analysis rules to the INDIAVIX candlestick chart and trying to predict whether volatility is going to increase or fall?

No, it is not a good idea to apply TA to INDIAVIX. I’d suggest you look up on few statistical techniques like GARCH(1,1) for predicting volatility.

Hi Karthik,

To Predict volatality of a stock

1.Where can i get GARCH Tool,pls share link

2. What are the input parameters required to use GARCH(1,1)

3.Where to check ANNUALISED IV of a stock,pls share the link.

Thank You ಕಾರ್ತಿಕ್ ಭಾಯ್!

You need to build one yourself – you can do this on excle if you know the math behind. Unfortunately, I’m not aware of any tool available online. I’m not an expert on GARCH, so my inputs is wont really matter 🙂

1. Pulp fiction is over rated

2. This chapter was a bouncer… should have written it within 3-4 chapters like delta and gamma. My brain is unable to understand this!

1) Pulp Fiction is very similar to markets – people are bullish and bearish on the same stock at the same time 🙂

2) I have, starting from chapter 15!

VIX is calculated based on OTM options order. That is the reason OTM options price changes more than say “X”% daily ? Want to know VIX impact only, other factors like theta, delta also matter but want to know vega effect only.

Vega effect on?

Vega effect on OTM strikes.

Increase in vega increases the option premium.

A decrease in vega decreases the option premium.

HI Karthik,

“Thank you” is very small word for the kind of knowledge and service you are doing for the financial world. You are teaching how to fish rather than giving fish. Hats-off for your efforts and dedication towards educating us and guiding us in proper direction.

Coming to this article, I have few doubts regarding Vega. Could you please elaborate the impact of Vega on deep OTM option?

Referring the August 24, 2015 scenario

1. I really don’t understand why the option buyer wanted to pay more premium when markets were in deep correction and also the other options below 8650 CE were available with lesser premium?

2. If high volatility increases(High Vega) the premium, why did the options below 8650 CE started losing the value.

Thank you in advance.

Thanks for the kind words, Subbarayudu 🙂

1) It is not really about what the buyer wanted to do – its more about why the premium of a call option shot up on a day like that. This is a counter-intuitive and can only be attributed to the increase in Vega

2) This is because they had a higher delta, which is more reactive to the changes in the spot.

Hi Karthik,

Really nice piece of article on the events of August 24, 2015.

Is there some instrument or way to trade Volatility in the markets on a day to day basis.

I tried searching for India VIX Future contracts but they have very poor liquidity.

Any suggestion will be helpful.

Regards

Kulbir

The best way to trade Volatility is via options. India ViX is not tradable anymore.

Hi Karthik,

Thanks for your quick reply.

As you may know that when markets open during the morning, there is a spike in volatility for the first 30 to 45 minutes after which the volatility dies down.

I was exploring the idea of buying options of Nifty with delta close to zero in the morning and then selling them before the morning volatility dies down. Before proceeding with this idea I wanted to collect some data and also take some suggestions from an experienced trader like you.Please let me know your opinion on this.

Regards

Kulbir

It looks like a good idea, Kulbir. But my concern is that for deep OTM options to react ( since you want to consider delta os 0), the increase in volatility has to be really high, which may not be the case at the opening.

However, this should not hold you back from collecting data and moving further also if you don’t mind, do share your results with the community here. Good luck!

Hi Karthik,

I understand the concern about the very deep OTM options. Just to get the probability in my favor I have thought about buying either deep OTM Calls or Puts(depending on if the market opens up or down). Will try not to go very deep OTM as liquidity might also be a concern.

Yes I will definitely share the data if I find it useful.

Regards

Kulbir

Good luck, Kulbir!

Hello sir,

In the above chapter, you have stated “The effect of Vega is particularly high for ‘Out of the money’ options”.

Is it because, the delta of ITM and ATM are higher, which affects the premium equally, in turn reduces the effect of vega on these options

or

the vega as such has higher impact on OTM options.(Like delta has higher impact on ATM and ITM). Kindly clarify.

Thank u so much sir.

