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And India VIX

Submitted By:

Ankit Kochar

PGDBM 2010 - 12

NLDIMSR

Page | 1

Report on

Analysis of

Option Strategies, Greeks

and

India VIX

Submitted by

Ankit Kochar

**N.L.Dalmia Institute of Management Studies and Research
**

Mira Road (E), Mumbai-401104

Page | 2

Acknowledgement

**Working on the Project with Religare Securities Limited has been a wonderful
**

experience over a period of the last two months. It was a great privilege working

with the Firm and getting a firsthand knowledge of some of the functions performed

by them.

I sincerely wish to express my gratitude to Prof. P.L.Arya, Director, N.L. Dalmia

Institute of Management Studies and Research for his encouragement and support

towards completion of this project.

I forward my sincere thanks to Mr. Sanjay Trivedi – Head Options Trading Religare Securities Limited without whom this project would not have been

possible. I also express my gratitude towards him for encouraging me to take

initiative while doing my project and giving me full co-operation in completing my

project.

**I am thankful to all the officials of Religare Securities Limited, who were
**

forthcoming and enthusiastic to answer all my queries. I would like to take this

opportunity to thank them for their kind cooperation and patience.

At the end I would like to thank all those who have indirectly helped me complete

my project & I may not have mentioned in this acknowledgement.

Ankit Kochar

PGDBM - FINANCE

N. L. Dalimia Institute of Management Studies and Research

Page | 3

from 2nd May 2011 to 30th June 2011. L. The duration of the summer project entitled ―Analysis of Option Strategies. Mumbai. Dalmia Institute of Management Studies and Research has successfully completed his summer training under my guidance at Religare Securities Limited. I have gone through the report and certify that it has been prepared to my satisfaction and all the facts mentioned have been verified to the best of my knowledge. Sanjay Trivedi Head Option Trading Religare Securities Limited Page | 4 .Certificate This is to certify that Mr. Greeks and India VIX‖ was Nine weeks. Ankit Kochar student of N. Project Guide _______________ Mr.

TABLE OF CONTENTS Sr .No Topic Pg 1 Executive Summary 6 2 Introduction to Options 8 3 Open Interest 12 4 Put Call Ratio 14 5 Implied Volatility 17 6 Option Greeks 25 7 Volatility Spreads 33 8 Volatility Arbitrage 47 9 Dynamic Delta Hedging 48 10 India VIX 49 11 Computation of India VIX 51 12 Using VIX with Option Strategies 57 13 Conclusion 58 14 Bibliography 60 Page | 5 .

with very little up-front outlay and the risk to the investor is high. Option market have grown by leaps and bound in current market phase. derivatives emerged essentially to satisfy both of them. because one can make money if one have the knowledge about it. And the most effective route to achieving this is to form a view that proves to be correct. Traders/investors are able to assume large positions . or leveraged. A thorough grasp of product technicalities is only one aspect of the knowledge and skills that traders require. If a trader estimation of volatility is right. of course. Through the use of derivative products. By their very nature ‗financial markets‘ are volatile. transactions. Trading in this choppy market is becoming complex day by day and we need to be equipped with new tools and market indicators with which we can predict the market behavior and invest accordingly. Volatility is both the boon and bane of all traders —you can‘t live with it and you can‘t really trade without it.with similar sized risks . having positioned one's self to obtain the maximum profit from it. it is important to appreciate that all derivatives are highly geared. especially in options. than through different volatility strategy he could make a lot of profit. Given the different risk bearing capacity of them. Page | 6 . Volatility plays a great role in derivatives. it is possible to manage volatility and risks of faced by the financial agents. whether market moves up or down. While the very core of derivative products is to manage risk. with some of the agents being riskaverse and some risk-lover. Now many companies gives more emphasis on volatility related activities.EXECUTIVE SUMMARY In this volatile market it is becoming extremely difficult for day traders and investors to predict the future market movement. profit from that view. Every trader has a view of the market and their end objective is.

Theta. And also studied how hedging can be done using the derivatives Greeks. how to calculate different types of volatility i. Relationship between Spot price and PCR. Vega and Rho. Gamma.e. Studied the Options Greeks used in derivatives market such as Delta. Developed a Real time VIX Calculator Trading VIX options(whenever introduced) Page | 7 . Working on ODIN. Studied the importance of Greeks on volatility spread Understanding India VIX. historical volatility. Dynamic delta hedging. Types of volatility. Studied the impact of four major indicators Put-call ratio (PCR) open interest (OI) implied volatility (IV) Studied the Volatility Strategies to handle the market volatility effectively and encash on it.Project Learnings : Understanding volatility and its importance in derivatives.software used for options trading. Implied volatility.

Options are fundamentally different from forward and futures contracts. In contrast. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset. but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date. the option has no intrinsic value and is an ―out-of.Introduction To Options Options are of two types . the option premium has an intrinsic value and is an ―in-the-money‖ option. Whereas it costs nothing (except margin requirements) to enter into a futures contract. the two parties have committed themselves to doing something. if the value of the underlying asset is higher than the strike price. the purchase of an option requires an up-front payment. If the value of the underlying asset is equivalent to the strike price. Puts give the buyer the right. If the value of the underlying asset is lower than the strike price. The holder does not have to exercise this right. In a call option. at a given price on or before a given future date. An option gives the holder of the option the right to do something.calls and puts. in a forward or futures contract. Intrinsic Value: The difference between the strike price and current value of the underlying asset is called the intrinsic value of the option premium. the call option is ―at-the-money‖ Page | 8 .the-money‖ option.

While the time value of the option premium is Rs. 5. For ―out-of-the money‖ option and an ―at-themoney‖ option the premium will denote only time value. the intrinsic value of the option premium is Rs. if the BSE June call of 4000 is quoting at a premium of Rs. as the call option buyer can buy the index at 4000. the difference between premium and the intrinsic value will denote time value of the option. 35. when the underlying BSE index is quoting at 4035. when it is quoting at 4035.In a put option. On expiration day. Thus. only if the option is ―in-the-money‖. Time Value: Time value is the amount an investor is willing to pay for an option. the put option is ―at-the money‖ The intrinsic value component of the option premium cannot be negative. in the hope that at some time prior to expiration its value will increase because of a favourable change in the price of the underlying asset. other wise the intrinsic value will be zero. These price changes have opposite effects on calls and puts. the option has an intrinsic value and is an ―in-the-money‖ option. the difference between the option premium and the intrinsic value. the option has no intrinsic value and is an ―out-of-the-money‖ option. as the price of the underlying asset rises. If the value of the underlying asset is higher than the strike price. 40. if the value of the underlying asset is lower than the strike price. The price of the underlying asset: (S) Changes in the underlying asset price can increase or decrease the premium of an option. Time value reduces as the expiration draws near and on expiration day. will it have an intrinsic value. If the value of the underlying asset is equivalent to the strike price. the premium of a call will increase and the Page | 9 . the time value of the option is zero. intrinsic value is zero. For an ―inthe-money‖ option. For instance. Factors affecting premium The theoretical premium or the price of an option is determined by the following factors 1.

