Options – briefly explained
Unlike futures, options are conditional futures transactions. Your risk profile is asymmetrical because the buyer (long position) of an option always has the right (but not the obligation) to choose whether to exercise his option, while the seller or writer (short position) must accept any exercise. If a call option (purchase option) was traded, then the option writer must deliver the underlying at the strike price when exercising; when exercising a put option (option to sell), the writer must accept the underlying and pay the strike price for it.
All options traded on futures exchanges, like futures, are precisely defined by contract specifications. In addition to the expiration days and point values, these also regulate how many options a contract contains (lot size) and whether, in the event of exercise on the expiry date, settlement is in cash (cash settlement) or by offering an underlying asset (physical settlement).
If you want to know how high the probability is that an in-the-money or even out-of-the-money call or put option will reach an intrinsic value in time before the expiry date, the first thing to do is look at the price movements of the underlying asset throw in the past. In this regard, the absolute historical prices are less of interest than their range of fluctuation (volatility). Only those who know how much prices can change can set up an investment strategy and choose the right products to implement it.
A look at historical volatility can provide guidance when estimating the range of fluctuation – it mathematically expresses the annualised, squared standard deviation of the daily returns of an underlying asset; i.e. its positive and negative changes compared to the previous day’s price. If the result is an annual volatility of 30 percent for a share, a projection into the future would show that, based on a current price of 50 euros, prices between 35 and 65 euros could be expected with a high degree of probability. Since a company’s economic environment is dynamic and dependent on a wide range of micro- and macroeconomic factors, past results should never be projected unbiasedly into the future.
Unlike historical volatility, an option’s implied volatility reflects a future range of fluctuation expected by the options market. The higher this is, the more expensive both call and put options become. Since all other pricing factors that go into the option pricing formula, such as strike price and time to maturity, are already known, volatility is the linchpin of option pricing.
Important: Call and put options are priced differently depending on whether the options are “In the Money” or “At the Money” or “Out of the Money”. ) lie. As a general rule, the further out-of-the-money any option is, the lower the option premium to be paid for the option – and consequently the higher its leverage will be.
Assuming that a call option with a remaining term of five days and a base price of EUR 100 costs only one cent at a share price of EUR 50 – the leverage compared to direct investment in the share is theoretically enormous. De facto, however, this call is worthless: the stock would have to more than double within 5 trading days in order to build up a minimal intrinsic value – a rather unlikely scenario. Anyone who relies on high leverage with options must be aware that the participation of an option in a price movement – denoted by the Greek letter delta – is not linear. It is not constant, but increases dynamically the further the call goes in the “in the money” direction. However, the delta of the exemplary option would be almost zero. As a rule of thumb, an at-the-money call option delta of 0.5 can be assumed – this means that the option price increases by EUR 0.50 if the underlying asset increases by EUR 1. Only if you multiply the simple leverage of an option by the delta of the option will you get the effective leverage (key figure: omega) and thus a realistic basis for comparing different options.