Part 2: Thread on #OptionBasics for #Nifty #BankNifty or #Stocks
In Part 1 we understood Intrinsic/Extrinsic Value, Theta Decay and IV
Now we need to understand another aspect of IV. Volatility is mean reverting. Means if Volatility is high, it tends..
In Part 1 we understood Intrinsic/Extrinsic Value, Theta Decay and IV
Now we need to understand another aspect of IV. Volatility is mean reverting. Means if Volatility is high, it tends..
to decline and if Volatility is low, it tends to rise. So when deciding on Option Strategy we should consider IV. If it is low, we should buy debit spreads so that we benefit from rise in IV. If IV is high, we should sell credit spreads so that we benefit from
fall in volatility. Let's look at IV or Nifty and Bank Nifty in the given image it is: 13.33 and 17.01 respectively. Now how do we decide which IV is low or which is high? I prefer to use IV Rank method for it.
The solution is to compare each stock's IV against its historical IV levels. We can accomplish this by converting a stock's current IV into a rank. Formula is attached here. You can learn in detail about IVR on google or projectoption.com
But to put it in simple words, I consider IVR>20 as high and IVR<20 as low. So when IVR is less than 20, we should initiate a debit spread hoping volatility will increase and do a credit spread when IVR is greater than 20 hoping the IVR will decrease.
We know how to deploy strategy using IV so now we need to construct a strategy using Option Greeks. We have to make it Delta and Theta Neutral. Let us suppose we are bullish on #Nifty (forgetting technical analysis) and IVR is 2.07, so we create debit spread.
Nifty is at 18412 when I am writing this. Let us construct a Bull Call Debit Spread. In Bull Call Debit Spread, we buy a lower strike call and sell an upper strike sell. Debit we pay is the max loss. Spread Size - Debit = Max Profit.
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