How Options Work. 3

Hopefully you now have a grasp of the basics. We will now discuss the internal workings of the Greeks and for our purposes we use the Black Scholes calculator

Hopefully you can now interact and generate new calculations, but our example here:

What does it all mean? Top row, left to right-days to expiry, this is deduced from the dates used in valuation and expiration boxes. Strike is the level at which the option is pegged. Type- call or put (also straddle if you want)  Underlying -the value of FTSE at that moment, valuation (today’s date) and expiration boxes then rate 2.25% is the bank rate. Now, ignore everything but look at

 Previous Calculations:

We have strike, type (call) under(underlying instrument- FTSE) Days(to expiry) Rate% (Bank Rate) Model (Black Scholes formula.)

Price- the 7250 call here is valued at 54.5,at £10 a point= £545. Vol(%) the calculated volatility here it’s 19.41% which means nothing in isolation.

Then we have the Greeks:

Delta which is 0.23 the rate at which the options price changes relative to FTSE. Gamma, rate of change of Delta. Vega– price sensitivity relative to volatility, and then Theta -time decay.

How to interpret the Greeks. The Delta can act as a proxy for likelihood of that option being in the money ie 23%. Theta is next important for me as Gamma and Vega you really have no control over when owning or selling the option in isolation.

In a nutshell, buying this on its own would make little sense- you have a 1 in 4 chance of being right, and it’s a lot of money. How could you mitigate costs? Sell another option, and that is where we get to strategies, the whys and wherefores of options:

Each week we show a trade that has some chance of winning. With a little application you could be up and running with a modest account within a few months. However, education is everything, and the best way to learn is by doing. We do, so you can learn.