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How Stock Options Pricing Decided?

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Traders use Options pricing models to calculate its value. Black Scholes Model and the Binomial Model are two of the most common models used in Indian stock market. Black Scholes Model being preferred by most of the expert traders in stock market.

If you want to invest in trading options, you need basic understanding of what factors determine their value. It’s critical that you know how the value is defined and how they move in step with the underlying stock to make profit. Not anticipating what can cause sudden decline and hikes in an options price can lead to some shocking surprises followed with losses. You can turn your account to best trading account in terms of performance when you know basic of options pricing model.

Black-Scholes Model

Option contract value are based on the Black-Scholes pricing model to determine their pricing at any given time respective of market sentiments. Security options are contract units; they are not actual assets like stocks or bonds. They are more of an intangible bet based on the value of a stock at a given point in time. It is not an investment in to something with intrinsic value like a corporation with earnings, or a tangible commodity future.

Options are valued depending on the value of the spare time left before lapsing of the stocks due to expiration, and the recently traded assets volatility or anticipation of volatility due to an upcoming event, like alerts, earnings or an important report. At one time, interest rates were a consideration in pricing, but they have been mostly flat since the global financial crisis of 2008 that had ripple effect in Indian stock market. And for the first time after bell curve rise in online demat account trading for two decades, decline was seen in online trading.

Options will rise as the chances of their expiration in the money increase, and will decline as the chances of them expiring in the capital decreases. As options realises more money, they absorb  more of their underlying assets, and as they get move away from the money, they absorb less of their underlying assets.

Theta

Theta calculates the drop rate in the price of an option in due course of time. Theta determines the time value that is paid to hold the contract. It is a rent payment for the shares for a certain period. This is over and above defined intrinsic value of the option if it’s still in the money.

Options are diminishing assets; their validity is set only until the due date or expiration date. At that time, the owner having option has the right to call the security to be sold at the strike price if it’s a call option, or they can put a security on others for the strike price of if it’s a put option. The theta value is time intensive and acts as a countdown timer. For theta value, time is actually money.

Delta

Delta improves as a stock goes deep in the money due to favourable odds of money expiration. It reduces as it moves away from the money due to decrease in scopes of it, expiring with defined intrinsic value. The odds are comprehensible based on your option Delta. This further gives you insights to make trading decisions.

Vega

The Vega of an option considers the changing rate of option’s value (premium) with every percentage change in dynamics of the market (volatility). Vega change occurs when there are massive changes in pricing in a security or commodity then an option is written on, further reducing the value as the option gets close to its due date or expiration time. Options rise in value during times of fluctuations and drop in times of lower volatility. Join free stock market courses to know how volatility impacts options trading in the market.

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