Aishwarya

This is because with increase in Vega, there is a greater chance for the OTM to transition to ITM, hence they react quite rapidly.

according to what you have stated here, % change in premium of NIFTY18MAR10200PE should be less than that for NIFTY18APR10200PE for similar change in IV.

However on comparing changes in premium of these 2 options in current month I found quite THE contrary!!!!!!!

premium of NIFTY18MAR10200PE FROM 27/02/18 TO 07/03/18 rose by 221.2% while premium of NIFTY18APR10200PE for similar period rose only by 132.4%

Please explain where am I getting it wrong???

The change in premium is applicable only from Vega perspective. However, you will have to look at all the geeks in perspective – the time to expiry (theta), delta (speed of mkts), and everything else which acts on the options. You cannot isolate just one geek.

Hello sir,

So far we have read, premium = intrinsic value + time value.

The intrinsic value is how much money we would make provided we exercised the contract today. But practically, we cannot do this on everyday and we need to wait till expiry. So the above formula works only on the day of expiry.

So, on all the other days,

premium = (delta x change in underlying) + Time value + (vega x change in implied volatity)

Of course, gamma is included in the above in the form of change in delta.

I really cant express how grateful I am to you. All that I can do is to include you in my daily prayers. God bless you and your family.

Thank you so much sir.

Aishwarya

Wow! Thanks for the very kind words, Aishwarya 🙂

Yes, that equation sort of makes sense, but please do backtest for accuracy. By the way, time value should be deducted.

Hello Sir,

1)In one of the above queries, you have responded like this – “Absolutely, Vega for ATM is the highest. It is quite natural, as ATM options sit on the fence. It can swing either ways…so its kind of fickle and volatile. However, OTM and ITM have already taken sides and therefore the volatility is lower for these options.”

But as per volatility smile, the IV is the lowest for ATM. Can you please clarify.

2)To find out whether the volatility of nifty is high or low, can we compare the historical annual volatility with the VIX ??

3)To find out whether the volatility of any stock is high or low, can we compare the historical annual volatility with the IV of the particular strike ??

Thanks in advance Sir.

Best Regards,

Aishwarya

1) You are comparing the IV with Vega. Remember, Vega captures the change of premium with the change in vol

2) Yes, you can. For a quick estimate, you can also compare the current day vol to historical vol

3) Yes, as long as you are comparing this with the ATM strike, OTMs and ITMs can give you biased opinion 🙂

Hi Karthik… in the prevailing market where the volatility isn’t that high if, we sell call option at higher than 1SD the premium collected will be very low. Do you think it is a better idea to do a short startngle at far OTM option on last Friday before expiry? Say, for example selling call at 10800 and put of 10100 with Nifty spot being 10500.. this way I think we can pocket larger premium and also have some cushion from premium of call option if, market falls drastically and volatility increases as days left to expiry will be just 4 and theta will also act as a saviour to an extent.

Yup, this works. Its just that the margins blocked will be way higher, but this also comes with a ‘certain’ amount of comfort. So margins blocked to returns generated may not make economic sense. It’s really up to you.

Also, you may want to consider strikes lower than 10100 for the puts.

Thanks a lot Karthik. Margin obviously is way higher but, for novice like me comfort is bigger ticker for now. Also, when you say strike lower than 10100 for puts you mean something like 10000 / 9900 correct (for present spot of 10,550 or so)?

Again all your help and knowledge sharing is highly appreciated.

I understand that, Vivek. You need to be comfortable with the position you hold, only then will you gain conviction to hold. Else the chance of messing up is quite high. Yes, I was referring to strikes lower than 10000 like 99900. Keep learning 🙂

” This can be a bit overwhelming for newbie traders. It can be so overwhelming that they quickly rebrand the markets as ‘Casino’. So the next time you hear someone say such a thing about the markets, make sure you point them to Varsity ☺. ”

Certainly… I have already directed few friends of mine to read Varsity, I have made 3 guys buy your Rupee tales. Awesome work .. seriously 🙂

Hahah, thanks for that Kiran!

