Question

1. What are the six determinants of call option values? Which one can be effectively discerned implicitly for trading? Explain how. What is the VIX and how is it calculated?

Answer 1

Determinats of Call Option Values

Call Option is an option to buy an asset at an agreed price on a specified date.

The following are the determinats of Call Option value:

1. Underlying Price: Underlying price and value of call option are directly proportional. When the value of underlying asset increase, value of call option also increases.

2. Exercise Price: Lower the exercise price higher will be the value of call option. They are inversely proportional.

3. Time to Expiration: The value of the call option will decline when it is near to the expiration date. If there is more time to expiration, the value of the option will be higher.

4. Volatility: It is the changes in the day to day stock prices. The volatility rate affects the value of the option.

5. Risk free rate: Risk free rate of interest affects the the value of the option. When risk free rate of interest increases the value of the option will increase

6. Benefits and costs: The benefit and costs are another factors which determines the value of the call option. Value of the option increases with more costs and decreases with more benefits

Which one can be effectively discerned implicitly for trading?

The "Volatility" of the option is a factor which can be effectively discerned implicitly for trading. Volatility is the fluctuations in price of the asset. Based on the degree of volatility, the value of the option changes

What is the VIX and how is it calculated?

VIX is Volatility Index. It is the index representing the fluctuations in the S&P 500 index, in the next 30 days.

VIX can be calculated as follows:

1. Calculate the Variance of the first and second expiration.

2. Then interpolate the two variances and calculate the 30 day variance.

3. Find out the standard Deviation (SD). SD is the square root of variance. So next step is to find square root of Variance. Then the value will be SD. This SD is called Volatility.

4. In order to find out the Index, multiply this Volatility by 100. Then the result will be VIX