6. Options and the volatility desk

Options from zero

What an option is, what it is worth, and the Greeks.

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  • 5 lessons
  • 27 min
About this section

The ideas before the tools: what an option is, what it is worth, how its price reacts (the Greeks), what volatility means, and what a volatility desk does with all of it.

What you will be able to do

  • Explain calls and puts with a house deposit and an insurance policy.
  • Split a premium into intrinsic value and time value, and find a breakeven.
  • Say what delta, gamma, theta and vega measure, with one number each.
  • Tell implied volatility from realized volatility, and turn a yearly volatility into a daily move.
  • Describe how a bank's volatility desk makes money and what it fears.

Five words to know

call
the right to buy at a fixed price
put
the right to sell at a fixed price
expiry
the last day the option exists
delta
how much the option price moves for a $1 move in the stock
implied volatility
the size of the swings that today's option prices assume
  1. 01What an option is (calls and puts)An option is the right, but not the duty, to buy or sell something at a fixed price before a deadline, and you pay a fee for that right.5 min
  2. 02Value and payoff at expiryAn option's price is what it is worth if used right now (intrinsic value) plus a bet on the future (time value), and at expiry only the first part is left.5 min
  3. 03The Greeks in plain words (OVME)The Greeks say how an option's price reacts when the stock moves (delta, gamma), when time passes (theta) or when expected swings change (vega), and OVME computes them for any option you describe.6 min
  4. 04Implied vs realized volatilityRealized volatility is how much a stock actually moved and implied volatility is how much option prices assume it will move, and comparing the two is the core question of a volatility desk.5 min
  5. 05What a volatility desk doesA bank's volatility desk makes markets in options, hedges away direction every day, and keeps a book of exposures to movement (gamma) and to volatility (vega), earning the spread and, on average, implied above realized volatility.5 min

Educational material about reading market data, not investment advice.