Part 5: Index Option Total Theoretical Values
Part 1: Index Option put/call Ratios
Part 2: Index Option value Ratios
Part 4: Index Option Open Interest
Option World: Specific statistics and details for each individual contract month
Legend:
The CBOE put/call ratio represents the CBOE exchange's total put volume divided by the CBOE's total call volume. However, this widely reported value may not reflect the nuance of a particular index. So we have probed into the CBOE's data and determined each individual index option's put/call ratio. Below are the put/call ratios of the CBOE's top 5 most active indices.
Below are the composite put/call ratios. We use the term composite to mean the sum of all puts and calls traded in all actively traded contract months. This produces one aggregate put/call ratio for each index option. In addition, each individual index option trades many different contract months simultaneously and each contract month can have its own put/call ratio. For a detail of each contract month ratios, visit our Option World.
Part 5
In part one, the index option composite put/call ratio and the CBOE exchange's daily put/call ratio was explained and illustrated. In part 2, the option values are used to create put/call ratios and are added to the charts. In part 3 the actual volumes are plotted and in part 4, the open interest is plotted. Part 5 will examine a rather unconventional view of option data - total theoretical value.
The essential question behind the graphs in this article is to ask who wins and loses today. At the end of every trading day the number of contracts held by option traders as reported in the open interest can be used to calculate a theoretical total market value. Those options "in-the-money" add value and those options "out-of-the-money" are worthless. So by tracking the total theoretical value the total amount of money made or lost can be be computed by subtracting yesterday's value from today's value. But first let's look at the how these theoretical values computed.
These calculations are very easy but are numerous and repetitive. The best way to understand this is to imagine a spreadsheet. The spreadsheet is the matrix and we're going to repeatedly loop through the rows and columns at various prices to calculate the value of each option at various price levels. For example, a if the SPX closes at 1000, both the call and put option at the strike price of 1000 are worthless if today were the expiration. Despite the fact that they posess value today is disreguarded in this simulation. The call option may actually close at 12 and the put option may close with a value of 12, but if the options expired today they would be worthless. However, a call option at the strike price of 990 would close with a value of 10, and the put option would be worthless. Or to the contrary a put option at the strike price of 110 (greater than the close) would have a value of 10 and the call would now be worthless.
The value of each option at every strike price is calculated and that value is multplied by the open interest. So each option will have a series of values ranging from 0 to its theoretical maximum value. One of the values in the series represents the real value for today while the other values in the series represent theoretical values if the index closed at higher or lower prices. As you know, puts increase in value as the index's price declines and the calls increase in price as the index's price rises. Then the number of options is factored into the computations and we know what the value of the options will be if the market rises or falls. Then the sum of all the theoretical put and call values is totaled for each trading day. Each contract month gets a total value for its calls and puts and the totals from all the different contract months are aggregated into one composite super-total. As the graphs depict, these aggregate total values change and show you which side of the market stands to make more money. Please note that this is a simulation. It's not guaranteed that the group of options with the most value will make the most money, it just is portraying that if today were the expiration day the group with the greatest value gets more money.
So to summarize, the total theoretical values are a representation of the real value of open-ended options with respect to the underlying index. These values do not reflect the market's current price of these options as does the dollar weighted option values.
Another interesting use of these total theoretical values is to look at the change in values at expiration. The large drop in values after expiration shows how much value disappeared. So in June 2003 in the SPX market the calls had a total theoretical value of $1 Trillion and the puts had a total theoretical value of $600 Million. The day after expiration those values dropped to $380 Million for calls and $250 Million for puts. You can't say that the call options made $620 Million because the total theoretical values doesn't represent one value, it represents a series of values created by each contract. So what can you say about the total theoretical values? These data show us how much money is invested in the option market. It helps to know the relative amount of money that is being spent in the option market. Remember, there is only one vast pool of money and that one pool can only be divided in so many ways. So if more money is in the option market then it is excluding funds from investing elswhere.
Another use of these total theoretical values to to find the point in the series where the options have the least value. In the example shown below, the inflection point is 990. This point will move slowly day to day but some traders believe that this point will act as a magnet. However, during the summer of 2003, this didn't occur. To view these inflection graphs visit our Option World.
What's interesting to note here is that in the SPX market the total theoretical values for calls is greater than puts. But the total theoretical values for the OEX, NDX, and DJX are still showing puts exceeding calls. This fact surprised us and still can't be explained given that all of the other option data for the SPX showed that the number of puts was greater than calls by a substantial difference.
Also view the differences between the SPX, OEX, NDX, and DJX. In each of those markets, the option traders pick different times to trade puts and the value of calls hasn't changed relatively very much. OEX option traders are selling any rise in price. NDX option traders are selling the breakout above 1300 in a big way. DJX option traders are also increasing their positions as prices rise but the same extent as OEX and NDX option traders. As for the SPX option traders, they were on the correct side of the market as prices rose as calls were the better investment. As for the XAU market, you can see the vascillations between the calls and puts. As stated in the other parts of this series on options, these traders seem to right every time. The group with the greatest value wins. In May-June 2003, calls exceed puts and XAU prices rose. In July the puts exceeded calls and prices fell. In the August, the calls exceeded puts and prices rose and then they flipped and prices fell. Currently puts exceed calls, so watching these traders can be helpful.
These differences between the top five option markets total theoretical values were illustrated in an attempt to find a more profitable trading strategy that incorporates option data. These data show that each market has its own characteristics and that different groups of option traders are applying different strategies. While the SPX, OEX, NDX, and DJX oiption traders are interested more in puts as prices rise, the value of those puts isn't exceeding June's levels in the OEX. The NDX and the DJX's values are greater than compared to June and the SPX is the same. However, the call values in the SPX and DJX are down from June while the OEX and NDX are posting increased call values.
created 9/24/03, ©2003 The Small Investors Software Co. All rights reserved.