Markets is chaotic from outside, buy quite systematic from inside 🙂

Hi Karthik,

Something strange happened today(31/05/2018), I was wondering if Volatility was a factor that the Premium went the other way around.

So i was holding HDFCBANK CE 2140 Strike and at 3:00 pm

HDFCBANK in Cash Market was trading at 2127.00 and the HDFCBANK18JUN2140CE at 46.00 ,

in a matter of few minutes by 3:18 HDFCBANK shot up to 2160.00 , crossing my strike price ,so i anticipated by option premium to go beyond 60 ,with Gamma turning 0.5 , but there wasn’t much movement in the premium ,it just fluctuated around 46.

Would be happy to understand why this happened?

I don’t see an option here to upload a screenshot to help you understand my point.

Laukik, this was literally 15 mins to expiry. YOur option was ITM by 20 Rupees, but according to you it was 46, so even at 15 mins to expiry, you had an awesome premium on your premium 🙂

Hi Karthik,

But this was June Series Call option i was holding which still has another 4 weeks left to Expire.

Ah, I see. Sorry, I thought this was May expiry. In this case, the premium would have been limited by liquidity and vega.

Hi Sir,

I have gone through the volatility chapters my question is using the STDEV formula can we calculate the range for one single day for nifty, any indices or a underlying for eg any stock if yes pls explain.

Yes, you can calculate the range for the day for any index or stock.

Dear Karthik,

Dude I am really big fan of u..!! Master blaster….Man 😉 Pro 🙂

Having query regarding volatility :

As per today’s 28-Aug-18 data from NSE site Maruti suzuki’s Previous Day(27th Aug) Futures Volatility is 0.0119, Current Day Futures Daily Volatility 0.0125 and Futures Annualised Volatility is 0.238. i.e. current volatility is almost half of annualised volatility.

as i have read in some module that higher the volatility, higher the premium and premium will cools off followed by volatility cools offff.

can we consider that lower the volatility is lower/cheap price of any counter [maruti in this case] ?

can we look up move in maruti as per annualised volatility?

Thanks for the kind words, Mayank 🙂

Yes, you can consider trading volatility either ways. But, if you are looking at buying options due to low vol, then remember you are also moving against the time decay factor, which you may have to avoid.

Thanks brother…!!!

now take maruti as example…

For sep month expiry having much time and time decay shudnt effect that much i think and can buy call option,?

Another view if we consider time decay …so shud we make bull put spread/ bull call spread or can we sell naked put to eat time decay?

Yes, when there is ample time to expiry, you can think of buying an option. You can take any position which suits your directional point of view. Generally speaking, if you are right on the direction, the naked option gives you maximum bang for your buck 🙂

It is being said that from 1st Oct. derivative market timings will be increased till 11:55pm.

But derivatives are based on underlying that is equity market, so how derivatives will be traded if spot market is close.

There is no official circular on this yet, Arun. For this reason, I’m assuming the price won’t deviate much from the spot. However, in the case of an overnight news on the stock, the derivative market will take lead and the stock would catch up at the opening.

Please check whether my understanding is correct with volatility –

1.If we calculate daily volatility(SD) of any stock based on historic 1 year data let say we got 3%, so meaning is, it can either go up by 3% or can go down by 3% on next day. We have to predict the stock direction based on our analysis, it can be technical analysis lke patterns,Prior trend,S&R.

Now Question –

2.If we see 24th Aug. example’s option chain screenshot, all ITM Put options premium increased and What is happen to put OTM (since screenshot is not visible) with respect to volatility and Delta. Can you please explain in detail.

Thank You.

1) Yes, thats right

2) This is because of less time to expiry. As you move closer to expiry, ITM/ATM options turn more sensitive to than OTM options.

but i just dont get it …does it make sense to buy such far out of the money(1000 to 1200 points away) strikes and if not why people buys it? thnx….

Nope, buying far OTM is not a great idea, unless you have some concrete reasons to do so.

