💡Concepts

Understanding the essential Metrics and Attributes for Effective Spread Analysis

In this section, we will provide a comprehensive overview of the key concepts that are relevant to using the spread tool. This includes defining the various metrics and explaining the various attributes, that are used in spread analysis. By the end of this section, you will have a solid understanding of the underlying concepts and terms that are essential for effective spread analysis.

Contracts

Options, futures, and perpetual contracts are all financial instruments that allow investors to hedge against future price risks.

Options contracts : these give the right, but not the obligation, to buy or sell an asset at a specified price at a predetermined future date. Options are commonly used to hedge against future price risks and can be bought or sold on an exchange. Options contracts have daily, weekly, monthly, or quarterly expiration dates.

Delta, Vega, Theta, and Gamma are commonly used terms to describe the characteristics of an option contract and the associated risks. Here is a brief description of each term.

• Delta : The Delta is a measure of the sensitivity of an option contract to the price of the underlying asset. A positive delta indicates that the option price will increase if the price of the underlying asset increases, while a negative delta indicates that the option price will decrease if the price of the underlying asset increases.

• Vega: It is a measure of the sensitivity of an option contract to changes in the volatility of the underlying asset. A positive vega indicates that the option price will increase if the volatility of the underlying asset increases, while a negative vega indicates that the option price will decrease if the volatility of the underlying asset increases.

• Theta: It is a measure of the sensitivity of an option contract to the passage of time. As the time remaining until the option expiration decreases, the theta will be higher. A positive theta indicates that the price of the option will decrease as time goes by, while a negative theta indicates that the price of the option will increase as time goes by.

• Gamma: is the measure of sensitivity of an option contract's delta to the price of the underlying asset. A positive gamma indicates that the delta will increase as the price of the underlying asset increases, while a negative gamma indicates that the delta will decrease as the price of the underlying asset increases.

Perpetual contracts : also known as non-expiring perpetual contracts, are contracts that don't have a specified expiration date. They are typically used to trade assets that are not easily traded or for which there are no standard futures contracts. Perpetual contracts are traded on an over-the-counter (OTC) market and can be more difficult to buy or sell.

Future contracts : These are contracts that fix the terms of the purchase or sale of an asset at a specified future date. They are typically used to mitigate future price risks and allow investors to hedge their positions. The difference between futures contracts and options contracts is the obligation to exchange the asset at a fixed price before the expiration date.

Strategies

25 delta Butterfly : The 25 delta butterfly is a specific type of butterfly spread that involves options with delta values close to 25. The delta value measures the sensitivity of an option's price to changes in the underlying asset's price. In this strategy, four options contracts with the same expiration but three different strike prices are used: a higher strike price, an at-the-money strike price, and a lower strike price. The 25 delta butterfly combines both a bull and bear spread and is a neutral strategy. It is used to take advantage of small price movements in the underlying asset and to potentially profit from a limited range of price movement.

25 delta Skew : The 25 delta skew measures the price of a call option with a delta of 0.25 and the price of a put option that has a delta of 0.25. If the skew increases then puts are becoming more expensive than calls; if the skew decreases, call premiums are going up against puts premiums.

Risk reversal : A Risk Reversal is an option combo trade that consists of selling (that is, being short) an out-of-the-money Put and buying (i.e. being long) an out-of-the-money call, with both options expiring on the same expiration date.

Volatility

- the volatility measures the amplitude of movements of an underlying asset (up or down)

Historical Volatility : It is based on past data of an underlying asset and is calculated using the historical record of the underlying asset's price evolution. It cannot predict future variations.

Implied Volatility : Each asset has a level of risk that is to be correlated with its profitability. Implied volatility evaluates the evolution of this risk over time and therefore determines the future profitability of the security. The higher the implied volatility, the greater the risk. In return, the expectation of gain is stronger. Implied volatility is expressed as a percentage. There are several models for calculating implied volatility, such as Black & Scholes. The higher the implied volatility, the higher the premium paid by investors to buy the option. Three factors that influence the level of implied volatility are the option maturity, the option price, and the risk-free rate.

Realized Volatility : Realized volatility is a measure of the observed variability of a financial asset over a given period. It is calculated by using the historical price data of the asset to estimate the standard deviation of the asset's returns over a specific time period. It is important to note that realized volatility is based on past price data and therefore cannot accurately predict future volatility.

Other Stats

Open interest : The total number of open derivative contracts, such as options or futures contracts that have not settled (opened, but have not been closed, expired or exercised).

Open interest is equal to the total number of contracts bought or sold, not the total of the two added together. Open interest decreases when buyers (or holders) and sellers (or issuers) of contracts close more positions than were opened that day.

Moving Average : is an indicator that serves to smooth price data by creating a constantly updated average price.

A simple moving average (SMA) is a calculation that takes the arithmetic mean of a given set of prices over a specific number of days in the past.

An exponential moving average (EMA) is a weighted average that places greater emphasis on a stock's price over the past few days, making it a more sensitive indicator to new information.

Value at Risk : the value at Risk (VaR) is a measure of the maximum possible loss in value of an asset or a portfolio of financial assets over a given period of time with a certain probability.

Confidence Interval : It is an interval of values ​​which is estimated from statistical data and which contains a certain probability of containing the true value of a parameter.

Standard deviation and variance : They are measures of the dispersion of values ​​in a data set. They indicate how scattered the values ​​of a data set are around the mean. The standard deviation is the square root of the variance.

Atm Iv : Stands for "At-The-Money Implied Volatility". It refers to the implied volatility of a financial instrument (such as a stock option) that is currently trading at the same price as the underlying asset. In other words, it is the expected volatility of a stock option whose strike price is equal to the current price of the underlying stock. ATM IV is an important metric in options trading as it provides a baseline for pricing options and determining their relative value.

Mean : The mean is a measure of central tendency that indicates the mean value of a set of data.

Median : The median is also a measure of central tendency, but is used when data is ordered ascending or descending. To find the median, you must first rank the data ascending or descending, then find the middle item.

Quartiles : These are three values ​​that separate a set of data placed in ascending order into four subsets comprising exactly the same number of data. They are used to give an idea of ​​the distribution of data in a set.

Z-Score : corresponds to the number of standard deviations separating a result from the mean.