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PTMC team 06.09 2014

Option master Protrader. Main functionality overview

Hey there, Protraders!

Continuing the topic of option trading, we will consider in details the functionality of “Option master” in the today’s article. As we know, price formation of the options is nonlinear and depends not only on the underlier movement, but also on such factors as implied volatility and option’s expiration date. When opening the option position the trader needs to know how he will manage the position in different market situations. To provide this he should assess the potential profit and possible losses. Practice of the option profiles construction here comes to the rescue.

Let’s run the “Option master”.

Let’s run the “Option master”.

Choose symbol which is interesting for us, for example, currency futures EUR with expiration in December 2014, its ticker – 6EZ4.

Choose symbol which is interesting for us, for example, currency futures EUR with expiration

The “Option master” panel consists of three parts:

  • Option chain (option desk) – in this window user gets access to the table which contains information about the options. The opening of option positions is also performed here.
  • Analyzer – window which displays graphically the option profile. Analysis of the influence factors of the option price formation on the behavior of the created option position is conducted in this window.
  • Volatility smile – window which displays graphically the volatility curve.

Let’s start with option chain.

Let’s start with option chain.

1 – The option desk directly. It is a table with option data by strikes. The amount of displayed information is easily customized to the individual requirements of each trader.

The option desk directly

Available information is as follows:

  • Last – the last trade price by selected strike;
  • IV – the implied volatility of the selected strike;
  • Trade – the number and direction of user’s opened option positions;
  • Ask – current price to buy the selected strike;
  • Bid – current price to sell the selected strike;
  • Ask size – the amount of lots at Ask price;
  • Bid size – the amount of lots at Bid price;
  • Delta, Gamma, Vega, Theta – “greeks” of the selected strike;
  • Open interest – the open interest on the selected strike;
  • Volume – the traded volume on the selected strike.

2 – Field for choosing the symbol;

3 – Field for choosing the trade account;

4 – Informational window which contains information about margin requirements and “greeks” of the opened option position;

5 – Settings window of the calculation and information displaying by the options;

6 – Window which contains current information by selected underlier.

In order to work in the “Analyzer” mode, we need to open option position, buy 1 Call option contract with the strike price 1.3400. To provide this, set “Trade” counter of the needed strike to the value = 1. Positive or negative values of the “Trade” counter meet the value of the long or short position respectively.

open option position

In this case, the information about opened option position appeared in the “Test on paper” window.

appeared in the “Test on paper” window

On the underlier chart it looks in the following way:

On the underlier chart it looks in the following way

Let’s move to the “Analyzer” window.

Let’s move to the “Analyzer” window

We see the graphical displaying of the bought option cost in the main window. The abscissa axis represents the underlier prices, the ordinate axis – the option position cost in pips.

How to “read” this chart? It may be noted that 2 curves were plotted on the chart. Red curve corresponds to the option position price at the moment of expiration, and the blue line - the current exposure. Initially the profile is below zero on the premium value, since we paid the premium when buying the option contract. If the underlier price grows then bought Call option will be closer to the state “in the money” and its cost will grow (the right side of the chart). If the underlier price declines then the buyer will lose only the premium paid.

We can display graphically not only the option position cost, but also its total “greeks”; to provide this choose the corresponding item in the “Chart type” menu. For example, chart of the “Delta” change for selected position looks in the following way:

 chart of the “Delta” change for selected position looks in the following way

When plotting charts of “greeks” change, it can be understood which from the price formation factors and in what extent will affect the cost of the option position. This is especially true for complex option constructions.

Thus, if the trader expects the underlier price movement to the specified levels, he can always assess the possible profit or loss by the option's profile. But, current exposure of the option position can fluctuate in significant range due to changes in the term to expiration, implied volatility and underlier price. We took into account the influence of the underlier movement by plotting the option’s profile. How to take into account the remaining factors? How to determine what will be the cost of the option position in a few days or at the expiration? How growth or fall of the implied volatility will affect the exposure? These are very important questions that every option trader should answer. User can choose the plotting method of the exposure lines with the implied volatility change (“Volatility change”) or with expiration date change (“Time change”) in the menu “Lines”. The change of unselected parameter in the menu “Lines” will be available in the window below. So, let’s plot the chart of the long position cost by strike 1.3400, Call option. Let’s choose plotting of the exposure lines after 10, 20, 30 and 40 days after opening the position, and also let’s model the fall of the volatility on 10%.

Let’s choose plotting of the exposure lines after 10, 20, 30 and 40 days

For more comfortable perception of the information the color of displayed lines can be changed according to your taste. As we see, over time, the possible position exposure is getting smaller due to the "time decay", which the "theta" describes. And the volatility decline also works against the option buyer, reducing the cost of bought option.

So, using the “Option master”, the option trader can assess profitability and risks of the selected position by modelling all the possible market situations. In its turn, the objective risk assessment is the key to successful market activity.

Let’s move to the “Volatility smile”.

In this window user can see the so-called curve of the volatility by all available strikes.

In this window user can see the so-called curve of the volatility by all available strikes.

The volatility curve is a graphical representation of the implied volatility at each strike. The form of this curve can tell a lot about the current market state to the experienced option trader. There is the phenomenon of the “Volatility smile”, it lies in the fact that by the Black-Scholes model the volatility for strikes “at the money” shouldn’t significantly differ from the volatility for strikes deeply “in the money” and “out of the money”. But due to actions of the market participants the distant strikes have the significantly greater value than the standard model requires. Since the option cost is high, the implied volatility also has values significantly higher than theoretical. By plotting the dependency of option volatility to the underlier price, we can see far up bent tails of the curve; such chart reminds “smile”, hence the name. Also there is a variety of this volatility pattern, in which only one tail of the curve is strongly bent then the volatility curve is called as “volatility skew”.

It should be noted that “Option master” has virtually all the functionality that trader requires during the calculation of option strategies. And the ability to model all possible market conditions gives a possibility more accurately to assess the risks and develop a plan to manage the position in the case of the negative event scenario implementation.

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