the levels of an option‘s time value. Time until Expiration: (T) As expiration approaches. An option‘s premium generally increases as the option becomes further in the money.premium of a put will decrease. 5. The strike price: (K) The strike price determines whether or not an option has any intrinsic value. for both puts and calls. in case of an option seller or received from alternative investments in the case of an option buyer for the premium paid. and is most noticeable with at-themoney options. Higher volatility estimates reflect greater expected fluctuations (in either direction) in underlying price levels. 3. Interest Rate: (Rfr) This effect reflects the ―cost of carry‖ — the interest that might be paid for margin. 2. Page | 10 . This expectation generally results in higher option premiums for puts and calls alike. A decrease in the price of the underlying asset‘s value will generally have the opposite effect. Volatility: (o) Volatility is simply a measure of risk (uncertainty). or variability of the price of an option‘s underlying.‖ 4. and decreases as the option becomes more deeply out of the money. Higher the interest rate. decreases or ―decays. higher is the premium of the option as the cost of carry increases.

the writer of a European style option can be assigned only on the expiration day. futures contracts of commodities. both the American and European type option can be squared-off any-time during the time-period of the option. metals. Likewise. An Option is a very flexible risk management tool and over the years. the option will expire worthless and cease to exist as a financial instrument. although early assignment is not always predictable. However. Options have been traded for spot and futures contracts of stock indices.Types of Options: There are two common types of Options: The American Option: This option can be exercised any time on or before the expiration date. This period may vary with different classes of options. The writer of an American-style option can be assigned at any time. Otherwise. energy products and many more. Page | 11 . European Option: This option can be exercised only on the expiration date. options have been designed for a number of underlying as well as on futures contracts of various underlying. either when or before the option expires. spot and futures contracts of individual stocks.

and it is shown as a positive or negative number. Open interest applies primarily to the futures market. The result will be that the present trend (up. expired. not the sum of both. down or sideways) will continue. Declining open interest means that the market is liquidating and implies that the prevailing price trend is coming to an end. Thus a seller and a buyer combine to create only one contract. or the total number of open contracts on a security. For each seller of a futures contract there must be a buyer of that contract. Page | 12 . The open interest position that is reported each day represents the increase or decrease in the number of contracts for that day. buyers or sellers. to determine the total open interest for any given market we need only to know the totals from one side or the other. A leveling off of open interest following a sustained price advance is an early warning of the end to an uptrend or bull market. or fulfilled by delivery. Therefore. Open interest. Observations while monitoring open interest Increasing open interest means that new money is flowing into the marketplace. It can also be defined as the total number of futures contracts or option contracts that have not yet been exercised (squared off).Open Interest Open Interest is the total number of outstanding contracts that are held by market participants at the end of the day. Open interest measures the flow of money into the futures market. is often used to confirm trends and trend reversals for futures and options contracts.

an increase in open interest along with a decrease in price confirms a downward trend.A confirming indicator An increase in open interest along with an increase in price is said to confirm an upward trend. Similarly. Similarly. An increase or decrease in prices while open interest remains flat or declining may indicate a possible trend reversal. The relationship between the prevailing price trend and open interest can be summarized by the following table: Price Open Interest Interpretation Rising Rising Market is Strong Rising Falling Market is Weakening Falling Rising Market is Weak Falling Falling Market is Strengthening Page | 13 . an increase in open interest along with a decrease in price confirms a downward trend. An increase or decrease in prices while open interest remains flat or declining may indicate a possible trend reversal.An increase in open interest along with an increase in price is said to confirm an upward trend. Open Interest .

There is also a contrarian sentiment measure. there are more Put options trading in the market. If more people are putting in orders for puts on a near term option than calls on the same near term option it is an indicator that short term the investors in that stock are thinking bearish. If the put call ratio is lower than it indicates bullishness. more people want to sell in the futurean indicator of bearishness. If the Put call ratio falls it is a sign of weakness in the market. If Put Call ratio is high. It can be measured in short or long term expectations. It gives an investor an idea of what the rest of the market is thinking. The opposite is true if the call orders significantly outweigh the put orders. If the Put call ratio rises then there is hope of higher prices in the near future. as more people want to buy in the future.Put Call Ratio Put Call Ratio is an important indicator that can help one in gauging the future direction of the market.e. But. The Put/Call Open Interest Ratio is simply the number of Put options Open Interest in a given day divided by the number of Call options Open Interest in same day. which says: PCR>1 = Bullishness (oversold) PCR<1 =Bearishness (overbought) PCR =1 Neutral Page | 14 . it means that more people are buying a right to sell i.

8 6/14/2011 1.36395 1.41 176706.89 123561.086584 5409 1.3009 5469.85 6/13/2011 1.58 81645.184702 5466.359812 5395.222976 5330 19.65 6/9/2011 1.289768 5501.4 6/22/2011 0.51 86435.8 1.5 6/28/2011 1.85 16.2920 5516.03 81820.55 18.456007 5563 1.312023 5426 19.2912 5531.5 6/16/2011 1.7 6/17/2011 1.6 1.98 83452.91 105076.10548 5/31/2011 1.292263 5575 17.6 20.901582 5276.35 6/15/2011 1.263015 5388.916585 5283 1.14 103047.7 1.1572 5452.21 91609.9 1.58 88267.4 6/20/2011 0.4 6/8/2011 1.330407 5480 18.9 5278 5550.127084 5481.Relation between PCR OI and Spot price: Date PCR Spot PCR Spot India June Price(June) July Price(July) VIX 5/26/2011 1.509599 5536.3 6/6/2011 1.1 1.99 188432.280253 5546.9 19.95 19.345429 5536 18.323823 5533 1.314462 5516 18.328426 5547.1 6/27/2011 1.1 16.368156 5629.18 221753.5 18.75 6/1/2011 1.8 1.333737 5522 1.4 17.268465 5497 19.27 128335.6 6/21/2011 0.2858 19.8 1.41606 6/2/2011 1.368682 5563 1.55 21.54 92235.82 1.350334 5565 19.374839 5554.582332 5608 1.301424 5577 18.165635 5286.32 241442.95 1.907709 5265 1.8 1.65 20.560638 5546 1.66 157936.7 1.35 5/30/2011 1.6 6/29/2011 1.5 Volume 5477.16609 22.6 6/24/2011 1.61 116783.9 Page | 15 .5 18.85 6/3/2011 1.265886 5550.35 6/10/2011 1.2 5536.359184 5533.319498 5472 1.65 6/7/2011 1.297201 5566.46 176382.73 5592.031033 5372.7 6/30/2011 2.112093 5647.284234 5467 1.1 1.271027 5605.65 18.5 144326.283494 5484 1.250078 5292.49 169163.8 6/23/2011 0.361217 5407 5/27/2011 1.237012 5652.997049 5319 1.31 142086.