Dear Karthik first of all we’re grateful to you of teaching one of toughest things in market- Options in a layman terms & given us wisdom more than what we deserved. Although I’m physics Ph.d students so mathematics isn’t big deal but still your explanation had given more deep insight. I’m also a client of zerodha from last one year. My few questions are as follows

1) From last few chapters especially theta & volatility, does it mean that we should not be a buyers of options at6 all? Or if we buy then kindly when & at what favorable conditions.

2) Since options sellers required huge margin, it’s often touted in market as big players cup of tea while mostly retailers are buyers? Is it true to this rumours ?

3)Zerodha by far till now has been very great experience in investing & trading but there’s sometimes rarely little problem arises in options trading as technical glitches don’t show the premium movement. How to deal if such situations?

Thanks a lot

…Your kindness

1) Not really, Harsh. Buying options really depend on the situation. A lot of time to expiry, momentum in the stock expected, then why not? However, option sellers, especially deep OTM have a better chance to retain the premium

2) The margins required is similar to that of futures, and as you may know many retain participants trade futures. So this is baseless 🙂

3) This is probably because there is no liquidity, not a technical glitch 🙂

Thanks a lot Karthikji for your kind reply.

Only few more query plz regarding qestion no.2 above…

1) Actually I read somewhere probably an article in rediff that 80% of traders In India trade in options & remaining in Futures & Intraday, although in that amount also buyers are more than sellers which points to retailers participation.

2) Even Sebi also raised red flags last year that the ratio of India’s Derivatives to Cash segments is one of highest in the world. The number reads 14 next only to Korea. Which again points to retailers participation in buying options or futures segments. In that report if my memory serves well then it’s been mentioned that Options sellers are mostly HNI’s ?

It’s due to above mentioned reason options buying seems more depressing than sellers because as you taught us has natural statistical edge…

How much truth to above query.

Kindly sorry for long query again…

Your kindness

1) Yes, I’d kind of agree. There are more people trading options than futures

2) I remember that number, but I think its flawed because the derivative volumes are notional. But yeah, option selling requires higher margin, probably that makes one believe that option writing is for HNI.

Dear Karthik,

Sorry to bother you again with my not so sensible questions. But I would appreciate if you can please let me know the following.

1. Do we have to calculate HV and IV on our own before making a trade ? Or is it readily available in the Zerodha platforms ?

2. Does Zerodha offer charts of HV and IV ( of all indexes and individual stock’s options ) in their softwares ? or do we have to work with the number’s provided for HV and IV.

3. How important is it for us to look at the HV and IV chart before making a decision to buy or sell ? or is it possible to make our option strategies decision based on the numbers available on HV & IV ?

Thank you once again Sir !

1) You need to calculate. However, you can check https://sensibull.com/ as well

2) Nope

3) I’d suggest you look at volatility, Ron.

Thank you very much Karthik.

Happy learning!

Dear Karthik

Is volatility measured per day ?Not sure how to put my question but let me try to ask you with an example.

Let’s say I have the India VIX chart open ( live ) for 5 mins chart and I want to short option based on the fact that volatility is high ( it can be Nifty or any other securities ). Do you think it makes any sense to trade volatility on a smaller time frame or is it only good on higher time frame ?

Thank you

Oh yes, it certainly does, Ron. All option greeks are on a continuous basis and not really on EOD basis.

Thank you Sir !!

Welcome, Ron.

Hi Kartik

What about Theta? Is it daily basis or continuous?

All greeks, including theta work on a continuous basis.

Hi kartik sir,

I recall you telling that when volatility increases nifty falls as both have inverse relationship. Today I have observed that while vix was rising even nifty was rising. Now how do we interpret this?

Rgds,

Shyam

Its not always the case, Shyam. Most often when volatility increases the fear is high and therefore Nifty falls. However, there could be instances when Nifty marginally increases and vol also increases.

Dear Karthik,

1) Where can I get a consolidated graph of Historic Volatility,Implied Volatility and Price data for a stock or Index?Or is there a way to get this consolidated data?

2) We say that when Implied Volatility increases then the option prices also increase. I would like to understand whether it is Call option or Put option whose price will increase. This will help to take decision whether call needs to be shorted or Put?

