Why is Options trading difficult?
Most traders believe there are unlimited gains in options trading while losses are limited. But many traders lose money not being able to understand how options work. Bewildered by greed, traders keep buying options with the approach that they are similar to investments and keep on averaging with the hope that it will turn into profits, but 9 out of 10 times it doesn’t. Traders forget that options have a finite life and the value falls to zero as it approaches expiry. An options fair value calculator can help to understand the intrinsic price of a contract
What is Options fair value calculator and simulator?
Samco’s Options fair value calculator and simulator arrive at a fair value of the option which can be then compared with the live market prices to understand whether the options are overvalued or undervalued. In addition, it also helps traders in online options trading to understand the effect of time, volatility and change in underlying prices which causes rapid decay in the value of options. Samco options fair value calculator is one of the kinds unique tools that can be used by the trader to predict the impact of volatility, impact of time decay and impact of change in underlying prices of the security. It simulates different permutations and combinations of various scenarios in a graphical format for immediate understanding.
How to use the calculator?
The calculator will arrive at a fair value of the option which will act as a benchmark for comparison with the live market prices. The value may differ, for example, if the fair value of a call option as per the calculator is Rs.145 and if it is available at Rs. 135 that means it is undervalued and can rise to its fair value, other things remaining the same. This is available for display on the top of the calculator as shown in Figure 1. This can be extremely useful to an Intraday options trader since it can help predict the price of the option as the underlying moves. For Eg. If the NIFTY is trading at 8143 and you expect the market to go up by 50 points to 8195 levels, you can see from the graph that the price of the 8200 Call will move from Rs. 146 to Rs. 173 – all other factors remaining the same. This can be used intelligently for intraday options trading to determine entry and exit prices of trades.
In order to arrive at a fair value of the options one needs to :
- Input the current value of the security,
- exercise or strike price,
- date of the transaction which by default will be today’s date,
- the expiration date of the contract,
- The risk-free rate of interest which is the running G-SEC (Govt. security) rate (It might be best to assume the risk-free rate at 10% since that rate is also same as assumed by NSE in their IV computations),
- Implied volatility values either for calls or puts as the case may be can be checked from the options chain on the NSE website as can be seen in Figure 2
- Reference historic volatility is system generated from the past records and cannot be changed manually. It is for your reference only to evaluate whether current volatility is higher or lower as compared to past recorded volatility,
- Call or put has to be selected so that the calculator computes the fair value of the option. Figure 1 also shows various scenarios when the value of underlying changes favourably or unfavourably. This diagram pictorially displays the rise and fall in the value of options, in the case where underlying price moves in favour or against. Figure 3 shows how time decay will destroy the value of the option over the life of its contract.
Figure 4 shows how the value of the option will increase with an increase in volatility and a decrease with a decrease in volatility.
Figure 5 shows with an increase in interest rates the value of options increases and with a decrease in rates the value decreases.
Just like any other rational decision-making process wherein various scenarios are created, positives and negatives are discussed before a decision is arrived at, why can’t such a rational decision-making process can be followed for options trading? We believe our options calculator will give first-hand insights into how options behave and how profitably it can be traded a day in and day out with a full and proper understanding of profits and losses. Options can be a very profitable and safe way of making money provided one is fully aware of various scenarios and elements that impact option prices. We believe Samco’s options fair value calculator and the simulator will be one such powerful tool in your trading arsenal to trade options profitably. Welcome to the world SMART Trading.
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