This fact also cannot be ignored that it is a very powerful tool. Put Call ratio will be read along with volatility. which helps the speculator a great extent to predict the market movement and invest accordingly. lot of call writing is done which is perhaps dragging market down. lot of put writing is done which is helping market to rally and at low PCR. Whenever PCR OI moves upwards Nifty rallies and vice versa. It can be interpreted that at high PCR.Interpretations: There is direct correlation between PCR OI and Nifty. Page | 16 . Conclusion: In the end we can conclude that Put/Call ratio is yet another tool and gives us a clear picture many times that when to exit or when to enter the market but then also one cannot rely only on Put/call ratio to survive in the market and earn money.

Implied Volatility

Implied Volatility can be defined as the volatility of an instrument as implied by the

prices of an option on that instrument, calculated using an options pricing model.

An option‘s value consists of several components –

The strike price

Expiration date,

The current stock price,

Dividends paid by the stock (if any),

The implied volatility of the stock and

Interest rates.

Instead of substituting a volatility parameter into an option model (e.g. BlackScholes) to determine an option's fair value, the calculation can be turned round,

where the actual current option price is input and the volatility is output. Therefore

implied volatility is that level of volatility that will calculate a fair value actually

equal to the current trading option price. This calculation can be very useful when

comparing different options on the same underlying & different strike prices. The

implied volatility can be regarded as a measure of an option's "expensiveness" in the

market, and issued by traders setting up combination strategies, where they have to

identify relatively cheap and expensive option contracts. Rising implied volatility

causes option prices to rise while falling implied volatility results in lower option

premiums.

As there are many options on a stock, with different strike prices and expiration

dates, each option can, and typically will, have a different implied volatility. Even

within the same expiration, options with different strike prices will have different

implied volatilities.

Implied volatility represents the market‘s expectation of a stock‘s future price moves.

High-implied volatility means the market expects the stock to continue to be volatile

Page | 17

**— i.e., make large moves, either in the same direction or up and down. Conversely,
**

low implied volatility means the market believes the stock‘s price moves will be

rather conservative. Because implied volatility is a surrogate for option value, a

change in implied volatility means there is a change in the option value. Many times,

there will be significant changes in the implied volatility of the calls vs. the puts in a

stock. This signals that there may be a shift in the bias of the market.

It is seen that the volatilities of both the calls & puts increase with the falling index

levels & top out at a point when index is bottoming out & vice versa. So, it can be

inferred quite conclusively that Call & Put IV‗s have an inverse correlation with the

movement in the broader market. Although, the inference drawn is from the

historical data and therefore doesn‘t guarantee to repeat itself in future, it, still, can

be used in conjunction with other technical indicators to improve the decisiveness of

the market direction predicted using those indicators.

Implied volatility is that level of volatility which is calculated from the current

trading option price. This can help to gauge whether options are cheap or expensive.

However the prices of deep ITM and deep OTM options are relatively insensitive to

volatility

As there are many options on a stock, with different strike prices and expiration

dates, each option can, and typically will, have a different implied volatility. Even

within the same expiration, options with different strike prices will have different

implied volatilities.

For example, suppose a certain futures contract is trading at 98.50 with interest rate

at 8%. Suppose also that a 105 call with three months to expiration is available on

this contract, and that our best guess about the volatility over the next three months

is 16%. If we want to know the theoretical value of the 105 call we might feed all

these inputs into a theoretical pricing model. Using the Black-Scholes model, we find

that option has a theoretical value of .96. Having done this we might compare the

option‘s theoretical value to its price in the marketplace. To our surprise, we find

that the option is trading for 1.34. The discrepancy between our value of .96 and the

Page | 18

**marketplace‘s value of 1.34 must be due to difference of opinion concerning one or
**

more of the inputs into the model. Since all other inputs are expect volatility. So, the

marketplace must be using volatility other than 16% to evaluate the 105 call.

To know the actual volatility in the marketplace, we can ask the following question;

if we hold all other inputs except volatility what volatility must we feed into our

theoretical pricing model to yield a theoretical value identical to the price of the

option in the marketplace? In our example, clearly the volatility has to be higher

than 16%. So, we start to raise the volatility and fitting it into black-Scholes model

we find that at a volatility of 18.55, the 105 call has a theoretical value of 1.34. This

volatility is known as implied volatility. When we solve for the implied volatility of

an option we are assuming that the theoretical value (the option‘s price) is known,

but that the volatility is unknown. In effect, we are running the theoretical pricing

model backwards to solve for this unknown.

The implied volatility in the marketplace is constantly changing because option

prices, as well as other market conditions, are constantly changing. It is as if the

marketplace were continuously polling all the participants to come up with

consensus volatility for the underlying contract. This is not a poll in the true sense,

since all traders do not huddle together and eventually vote on the correct volatility.

However, as bids and offers are made, the trade price of an option will represent the

equilibrium between supply and demand. This equilibrium can be translated into an

implied volatility.

Assuming a trader had a reliable theoretical pricing model, if he determines the

future volatility of an underlying contract he would be able to accurately evaluate

options on that contract. He might then look at the difference between each option‘s

theoretical value and its price in the marketplace, selling any options which were

overpriced relative to the theoretical value, and buying any options which were

underpriced. If given choice between selling one of two overprice options, he might

simply sell the one which was most overpriced. However, a trader who has access to

implied volatilities might use a different yardstick for comparison. He might

Page | 19

then a trader will want to be a buyer. future volatility is an unknown.96 and a price of 1. the implied volatilities of calls and puts show a distinct pattern.5% overpriced since its theoretical value is based on a volatility of 16% while its price is based on a volatility of 18. If a contract has a high value and a low price. The skew can be caused by a strong directional bias in the stock or the market.‖ the price of the option becomes entirely dependent on the implied volatility. But in the final analysis. which pushes implied volatility higher. Because all other factors can be ―locked in. For an option trader this usually means comparing the future volatility with the implied volatility. so we tend to look at the historical and forecast volatilities to help us make an intelligent guess about the future. a trader will prefer to buy the option. then a trader will want to be seller. if implied volatility is high.compare the implied volatility of an option to either a volatility forecast.34. it is the future volatility which determines an option‘s value. and cannot be ―hedged‖ or offset with some other trading instrument. This is because OTM options present more risk on very large moves to compensate for this risk. If a contract has a low value and a high price. with a theoretical value of . Going back to our example. It is the only parameter in option pricing that is not directly observable from the market. Of course. they tend to be priced higher. it is often more useful for the serious trader to consider an option‘s price in terms of implied volatility rather in terms of its total price. or to the implied volatility of other options on the same underlying contract.38 overpriced. the 105 call is . a trader will prefer to sell options. called the skew of implied volatility. Due to the unusual characteristics of an options. Implied volatility tends to be higher for out-of-themoney (OTM) options compared to at-the-money (ATM) options. Page | 20 . and this difference represents the bias or skew of the market. or by very large demand for either calls or puts.5% (the implied volatility). Generally. But equally OTM calls and puts do not necessarily have the same implied volatility. Implied volatility acts as a proxy for option value. If implied volatility is low with respect to the expected future volatility. But in volatility terms it is 2.

