Premium Calculation Problem
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     kruupy
Member
Username: kruupy
Post Number: 28
Registered: 07-2005Rating: N/A
Votes: 0
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| | Monday, May 15, 2006 - 05:25 pm: |  
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hi all,
im learning and paper trading options.
When I look at the share options prices on the net or especially in the Australian Financial Review i get the following table:
Series | Ex Price | Fair Value | Last Sale | Week Vol 000's | Open Int | Implied Volatility | delta | Annual % return
How do I calculate ( or estimate) the premium price to purchase a call/put?
Thankyou all for your help,
From Kruupy
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kruupy
Member
Username: kruupy
Post Number: 29
Registered: 07-2005Rating: N/A
Votes: 0
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| | Tuesday, May 16, 2006 - 01:06 pm: |
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ok, so if its the last sale, does that mean that some options contracts only cost a mere 46c?? that doesnt seems right to me
but if it is then ok.
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kathyb
Member
Username: kathyb
Post Number: 96
Registered: 08-2003Rating: N/A
Votes: 0
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| | Tuesday, May 16, 2006 - 10:56 pm: |
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Hi Kruupy
The last sale on an option series means very little unless you have access to market depth and know what time the last sale was made. The underlying share price may have moved substantially (up or down) since that time. Probably for the purpose of your exercise you should use fair value.
If you want to find out the theoretical fair value of a specific option series/strike price, you can log on to the ASX website and use their option calculator
http://www.asx.com.au/opc/OpcStart?Mode=T
Here at least you can put in the price for the underlying stock and work out the fair value at a given share price
For paper trading I guess this will be of some assistance, however in reality when you purchase an option, the spread between bid/ask can be quite large You should NEVER pay more than fair value for an option otherwise it means it is overvalued and you'll get screwed when you want to exit, unless there is a BIG price movement in the underlying share.
Hope this is of some assistance.
Kathyb
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kruupy
Member
Username: kruupy
Post Number: 30
Registered: 07-2005Rating: N/A
Votes: 0
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| | Wednesday, May 17, 2006 - 01:44 am: |
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Hi Kathyb,
thankyou for your reply. The calculator is very handy!
So once I know the fair value of an option, what does that mean in terms of the Premium I have to pay to buy the option? ie I have a (fair)Value price of 0.7650 does that mean that the premium that I have to pay to buy the option is 1000x0.7650 per contract or is the premium a mere 0.7650 per contract?
Thanks for your help.
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kathyb
Member
Username: kathyb
Post Number: 97
Registered: 08-2003Rating: N/A
Votes: 0
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| | Wednesday, May 17, 2006 - 04:07 am: |
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Hi Kruppy
You will pay 1000 times the fair value price for the option i.e. $765 per contract. The majority of contracts are in 1000 lots, however there are some that have odd amounts due to previous splits, capital returns, etc. eg RIO has 1020 sized contracts due to its previous capital return.
Kathyb
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kruupy
Member
Username: kruupy
Post Number: 31
Registered: 07-2005Rating: N/A
Votes: 0
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| | Wednesday, May 17, 2006 - 12:41 pm: |
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Oh ok,
thanks for that I thought that was what I had to do.
The only other thing, that isnt taken into account with paper trading is the liquidity of options?
If I "purchase" a call option for $765 and then decide to sell it again to make some profit, is the profit that I make the new premium I get for resale less(-) the old premium I paid. ie 900-765=135.
Am I assured that the sale of the option will go forward?
How can I make sure the sale does happen before its expiry date?
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kathyb
Member
Username: kathyb
Post Number: 98
Registered: 08-2003Rating: N/A
Votes: 0
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| | Tuesday, May 23, 2006 - 09:45 pm: |
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Hi Kruppy
You are correct - your profit is the price you receive when you close the contract less what you paid for it initially.
You will ALWAYS be able to sell your option - that's what Market Makers are for. However you don't want to rely on the market makers to close out your option, as they certainly won't give you a fair price. They know you are looking to close your position and they will make you pay for the privilege. That is why you need to ensure when purchasing the option initially that there is a lot of open interest and liquidity;
This is one of the main reasons why you should NEVER buy overvalued options. I cannot emphasise this enough. When you go to close your position - even if the underlying share price has moved it won't be reflected in the value of your option. Depending on the delta value of your option (i.e. ATM options have a delta of around .5, OTM options have substanially less depending on how far you go out) means that for every 10c movement in the underlying share price your option only increases by 5c. If you paid 10 or 15c too much for the option in the first place, that means the underlying share has to move 20 or 30c before you are even in profit.
When you first look at a particular strike price for an option, make sure the spread is not too great, at least you know you will be able to get out at a reasonable price if there are plenty of buyers/sellers around and you wont have to rely on the market makers.
Just to reiterate - when looking at buying options:
1. NEVER pay more than fair value
2. Look for liquidity and lots of open interest in the series
3. You should never hold bought options less then 3 weeks before expiry (unless they are VERY DEEP in the money) as time will quickly erode the value of the option.
In case you are not aware - option buy/sells are only current for the day (unlike share purchases) and are automatically cleared at market close.
I hope I'm not telling you how to suck eggs  and this is of some assistance
Kathyb
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