Question about ATM call price change due to price change
Hi guys, I have one question concerning with hedging strategy using call. If the stock price increase 20% by tomorrow, what would be the percentage change we should expect in the price of ATM call written on this stock?
My idea is that the ATM call would increase a lot because it would expire much sooner and we know there's a huge profit in stock. Thus the call change should be much larger than 20%.
Any help:)
Short answer is yes, the change in the price of the option will most likely be more than 20% of the stock if it moved that % in one day. At the most basic level, the reason why people buy options is because its cheap leverage.
However, your ATM call premium depends on a lot of factors. How much time is left until expiry and what is the volatility priced at? In an extreme example, if your option was short dated (1w) and the vol base was very high, the 20% move in the underlying might be more than what you gain on the option because of theta decay. Or if there was a lot of time until expiry with a very high vol base, your gain on delta might not be as much as just holding the underlying. It really just all depends on the details of the ATM call and how it was priced to begin with.
So if I observe a decreasing put price, due to stock price drop a lot, is that because of a predicted decreasing future vol?
Yes, if a stock price dropped and your put option still lost money overall, it would mean the move has not covered your decay in theta (time value) which is most likely attributed to the fact that the stock has not moved more than what the volaility was pricing.
Thanks！
Just to tack onto what @koalamacro said - if you want to learn more about what generally drives option prices look up the "option greeks" on google/investopedia and I'd recommend reading "option volatility and pricing" by natenberg (download a free PDF if you can) - will give you a holistic idea but you are on the right track with your thinking so far :)
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