This is an important fact to consider when looking for relative value in options. there are two types of Volatility – historic volatility and implied volatility. the bottom of the ―U‖ being the at-the-money strike. Volatility Skew is ―U‖ shaped. the higher the option‘s volatility. Generally as the IV of Call option increases. The volatility skew gauges and accounts for the limitation that exists in most option pricing models and is used to give an edge in estimating an option's worth. Call IV and its option price are inversely related. the skew rises on both sides. volatility implied by premiums in options. Therefore. This formation is sometimes referred to as the ―smile‖ curve. The farther an option‘s strike is from the market price of the underlying instrument. its option price should decrease & viceversa.e. Page | 21 . Historic volatility is based on historic prices of the futures and implied volatility is based on the volatility calculated from options i. Volatility skews are present when two or more options on the underlying have a significant difference in implied volatility levels. Basically. From there.

However Page | 22 . make large moves. I will go for long straddle because the decrease in call price (0. This signals that there may be a shift in the bias of the market. a change in implied volatility means there is a change in the option value. It is seen that the volatilities of both the calls & puts increase with the falling index levels & top out at a point when index is bottoming out & vice versa. can be used in conjunction with other technical indicators to improve the decisiveness of the market direction predicted using those indicators. the puts in a stock.7x) will be higher.. low implied volatility means the market believes the Index/stock‘s price moves will be rather conservative.e. still. When spot price falls.As the IV of Put option increases. Therefore. Because implied volatility is a surrogate for option value. either in the same direction or up and down. Implied volatility is that level of volatility which is calculated from the current trading option price.3(otm) and put delta is -0. Put IV and its option price are directly related. the inference drawn is from the historical data and therefore doesn‘t guarantee to repeat itself in future. there will be significant changes in the implied volatility of the calls vs. When spot price falls. thus there will be net positive payoff High-implied volatility means the market expects the stock to continue to be volatile — i. This can help to gauge whether options are cheap or expensive. put price also falls because it goes in the money and thus demand higher price. So. Conversely. its option price increases & vice-versa. spot price falls--->call price falls--->IV increases Spot price falls--->put price rises--->IV increases If the market is falling. Although.7(itm) . suppose call delta is 0. it can be inferred quite conclusively that Call & Put IV‗s have an inverse correlation with the movement in the broader market. call price also falls because it goes out of the money and thus demands lesser price. it.3x) will be lesser and increase in put price (0. Many times.

the market expects that it will continue to be more volatile in the future. In other words. Over time. The volatility of an option actually gives the theoretical option value that is same as the current market price. If the Index/stock becomes more volatile over time. For the options that are included in the delta neutral portfolio. it can also be said that the implied volatility of an option refers to the volatility that is connoted by the option market price depending on the pricing model of an option. IV tends to move up and down with actual volatility. If volatility falls and PCR rises. it has bearish implications. Because of the huge importance of the Page | 23 . it has bullish implications. implied volatility plays as the most important factor in order to determine the option value. Inference However relationship between the IV of the options we trade and the actual volatility that the underlying Index/stock displays is important. and IVs of the options tend to go up. The implied volatility very often gives the measure of the relative value of the option. But it does not give the price of the option and this is because the option price depends directly on the underlying instrument price. so when Volatility increases . when VIX goes down and OIO PCR goes up its bullish when VIX goes down but OI PCR also goes down then (no comments) when volatility increases spot price decreases.the prices of deep ITM and deep OTM options are relatively insensitive to volatility If volatility rises and PCR falls.call price should decrease since it is getting out of the money (spot price decreases) and put price should increase since it is getting in the money (spot price decreases).

Page | 24 .implied volatility. the options are generally cited in terms of volatility. This happens because the volatility of the underlying security is variable and is dependent on various factors like underlying security's price level. will generally give dissimilar implied volatility. The options that are based on the same underlying security but having different expiration time and strike value. rather than the price. recent variance of the underlying security and the time passage.

Delta Delta is the change in the price of an option for a one point move in the underlying.Options Greeks: The Greeks have given us feta cheese. because most use Greek letters as names. put: -1) At-the-money options: Delta is about 0. they are known as the "greeks". put: -0. philosophy. vega measures the change in the option price due to volatility changing. mathematics. and the oedipal complex. and rho measures the change in the option price due to a change in interest rates.5) Page | 25 . Negative delta means that the option position will theoretically rise in value if the stock price falls. theta measures the change in the option price due to time passing. They also tell us how much risk our option positions have. Each greek estimates the risk for one variable: delta measures the change in the option price due to a change in the stock price. and drop in value if the stock price falls. Positive delta means that the option position will rise in value if the stock price rises. They are numbers generated by mathematical formulas. such as the risk of the stock price moving up or down. Call options: 0 < Delta < 1 Put options: -1 < Delta < 0 In-the-money options: Delta approaches 1 (call: +1.5 (call: +0. Collectively. implied volatility moving up or down. There are ways of estimating the risks associated with options. or how much money is made or lost as time passes. gamma measures the change in the option delta due to a change in the stock price.5. and theoretically drop in value if the stock price rises.

Positive gamma means that the delta of long calls will become more positive and move toward +1 when the stock prices rises. the more the price of the option responds like actual long or short stock when the stock price moves. short calls have negative delta.5. and less positive and move toward 0 when the stock price falls. Time to expiration: As time passes. A big gamma means that delta can start changing dramatically for even a small move in the stock price. Gamma tells us how "stable" the delta is.Out-of-the-money options: Delta approaches 0 Long calls have positive delta. has roughly a 50/50 chance of ending up in-the-money. The reverse is true for short gamma. short stock has negative delta. Gamma Gamma is the change in an option‘s delta for a one-point change in the price of the underlying. Long puts have negative delta. An at-the-money option. This means that the delta increases as the underlying price increases and that delta falls as the underlying price falls. Stock has zero gamma as its delta is always 1 – it never changes. and less negative and move toward 0 when the stock price rises. Page | 26 . The gamma of a long option position (both calls and puts) is always positive. which has a delta of approximately 0. the delta of in-the-money options increases and the delta of out-ofthe-money options decreases. short puts have positive delta. Long stock has positive delta. Call deltas can be interpreted as the probability that the option will finish in the money. It means that the delta of long puts will become more negative and move toward –1 when the stock price falls. The closer an option's delta is to 1 or –1.

