Option Analysis Values - Defined

Submitted by linnsoft on Tue, 04/23/2013 - 20:47

See Also... - Setting Up an Options QuotePage - Volatility and Black-Scholes Calculations

  • Historical Volatility Historical Volatility reflects how far an instruments price has deviated from it's average price (mean) in the past. On a yearly basis, this number represents the one standard deviation % price change expected in the year ahead. In other words if a stock is trading at 100 and has a volatility of 0.20(20%) then there is a 68% probability(1 standard dev = 68% probability) that the price will be in the range 80 to 120 a year from now. Similarly there is a 95% probability that the price will be between 60 and 140 a year from now (2 standard deviations). The higher the volatility number the higher the volatility. Within Investor/RT, there are two methods to choose from when computing volatility: The Close-to-Close Method and the Extreme Value Method. The Close-to-Close Method compares the closing price with the closing price of the previous period, while the Extreme Value Method compare the highs and lows of each period. The method used, along with the number of periods used in the calculation, and the periodicity (duration of each period) may be set by the user in the Options Analysis Preferences. (Volatility Computation Details)
  • Theoretical Value The Theoretical Value of an option is expressed without the influences of the market, such as supply/demand, current volume traded, or expectations. It is calculated using a formula involving strike price, exercise price, time until expiration, and historical volatility. Currently, Investor/RT uses the Black-Scholes model to calculate the theoretical value of the option, although other model options may be added in the future. (Black-Scholes Computation Details)
  • Implied Volatility Implied Volatility is calculated by inspecting the current option premium, and determining what the volatility should be in order to justify that premium. It is determined by plugging the actual option price into our Theoreticl Value model and solving for volatility. This implied volatility can be compared to the historical volatility of the underlying in search of underpriced and overpriced options.
  • Delta Delta is the rate of change of the theoretical value of an option with respect to its underlying. It is also defined as the probablility that an option will finish in the money. Higher deltas(approaching 1.0) represent deep in-the-money options, and lower deltas(approaching 0.0) represent further out-of-the-money options. At-the-money options generally have deltas around 0.50, representing a 50% chance the contract will be in the money. This also represents the fact that if the underlying moves 1.0 point, the options should move 0.50.
  • Gamma Gamma represents the rate of change of an options Delta. If an options has a delta of 0.35 and a gamma of 0.05, then the option can be expected to have a delta of 0.40 if the underlying goes up one point, and a delta of 0.30 if the underlying goes down one point.
  • Theta Theta is also commonly referred to as time decay. It represents the options loss in theoretical value for each day the underlying price remains unchanged. An option with a theta of 0.10 would lose 10 cents each day provided the underlying does not move.
  • Vega Vega is the sensitivity of an options price to a change in volatility. An option with a vega of 0.25 would gain 25 cents for each percentage point increase in volatility.
  • Lambda Lambda measures the percentage change in an option for a one percent change in the price of the underlying. A Lambda of 5 means a 1 percent change in the underlying will result in a 5 percent change in the option.
  • Rho Rho measures the sensitivity of an option's theoretical value to a change in interest rates.