Nitin has so far been investing in the stocks directly, but he is planning to take a leap and start investing in derivatives as well. But as a newbie to this, he is facing a dilemma regarding analyzing options and formulating strategies. One of his friends, Akash, who is already trading in options, encourages him to go ahead and not to worry about the analysis much.
Akash suggests Nitin use an options calculator as it could help him with related analyses. Here’s what Akash had to say about the concept and usage of the options calculator.
What is an option calculator?
Options calculator is an arithmetic calculating algorithm, which is used to predict and analyze options. It is based on the Black Scholes Model.
To calculate the theoretical value of an options premium or implied volatility, you can use the options calculator.
Before getting into the details of how to use options calculator, let us understand the Black Scholes Model, which is the foundation of options calculator.
What is Black Scholes Model?
The Black Scholes Model is used to calculate options greeks. Though it involves complex calculations, the user is only required to key in the input values. Popular finance and stock portals have inbuilt options calculator.
How to use options calculator?
To use options calculator, you must put in the following four mandatory inputs:
This is the current price of the underlying asset.
Here, you need to put the risk-free prevailing rate in the economy. You can put the 91-day Treasury bill data from the RBI (Reserve Bank of India) website for the interest rate value.
For this field, you need to put the expected value of dividend per share, where the stock goes ex-dividend within the period of expiry.
Number of days prior to expiry:
It is the number of days left before the date of expiry.
Apart from these mandatory inputs, if you are looking forward to calculating the theoretical value of options premium, then you need to put implied volatility as the fifth input.
To calculate the theoretical value of options premium, put the implied volatility value. Volatility Index (VIX) value can be put here as it is a reliable measure of market volatility.
While, if you want to calculate implied volatility, then you need to put options price as the fifth input in the options calculator.
To calculate implied volatility you need to put the actual market value for the options price. This is the rate at which the option is being traded in the market.
The values of implied volatility and options price which is calculated with the help of options calculator can help you in formulating a better options trading strategy. If you too are in the same place as Nitin and find analyses and calculations for options trading difficult, then you should also follow Akash’s advice and use an options calculator.