Theta has much more impact on an option with fewer days to expiration than an option with more days to expiration. The gamma of ATM options is higher when either volatility is lower or there are fewer days to expiration. Time to expiration: As time passes. so they have more extrinsic value to lose over time than an ITM or OTM option. Theta is highest for ATM options. and is progressively lower as options are ITM and OTM. the gamma of deep in-the-money and out-of-the-money options decreases. Page | 27 . the gamma of at-the-money options increases. the gamma of at-the-money options increases. Volatility: As volatility falls. The further an option goes in-themoney or. But theta doesn't reduce an option's value in an even rate. This makes sense because ATM options have the highest extrinsic value. Long calls and long puts always have negative theta. the gamma of deep inthe-money and out-of-the-money options decreases. Short calls and short puts always have positive theta. Theta Theta is an estimate of how much the theoretical value of an option decreases when 1 day passes and there is no move in either the stock price or volatility the theta for a call and put at the same strike price and the same expiration month are not equal. out-of-the-money the smaller is gamma.At-the-money options have the largest gamma. Stock has zero theta – its value is not eroded by time.

The reason for this is that higher volatility means a greater price swings in the stock price. which translates into a greater likelihood for an option to make money by expiration.e. the theta of deep in-themoney and out-of-the-money options decreases. Time amplifies the effect of volatility changes. Page | 28 . Positive Vega means that the value of an option position increases when volatility increases and decreases when volatility decreases. Vega decreases. the theta of at-the-money options increases. As a result. and increases when volatility decreases. This means that the value of ATM options changes the most when the volatility changes. Long calls and long puts both always have positive Vega. and is progressively lower as options are ITM and OTM.Time to expiration: As time passes. Stock has zero Vega – its value is not affected by volatility. Volatility: (Subject to certain conditions)(i. Vega An estimate of how much the theoretical value of an option changes when volatility changes by 1%. Vega is greater for long-dated options than for short dated options. Higher volatility means higher option prices. Negative Vega means that the value of an option position decreases when volatility increases. Time to expiration: As time passes. The Vega of ATM options is higher when either volatility is higher or there are more days to expiration. Short calls and short puts both always have negative Vega. we either gain in gamma at the cost of theta or vice versa). Vega is highest for ATM options.

Volatility: As volatility falls. Vega decreases for in-the-money and out-of-the-money options. Page | 29 .

Page | 30 . SENSTIVITY OF THETA: A Gamma and Theta position will be opposite in sign and size will also correlate. traders stop playing with gamma because it becomes difficult to handle. Highest around the at-the-money level (uncertainty is maximum). Delta Gamma Theta (time Vega If you are… (hedge ratio) (curvature) decay) (volatility) Long the underlying positive 0 0 0 short the underlying negative 0 0 0 Long Calls positive positive negative positive Short Calls negative negative positive negative Long Puts negative positive negative positive Short Puts positive negative positive negative SENSTIVITY OF GAMMA: The magnitude of gamma is consistent with the uncertainty whether the option will expire ―in‖ or ―out‖ of money. but benefits from price movements. particularly when the option is approaching expiry The gamma for ITM and OTM options increase with the increase in volatility and the time to maturity (Uncertainty increases) Gamma for ATM option falls with the increase in volatility and increase in time to maturity Normally towards end of the month. The owner of a Gamma (who is net long options) is subject to time decay of spot doesn‘t move much.In a nutshell.

As expiration approaches Gamma of an ATM option becomes increasingly large and the same is also true about Theta. Page | 31 . The Theta of an ATM option increases as expiration approaches. This implies that a short term option will decay more quickly than a long term option.

MOST IMPORTANT THINGS TO UNDERSTAND: We have already learnt from B & S that gamma and Theta are of the same magnitude (opposite in sign) Though Theta and Gamma are equal and opposite. regardless of direction Negative move slowly. Theta is more or less fixed in terms of loss per day whereas gamma is directly proportional to change in the price of the underlying. regardless of direction If your theta position is… you want the underlying contract to… Positive increase the value of your position Negative decrease the value of your position If your vega position is… you want the underlying contract to… Positive rise Negative fall Page | 32 . When there is a big move in the price of the underlying gamma change is more than Theta and therefore for a delta hedged portfolio with long potion and short underlying (positive gamma) position it returns in a positive cash flow. The positive or negative effect of changing market conditions is summarized below: If your delta position is… you want the underlying contract to… Positive rise in price Negative fall in price If your gamma position is… you want the underlying contract to… Positive move very swiftly.

Make sure that the current volume exceeds the prior day's open interest. we try to check the delta of the ATM (Strike price). Compare Open Interest . If a rise in volatility is expected If a fall in volatility is expected Long straddle Short straddle Long strangle Short strangle Short butterfly Long butterfly Buying both the call option and put option at the same at the money strike price is a popular delta neutral option trading strategy.Look for call or put options with current volume that is in excess of the average daily trading volume. Implied volatility will tend to rise during periods when demand from options buyers is strongest and will fall when demand is weakest. Finding these target options is a two-step process: 1. which indicates that today's activity represents new positions. 2. Page | 33 . Select the one which gives answer closest to 0. Look for the Unusual . Learnings: When you select ATM for Long Straddle. The key for all options trader is to buy volatility when it is perceived to be low and to sell volatility when it is perceived to be high.Volatility Spreads Volatility is subject to the forces of supply and demand. profiting when the underlying stock moves up or down significantly. called a Long Straddle. particularly in near-term months.

Unlimited profit - Unlimited loss .Needs a large Cash credit .Needs market market move in either direction.Needs a large Cash credit . Long strangle Short strangle Market directional neutral Market directional neutral (delta=0) and implied volatility (delta=0) and implied volatility up (vega>0) down (vega<0) Limited loss . direction stability. Strangle Anticipations and characteristics Page | 34 .Unlimited profit - Unlimited loss .Limited profit - Important cost . Buy call and put with same Sell call and put with same strike price.Straddle Anticipations and characteristics Strategy Long straddle Short straddle Market directional neutral Market directional neutral (delta=0) and implied volatility (delta=0) and implied volatility increase (Vega>0). decrease (Vega<0). Limited loss . strike price.Needs market market move in either direction.Limited profit - Important cost . direction stability.

this is not the requirement. 70.0 Premium Premium : Rs. forecasting explosive movement in price either way COMBINATIONS: Combinations represents strategies which involve taking positions in both calls and puts on the same stock. • While most straddle are executed with one-to-one ratio (one call for each put).Long straddle LONG STRADDLE .0 Initial Investment: Rs. • It involves buying a call and a put option with same exercise price and date of expiration. so that it consists of unequal numbers of calls and puts. 9.0 Page | 35 .Bullish & Bearish trade. Any spread where the number of long market contracts (long calls or short puts) and short market contracts (short calls or long puts) are unequal is considered a ratio spread Example: Buy Call Buy Put Strike Price: Rs. • Involves initial cost of investment.0 : Rs. 70. 5.0 Strike Price: Rs. 4. A straddle can also be rationed.

