Best tools to use for analysing options
An option allows you to buy (call options) or sell (put options) something at a fixed price before or on a specific date, called the expiry date of an option. Options trading is about buying and selling options, making money from other people’s ignorance. When trading with options, it’s advised that you use tools to help you through the process.
The black Scholes calculator allows users to input specific information about the options they are looking to trade. A section asks for the strike price, an input variable of the underlying asset’s current price, and asks for how far away from the strike price you want to buy or sell your call/put option.
The results provide essential information such as the theoretical value of one unit of an underlying instrument at maturity, with its volatility given by the standard deviation of returns on that product over time. It is beneficial because it gives traders an idea of what each contract should be trading at to break even after their transaction costs have been taken into account. It’s critical to remember that all of the results provided are US dollars.
Option payoff diagrams are a great way to visualise how profitable your options trade will be. It displays the theoretical profit of one unit on an underlying instrument at maturity based on different spot prices at option expiry.
For example, an Australian trader trading with the AUDUSD currency pair can input into this tool what price they believe that 1 AUD will be worth when their options expire and then see how much it would theoretically be worth. There are also calculating functions where you can input your loss if the asset moves in a particular direction while holding onto your contract/option.
Implied volatility is the estimated volatility of an underlying instrument at a given point in time, which can be helpful to know if you are trying to buy or sell options. This information is critical because it tells traders whether or not they should be buying or selling options right now. Essentially if implied volatilities are high, it means that their current price reflects little risk, and there’s little room for prices to move much lower before expiration.
It might cause traders who have sold options with higher premiums to have significant losses when the market eventually starts moving up. Whereas if implied volatilities are low, it means that their current price reflects a lot of uncertainty, and there’s plenty of room for markets to move both up and down before the expiry date. This might cause buyers of options to have significant gains.
Delta is a valuable tool because it helps traders determine how much an option contract will benefit from a one-dollar move in the underlying market. It does this by measuring the rate of change in an option price concerning changes in the price of the corresponding spot instrument. For example, if you wish to buy call options of GBPUSD on its 46th day until expiry for 0.7 lots and have delta’s associated with each contract, it would be advisable that you buy contracts with more delta than contracts with less delta.
Having more delta means that for every 1 dollar increase on the GBP/USD spot price, the contract will be expected to increase more than the ones with less delta.
Over/underpricing is a tool that measures the difference between the implied volatilities on the underlying spot market and its corresponding options markets. You can have a look at the Saxo markets for a better idea of how this works. It can be helpful because it tells traders whether or not they are being overpriced or underpriced at any given time.
For example, suppose there is higher volatility on an options market than its corresponding spot market. In that case, this might indicate that traders are being overpriced by selling options of the specific instrument. Whereas if there’s lower volatility of an options market than its corresponding spot market, this might show that traders are under-priced by buying options of the specific product.