Regards

Chander

1) Maybe you should check with Sensibull if they have this or intend to put this up anytime soon

2) With the increase in implied volatility, the premium of both call and put option increases.

Dear karthik Sir

There are 2 implied volatility (call side and put side for same strike price).

How should do 1 implied volatility (for analysis)?

I think we should find out the average of implied volatility.

Please reply me.

I know it is difficult to me write english please ignore if I don’t write english properly because I’m familiar with hindi and also don’t understand english properly but your expression is so good so I read your articles 👍

Nayak, yes, ideally for a single strike, the IV should be common across both CE and PE. However, this varies because of the demand and supply situation.

Thank you sir,

Can you talk in hindi ?

It will useful for my other query.

I can understand but speaking in Hindi is quite bad 🙂

To mai ab se agli bar aapko apne query hindi me puchhunga.

Aap jitna ho ske pls hindi me ans. Krna☺️

Uske baad n ho paye to english me dena.

It will helpful for me to understand all your priceless knowledge and thank u for answering me.

Acha, mai koshish kar than hoon 🙂

Sir, what is the effect of Vega on premiums on the expiry day(intraday)…is it completely negligible?

The effect of Vega reduces as we approach expiry. However, it certainly is not negligible 🙂

Just awesome!!!!

Keep going!

I have recently started trading in options. However still not clear about option writing. I can’t see any way on zerodha kite platform how I can create / write an option . In practice Is it same as selling an option be it call or put.

Its quite straight forward, Sanjeev. Click on the option you want to sell and click ‘Sell’ and hit enter, with this, you would have sold/written an option.

Hi Karthik , Thanks for a quick reply , so what you are telling me is that writing an option is basically same as selling an option . However my query is bit more detailed . When we select any option in the watchlist we get already listed options at various strike rates with CE / PE option. Who creates these options at different strike rates ? let’s say Infy options are available upto strikes of 960 ( as on 2nd feb , 11:20 am ) but I want to create an CE/PE option at strike of 980 , so can I do that as a individual trader . If not who creates these options in the system ?

Yes, Sanjeev both writing and selling refer to the same thing. The strikes are dynamically created by the exchanges and vary based on the movement in the stock price.

How to find implied volatility is increased or decreased?

Refer it with the historical volatility.

while comparing IV and historical volatility, which IV should I use as different strike prices have different IVs.

Look for the ATM strike, Jasdeep.

Hi Karthik,

If an index (or) a stock price value is increasing and also if volatility is increasing, then it does make sense that the premiums can be increased, since there is a high probability that the Call Option OTM options tend to become ITM soon rather than later.

However, when the same price value is decreasing and the volatility is increasing, in such a case, the Call Option ITM option might become ATM (or) OTM options soon. So, in this case , if you take any particular strike, my thinking is the premiums should decrease.

But, instead of decreasing, whenever the Volatility is increasing (so as Vega), the option premiums are increasing irrespective of the direction. So, why is the Black & Scholes algorithm designed in this way? Any particular point I am missing here?

Thanks

Srikrishna

Agreed to some extent, but then the direction of the market is an output of human judgment. Volatility and its impact on option premium is the same across both CE and PE. Think about it, an increase in vol means more change for the options to transition from OTM to ATM.

Agree with this “the direction of the market is an output of human judgment” and also with this to some extent “an increase in vol means more change for the options to transition from OTM to ATM” but there is an equal chance that “an increase in vol means more chance for the options to transition from ITM to OTM” even.

However, as you mentioned earlier, the direction is a human judgement, and since it’s not possible to act on the same in different ways, they would have generalized the premium increase or decrease when volatility increases or decreases respectively.

But, I got , what you were trying to explain. Thankyou:)

Thanks

Srikrishna

Welcome, Srikrishna! Good luck with Options 🙂

Hi Karthik,

When I google about “India VIX” , I see that this statement below:

“A negative correlation between India VIX and Nifty, VIX tends to drop when Nifty goes up, and vice versa.”