but should not really be viewed as a low risk strategy because you are paying out for two options which are both wasting assets Reward: Unlimited When to use: You believe that the stock/index is about to make a large move in either direction. But our view should be different from general view. Profit: Unlimited for an increase or decrease in the underlying Page | 36 . Hence loss is limited up to the initial investment. Hence. Risk: Limited.• When stock price is Rs. If this is the case look to do longer dated months rather than the shorter ones Volatility expectation: Very bullish. 9. A good time to utilize straddles is where there has been a prolonged period of extreme quietness (in prices) and implied volatility is around multiyear lows.Maximum Loss of Rs. 70 . Volatility increases improve the position substantially. Volatility should therefore be monitored closely. suitable if volatility is expected. • Investor can earn profit if the stock price moves in either direction significantly.

if the hoped for movement fails to materialize. Time decay: Hurts a lot. Decay depends a lot on volatility if volatility increases time decay will decrease etc. Page | 37 . he soon find that losing money little by little hurt a lot at the end. one have to very careful while choosing this strategy. Breakeven: Reached if the underlying rises or falls from option strikes by the same amount as the premium cost of establishing the position. because you have paid for two option.Loss: Limited to the premium paid in establishing the position. So. Always best to use some sort of time stop because of the time decay If you‘re expecting a very large breakout then better to trade strangles Very hard trade to make money on if you buy the options when volatility is high The new option trader often finds long straddle attractive because strategies with limited risk and unlimited profit potential offer great appeal. especially when the profit is unlimited in both directions. remember you have double time erosion because of the two options bought. Loss will be greatest if the underlying is at the initiated strike at expiry. LONG STRADDLE IDEAS Work best on stocks/indexes that are likely to experience explosive moves. However.

5. The stock may rise or fall but is generally in a range bound pattern.SHORT STRADDLE Forecasting little movement or a good contraction in movement For traders who are generally neutral about a stocks potential.0 Strike Price: Rs. Example: Sell Call Sell Put Strike Price: Rs. The trade works because both the option premiums fall.0 Initial Inflow: Rs. 9. • Generates initial positive cash flow for the investor as he is taking short position in both call and put options. 4. • Also known as top straddle or straddle writes.0 Premium : Rs. 70. 70.0 Premium : Rs.0 Page | 38 .

If you only expect a moderately sideways market consider selling strangles instead Volatility expectation: Bearish.Maximum profit of Rs. 9. Hence. but profitable strategy. especially when the trade is initiated in periods of high volatility Page | 39 .• When stock price is Rs. Breakeven: Reached if the underlying rises or falls from sold strike by the same amount as the premium received from establishing the position. 70 . Time decay: Helps. highest profit when the market settles at the sold strike Loss: Unlimited for either an increase or decrease in the underlying. • Loss can be unlimited if the stock price moves in either direction significantly. volatility increases wreck the position. the short straddle can be a risky. Straddles are not as susceptible to volatility increases as strangles. Keep an eye on volatility throughout the position Profit: Limited to the premium received. Hence profit is limited up to the initial investment. suitable if volatility is not expected Risk: Unlimited Reward: Limited When to use: For aggressive investors who don't expect much short-term volatility.

even more so than with a Long Straddle • Also known as bottom vertical combination. forecasting explosive movement either way. 4.0 Premium : Rs. 65. 9. • Created by buying a call and a put option of same stock and expiration period but of different strike prices.LONG STRANGLE Bullish & Bearish trade. 70. Example: Buy a Call Buy a Put Strike Price: Rs.0 Premium: Rs. 5.0 Strike Price: Rs. • Initial investment is needed.0 Page | 40 .0 Initial Investment: Rs.

Hence. suitable if volatility is expected. 9. Loss: Occurs if the market is static. Rs. This strategy is similar to the buy straddle but the premium paid is less but then a larger move is needed to show a profit. • Investor can earn profit if the stock price moves in either direction significantly. limited to the premium paid in establishing the position Breakeven: Occurs if the market rises above the higher strike price at B by an amount equal to the cost of establishing the position. value of position erodes toward expiration value. erosion speeds up. erosion slows.e.• When stock price is in the range of both strike prices i. Time decay: This position is a big wasting asset. Volatility expectation: Very bullish.0. increases in volatility work marvels for the position Profit: The profit potential is unlimited although a substantial directional movement is necessary to yield a profit for both a rise and fall in the underlying. Hence loss is limited to the initial investment. if volatility decreases. If volatility increases. Page | 41 . 65 Maximum Loss of Rs.70 – Rs. As time passes. or if the market falls below the lower strike price at A by the amount equal to the cost of establishing the position. Risk: Limited Reward: Unlimited The Trade: Buying out-of-the-money calls and puts When to use: You believe the stock/index will have an explosive move either up or down.

50P and 5. If stock is at 5.LONG STRANGLE IDEAS Can mix the strikes up depending on whether you lean towards the bull or bear tract but are still overall neutral .Perhaps you feel the odds slightly favor a bull move.50C you could buy the 4.00 instead of buying the 4.50P and 6.00 call Use some sort of time stop because time erosion is your enemy If you expect a mega move than better strategy than straddles because strangles are cheaper to buy therefore can buy more with the same amount of capital Page | 42 .

Short Strangle • Strangle can also be created selling call and put options. Example: Sell a Call Sell a Put Strike Price: Rs.0 Initial Inflow: Rs. 70. 65.0 Premium : Rs. 9. 5. • This is known as short strangle or top vertical combination. • Generates positive inflow for the investor.0 Premium : Rs.0 Strike Price: Rs. • Strike price of put option is less than strike price of call option. • Created by selling a call and a put option of same stock and expiration period but of different strike prices. 4.0 Page | 43 .

Page | 44 . suitable if volatility is not expected. than the investor can make loss which can be limited. investor can earn a limited profit. Hence.• When stock price is in between the strike prices. • If the stock price moves significantly.

Limited profit - characteristics Low cost .Limited profit - Limited loss . direction stability.Needs market move in either direction. Preferably always done at ATM Preferably done at OTM strikes Anticipations Page | 45 .Butterfly Short butterfly Long butterfly Market direction neutral Market direction neutral (delta=0) and implied volatility (delta=0) and implied volatility up (Vega>0) down (Vega<0) and Limited loss .Needs a large market Low credit .

Spreads short call spread or bull spread or Implied volatility direction depends on the strikes: volatility spread (here we neutralize delta If a rise in implied volatility is expected: 1*buy ATM call / sell 1*ITM call with futures or If a fall in implied volatility is ratio spreads expected: buy 1*OTM call / sell and only trade 1*ATM call Unlimited profit .Risk profile at expiration volatility) Implied volatility direction depends on the strikes: Long put spread or bear spread If a rise in implied volatility is expected: buy 1*ATM put / sell 1*OTM put Unlimited profit .Limited protection .Low cost If a fall in implied volatility is expected: buy 1*ITM put / sell 1* ATM put Page | 46 .Unlimited loss .Low cost .Unlimited loss .Limited protection .

