Markets will always move upside, downside or sideways. Now presence or absence of these movements will be responsible for profits or losses in the portfolio. As an investor or trader, we all understand this.
When we trade in multiple hedged options, it becomes all the more important to know the effect of three different things on our portfolio. Three things which can affect our portfolio are: –
– swing or movement in the market,
– time left for expiry (options are decaying assets) and
– changes in volatility of option contracts.
Let us try to understand with an example: –
Say Nifty is at 7850 and as a trader, you are expecting market to move up. So you purchase a call of 7900 strike price at Rs 80, so that in case market goes up, you make good profit.
The question to be answered is, when will the market move up?
Suppose market moves to 7900 in next five days.
What will be the value of the 7900 call you had purchased in Rs 80 /-?
Will it be profitable?
May be, maybe not.
Quite possible that even when the market has gone to 7900, the price of this call is Rs 60 only. So, if I had purchased this call in Rs 80, thinking market will go up, I will still lose Rs 20, although my judgement of direction of market is correct!
My prediction of market was correct!
My trade of buying a call was correct!
Market has gone up!
Still, I am losing money??
This may seem to be totally illogical.
But, please hold on. Markets are very very efficient.
There is surly a logic behind this.
The answer lies in knowing at least three Greeks – DELTA, THETA and VEGA.
- How much the portfolio value increase or decrease with market movement?
- How much the portfolio or particular option value will increase or decrease every day?
- What will happen if market remains there, but volatility increases?
Knowledge of these Greeks will answer all this questions.
After knowing these Greeks, we can decide whether to do adjustment in our portfolio or not. Not only this, but what adjustment to be done will also become clear with knowledge of Greeks.
These are very important concepts so that you can steer your option strategies towards profits.
Without them, its driving a car without a steering! Dangerous !
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