I didn’t clearly understand this stmt. How is “Nifty going up” and Volatility drop has a relation? Similarly when “Nifty going down”, how is this related to “Volatility increasing”.

Thanks

Srikrishna

They tend to compare the Nifty Index with India ViX. ViX is also called a fear index, goes up when fear in the market shoots up or in other words, the markets go down. Hence the -ve correlation.

But since “India VIX” is related to volatility and volatility exists in both the directions of the market. So, when Nifty goes up, why is volatility index “India VIX” decreasing?

I hope you got my point.

Thanks

Srikrishna

Hi Karthik,

I have seen a study “Historical Volatility” in Kite. Is this study different from what we are discussing here?

The values shown using this study differs from that in nseindia.com .

If they are different, can you explain the difference. Thanks in advance.

Thanks

Srikrishna

I need to check that particular study, Srikrishna.

And also please do check

1) “Standard Deviation” study available in Kite. Is this same as what we discussed earlier?

2) Above this doubt, I have asked one about “India VIX”, plz clarify that too.

Thanks

Srikrishna

1) Std Deviation is the same

2) Guess I had clarified about India ViX. Can you repost in case I missed answering it? Thanks.

Typo… It should be “movement” and not “moment” in the line-

“This means, irrespective of the move in the underlying the moment in the option premium will be very restrictive.”

Thanks for pointing that, Dipen 🙂

Hi,

I transferred 23k to my zerodha account and bought shares worth Rs 22,988. Now my withdrawal balance is showing negative 24.85. Why is it so? Please explain.

This is because of the applicable charges.

Thanks for clarifying, so from the current profit/loss which is shown in my holdings, no further money will be deducted from that for this particular transaction upon selling the shares.

Yes, all charges are mentioned here – https://zerodha.com/charges

Thanks

Hi,

Where Can I get Historical IV of nifty options for each strike price.

NSE option history does not have this data.

Thanks,

Vinod.

That can be a bit tricky, you should probably try checking with – https://sensibull.com/

Sir till Vega learning was going smoothly here everything become hard to understand.

1.HV and AV are the same or

2.HV and India vix are same.If not were to get historical volatility.

3If I have to buy 12000ce should we compare IV of this strike with HV or India vix.

4.How important is it to consider IV of individual strikes.

1) HV = Historical Volatility, AV = ?

2) No, HV is the realised volatility of today (which becomes historical t’row). India ViX is the market’s expectation of realized volatility

3) India ViX is fine

4) It does make a difference, so I’d suggest you do.

Av=annualised volatility is HV and AV are same.If not. As you said HV is the realised volatility of today where will we get HV for today.

The historical volatility, when calculated on a daily basis and expressed in a yearly format becomes annualized volatility.

India vix is currently at 26 is it for current may expiry or yearly expectation what does this number signifies.

This is the expected volatility for the month of May, expressed on an annualised basis.

hi Sir,

You have explained that “The Vega of an option measures the rate of change of option’s value (premium) with every percentage change in volatility ” which means change in premium w.r.t change in volatility in underlying is captured by Vega.

But towards the end of this chapter you have also mentioned that ‘With increase in volatility, the Vega of an option increases (irrespective of calls and puts), and with increase in Vega, the option premium tends to increase’.

My doubt is regarding “With increase in volatility, the Vega of an option increases “- Does Vega itself changes with change in volatility or Vega just capture the premium change w.r.t volatility change in underlying?

Yes, vega too changes with change in the underlying prices.

Sir,

In 24th August 2015 practical example, It has been clearly mentioned that Deep Otm options have 0 delta and hence, Thought underlying decreased, The premium increased because of Volatality increased.

In “Trading Options greeks” book of Dan Passarelli – It has been mentioned that with increase in Volatality – Delta of Otm options increase, Delta of Itm options decrease.

Sir the above two are contradictory. Can you please clarify Sir ?

Deep OTM have ‘near 0’, delta. It usually hits a low, non-zero number and stays there until the stock moves. With the increase in volatility, the premium of both call and put increases, implying the increase in the delta. I think what the author means is that the increase in OTM delta is higher than the increase in ITM delta.