The traders should also consider other factors like whether there will be any unexpected events in the near future or whether the period will be unexpectedly volatile or not. which will be profitable if the realized volatility on the underlying asset is ultimately lower than the option's implied volatility. The traders who wish to be engaged in volatility arbitrage should be able to forecast the future realized volatility of the underlying. Traders are said to be long volatility when they buy options and they are known as short volatility when they sell options. The traders can do that by determining the daily returns for the particular underlying asset depending on the sample data of the last 252 days. Conversely. This strategy will be profitable if the realized volatility on the underlying asset eventually proves to be higher than the implied volatility on the option when the trade was initiated. Page | 47 . we can say that the trader is capable of carrying out the volatility arbitrage trade. a short position in an option combined with a long position in the underlying asset is equivalent to a short volatility position. A long position in an option combined with a short position in the underlying asset is equivalent to a long volatility position.long volatility and short volatility. A volatility arbitrage strategy is generally implemented through a delta neutral portfolio consisting of an option and its underlying asset.Volatility Arbitrage The traders involved in the volatility arbitrage can be of two types . If the trader can predict the market price of an option depending on the implied volatility.

The hedge may not be done frequently enough to prevent losses due to hedge slippage or Gamma Risk. Page | 48 . the delta hedge also must be adjusted continuously. The delta hedging strategy is grounded on the price change of option.Delta hedging It is a kind of option strategy that offsets the long and short positions in order to diminish the risk that is associated with the movements of the prices of underlying assets. ISSUES IN DELTA HEDGING The log-normal assumption may not be valid. Since the value of delta changes according to the underlying price. The derivative dealer first determines the delta of the portfolio with respect to the underlying security and then turns the delta of the portfolio to zero by adding an offsetting position in the underlying security The derivative delta is used to hedge or eliminate a derivative holding with underlying security position or vice-versa. The concept of delta hedging is implemented in order to cover the positions of trading and also to arbitrage the difference between the costs required for the purchasing of adequate amount of underlying and the cost of derivative. it can also be said that delta hedging is a plan that is adopted by the derivative dealers in order to reduce the exposure of the portfolio to certain underlying instruments. The number of underlying security units that is required to hedge a derivative is same as the delta of derivative. In other words. The volatility estimate may not be correct. which is caused by the price change of the underlying security.

it is important to emphasize that it is forwardlooking.e. Yield to maturity is the discount rate that equates a bond‘s price to the present value of its promised payments. Conceptually. financial news services have begun routinely reporting the level of the ―India VIX‖. NSE will also start derivatives based on India VIX. For this. measuring volatility that the investors expect to see. This volatility index is computed by NSE based on the order book of NIFTY Options. it depicts the expected market volatility over the next 30 calendar days. the best bid-ask quotes of near and next-month NIFTY options contracts which are traded on the F&O segment of NSE are used. While this new practice is healthy in the sense that investors are asking for more information in helping to assess the state of the current economic environment and to guide through turbulent waters.INDIA VIX ABSTRACT In the recent weeks of market turmoil. The price index measure the direction of the market and is Page | 49 . India VIX is India‘s volatility Index which is a key measure of market expectations of near-term volatility conveyed by NIFTY stock index option prices. measuring volatility that has been recently realized. In attempting to understand VIX. a bond‘s yield is implied by its current price and represents the expected future return of the bond over its remaining life. India VIX indicates the investor‘s perception of the market‘s volatility in the near term i. Most probably NSE will come out with India VIX Futures first followed by India VIX options as had been done by the CBOE in the past. It is not backwardlooking. it is important to understand exactly what the index means in order to fully misconception. It is important to understand that Volatility Index is different from a price index such as NIFTY or Sensex. higher the expected volatility and vice-versa. VIX is like a bond‘s yield to maturity. As such. Higher the India VIX values.

It uses the prices of the options to guess the future volatility.63 divided by square root of 12] and demanding premium as per this value. This is what Volatility Index really tells us. VIX can enable us to provide an index upon which futures and options contracts on volatility could be written. of course. after doing several other operations as well but in a nutshell.67% [19. Low value of VIX indicates stability in the market while higher value indicated stress.63 which means people are thinking that over the next 30 days markets can move up or down by 5. fear and anxiety. There would be millions of such people and if we try to calculate the average volatility from the options they have written. The social benefits of trading volatility have long been recognized. it is the reverse process of option pricing taken all the options being traded into account and thus calculating the sentiment of the entire market. Now what does a particular value of the India VIX indicates? Suppose the value of India VIX is 19. You can read the exact method of calculating India VIX here.computed using the price movement of the underlying stocks whereas Volatility Index measures the dispersion or variance or change and is computed using the order book of the underlying index options and is denoted as an annualized percentage. Page | 50 . Now if we consider all the option writers present in the market. we can get a value which can describe the overall sentiments of the market about volatility.

Volatility refers to the amount of uncertainty or risk about the size of changes in a security or index value. India VIX uses the computation methodology of CBOE. Page | 51 . Calculations for India VIX: India VIX is a volatility index based on the index option prices of NSE‘s benchmark index NIFTY. The time to expiry is computed in minutes instead of days in order to arrive at a level of precision expected by professional traders.India VIX Calculations Before we understand how India VIX (India Volatility index) is calculated. A lower volatility means that a security‘s value does not fluctuate dramatically. There are several factors which are used to calculate the index. The Volatility Index indicates the volatility in the market at present or in the near future. Some important ones are these – 1) Time to Expiry: Time to expiry of the options contracts of Nifty that are selected to calculate the index.e 30 days or 90 days) is being considered as risk-free interest rate for the respective expiry months of the NIFTY option contracts. All securities portfolios as well as stock market indices are subjected to volatility and thus the studying them can be helpful because options prices are chiefly governed by the volatility in the market. but changes in value at a steady pace over a period of time. This means that the price of the security can change dramatically. A higher volatility means that a security‘s value can potentially vary over a larger range of values. which are traded on the F&O segment of NSE. let‘s understand what volatility is and what volatility index is. India VIX indicates the market‘s perception of the expected near term volatility. 2) Interest Rate: The NSE Mibor rate of relevant tenure (i. with suitable amendments to adapt to the NIFTY options order book. India VIX is computed using the best bid and ask quotes of the out-ofthe-money near and mid-month NIFTY option contracts.

