The Greeks

In finance, the Greeks are quantities representing the price sensitivity of derivatives (options in our case) to a change in an underlying parameter. Now that we know what goes into pricing an option, we can start deriving the derivatives of the price of an option in respect to each of…

Pricing an Option Part 4

Extrinsic value (also called time value) is a little harder to understand. It's not something inherent in the option as it depends on a number of variables (time to expiration, strike price, perceived volatility). It is defined to be the premium a rational investor would pay over the intrinsic value…

Pricing an Option Part 3

Another way to look at the price of an option is to look at its intrinsic and extrinsic values. The price of an option is the sum of these two parts. Let's talk about intrinsic value. The intrinsic value is what the option is inherently worth. Or, in other words,…

Pricing an Option Part 2

So knowing the concept of expected value and fair price of a bet, we can start diving into pricing an option. As a quick reminder: options are contracts that give you the right but not the obligation to buy/sell the underlying at a predetermined price (known as the strike…

Pricing an Option Part 1

Today, I'm going to talk about how to price options. I'm not going to do a deep dive but I will look at the different variables that go into pricing an option. In the past few posts, I mentioned we pay 2 or 3 for the option to buy/sell,…

Options PnL Part 2

So, we looked at buying calls and buying puts. Respectively, the graphs look like: The blue graph is buying a call option with the strike price of 15 for a price of 2 (kink is at 15 and the most we can lose is 2). The orange graph is buying…

Options PnL Part 1

First, we'll look at general profit and loss graphs to make sure our audience understand basic algebra (Cartesian planes, slopes, intercepts, etc.). Then we'll take a brief look at futures. And finally, we'll touch on options. So first, what does your PnL graph look like if you purchased a single…