Page | 52 . In a nutshell. 4) Bid-Ask Quotes: The strike price of NIFTY option contract available just below the forward index level is taken as the ATM strike. Finally. In respect of strikes for which appropriate quotes are not available. higher the VIX index value. The forward index level is taken as the latest available price of NIFTY future contract for the respective expiry month. India VIX is computed using out-of-the-money option contracts.3) The Forward Index Level: A methodology called the forward index level is being used to select the contracts which will be used to calculate the index. 5) Weightage: The variance is computed by providing weightages to each of the NIFTY option contracts identified for the computation. from usage point of view. the variance (volatility squared) is computed separately for near and mid-month expiry. The forward index level helps in determining the at-the-money (ATM) strike which in turn helps in selecting the option contracts which shall be used for computing India VIX. Out-of-the-money option contracts are identified using forward index level. NIFTY option Call contracts with strike price above the ATM strike and NIFTY option Put contracts with strike price below the ATM strike are identified as out-of-the-money options and best bid and ask quotes of such option contracts are used for computation of India VIX. as per the CBOE method. the variance for the near and mid-month expiry computed separately is interpolated to get a single variance value with a constant maturity of 30 days to expiration. values are arrived through interpolation using a statistical method namely ―Natural Cubic Spline‖. higher the volatility. The weightage of a single options contract is directly proportional to the average of best bid-ask spread of that option contract and inversely proportional to the option contract‘s strike price. After identification of the quotes. The square root of the computed variance value is multiplied by 100 to arrive at the India VIX value.

The formula used in the India VIX calculation is: Page | 53 .India VIX:: Computation methodology India VIX uses the computation methodology of CBOE. with suitable amendments to adapt to the NIFTY options order book.

30 days or 90 days) is being considered as risk free interest rate for the respective expiry months of the NIFTY option contracts. 3:30 p.600 = 0. It may be noted that CBOE VIX rolls to the next and far month with less than a week to expiration. with 3 trading days left to expiry. the near month option has 9 days and next month option has 37 days to expiration. in order to bracket a 30-day calendar period.00 am) MSettlement day = Number of minutes from midnight until closing hours of trading (i. F Volatility index is computed using mainly the quotes of the out of the money (OTM) options.e.02466 T2 = {510+ 930 + 51840) / 525. However.e. MCurrent day = Number of minutes remaining until midnight of the current day (from computation time 3.10137 India VIX uses put and call options in the near and next month expiration. The time to expiration is given by the following expression: T = {MCurrent day + MSettlement day + MOther days}/ Minutes in a year Where. The strip of OTM option contracts for computing India VIX could be Page | 54 . using minutes till expiration. the time to expiration (T1) for the near month and (T2) for the next month works out to: T1 = {510 + 930 + 11520) / 525. Risk free Interest Rate (R) The relevant tenure of NSE MIBOR rate (i.30 pm up to 12.600 = 0. Accordingly. Determination of forward index level.m. India VIX ―rolls‖ to the next and far month.Time to expiration (T) India VIX calculation measures the time to expiration in years.) on expiry day MOther days = Total number of minutes in the days between current day and expiry day excluding both the days In the hypothetical example provided.

Computation of K0 K0 is the strike price just below the forward index level. This helps in determining the ATM strikes and thus the OTM strikes for the purpose of computation of India VIX. India VIX is computed using mainly the quotes of the OTM options. Therefore the latest available traded price of the NIFTY futures of the respective expiry month is considered as the forward index level. In respect of the ATM strike.identified if the at-the money (ATM) strike is identified. the average of the mid prices of both call and put options are considered Page | 55 . This is considered as the atthe money strike (K0). the midpoint of the bid ask quote for each option contract with strike Ki . NSE has an actively traded. is required. the forward index level is arrived at by using the strike price at which the absolute difference between the call and put prices is minimum. large and liquid NIFTY futures market. All call options contracts with strike prices greater than K0 and all put option contracts having strike prices less than K0 are therefore considered for this purpose. Q(Ki). Selection of option contracts to be used in the calculation As stated earlier. Computation of Mid-price Q(Ki) As seen above. for computation of India VIX. In case of CBOE.

Computation of India VIX from the Volatilities Page | 56 .Computation of Volatility The volatility for both near month and next month options are then calculated by applying the formula for calculating the India VIX with time to expiration of T1 and T2. respectively The contribution of a single option to India VIX value is proportional to the quote of that option and inversely proportional to the option contract‘s strike price.

such as the Short Straddle. Page | 57 .Using VIX Options with Options Strategies Many volatile options strategies such as the Long Straddle and the Long Strangle depends on rising volatility in order to ensure profitability. these volatile options strategies may not profit even if the underlying asset moves strongly. Similarly. If implied volatility in the market drops. could similarly be hedged by buying VIX call options. With VIX options. options strategies sensitive to rising volatility. This forms a hedge against volatility for options strategies sensitive to volatility. VIX put options may be bought in conjunction with these volatile options strategies so that losses occurring from a reduction in implied volatility would be offset by the gains in the VIX put options as the VIX falls.

margin requirements are not yet out but the real question is whether it is going to attract enough liquidity or not? Right now. has given permission to the stock exchanges for starting derivatives based on volatility index. high market volatility and absence of other developed products to hedge volatility risks may make India VIX a success. a developed and matured market. tick values. there are more failures then successes when it comes to instruments on volatility index and hence there is a huge question mark on whether India VIX is going to be successful or not. Looking at the history of volatility index products in the world arena. NSE will be submitting the application to SEBI to start the F&O contracts based on India VIX soon. VIX by CBOE and VSTOXX by Eurex. as their P&L is driven by the difference between realized volatility and implied Page | 58 . The contract specifications like contract lot size. Securities and Exchange Board of India (SEBI). In India. there are only two exchanges which have successfully launched instruments on the volatility index in the world. It‘s a very good product and very relevant for the current stock market conditions and also very necessary for the Indian markets to have a product based on the market volatility if we want to make India. India‘s market regulator. NSE has also started real time dissemination of India VIX which is one step towards introduction of India VIX derivatives. India VIX futures and India VIX options can be used to hedge the risk of market volatility. Other exchanges tried but failed to make it popular among the traders.Conclusion NSE is soon going to start India VIX Futures trading which is going to be the first instrument based on the volatility index for India. The India VIX will be a useful tool for option writers attempting to manage their risk.

reducing Gamma exposure) and to take directional bets on the realized volatility of the Nifty. trades in a range. has high volatility of its own and cannot go to zero. Because the VIX formula isolates expected volatility from other factors that could affect option prices such as dividends. Page | 59 . changes in underlying price and time to expiration. the VIX options offer a way for investors to buy and sell option volatility without having to deal with factors that have an impact on the value of an option position.volatility over the life of options written. interest rates. All of this means that option traders now have a new instrument to add to their trading arsenal .e.one that isolates volatility. traders can now have access to volatility trades. Products based on the India VIX family of indices will allow Indian traders to hedge against sudden price movements (i. By buying VIX calls or puts (or spreads).

com www.ivolatility.com www.com optionwala.Cboe.nseindia.bseindia. John C.com Appendix Excel Sheets (3) Page | 60 . Option volatility And Pricing NCFM – Derivatives Core Module NCFM – Option trading Strategies Module NCFM – White paper India VIX Web – Bibliography www.com www.com optiongreeks.com www.indiaderivatives.theoptionsguide.com www. Sheldon Natenberg. Inc. Option.com www.Bibliography Hull.org www. Futures.optionistics.com www.thinkorswim. and Other Derivatives.optiontradingpedia.calloptioputoption.com www.investopedioa. Pearson Education.com www.

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