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First
We need to understand how options decay.
The theory and the reality.
Everyone understands options decay in value. See
illustration #1
Please bear in mind for every point on this chart there is an "entire
strike price distribution curve or ESPDC" as shown in Illustration 3.
However, that is not reality. Here is reality. We have overlaid a yellow
line on the theory curve. This has only a few illustrations of what is actually
happening. As you can see they are all different. You could have
over a 100 of these up and down swings on a day to day basis. You can have
just as many during a single days trading. See illustration #2
Next
What we mean by "options" is the time value of all options in
the entire monthly contract, at every strike
price, from deep in the money, to "at" the money, to
deep out of the money. This is defined as the entire strike price distribution
curve or ESPDC for short. When traders look at their screens they do not
see a value for every strike price, only those currently trading, but every contract has an option
premium for all strike prices, whether listed or unlisted. Our
option model was originally created as a real-time option pricing program,
this enables us to fill in a value for every strike price. Both puts and calls
have their own ESPDC. The
area under that curve is the total of all the strike price option premiums added
together at that moment and we define this as the "OSCC Total Option
Premium". We average the put and call values. Normally the
difference is insignificant. However, the entire "actual ESPDC" will get
smaller as we go to expiration. See Curve #1and Curve #2 on illustration
2. You can look at these curves as an example of a decrease in the ESPDC.
See illustration #3
for a better understanding of what we mean.
Now as the future moves from side to side the
actual option premiums at every strike price go either up or down and
traders see this as rapid change in their option values, Thus the actual time value of an option will go up or down
slowly or very fast depending on how close your
strike price is to the future on the ESPDC. This is how options have to work and we all see it happen
every minute of the day. However, the entire "actual ESPDC" in theory
"falls" or decays as we go to expiration. See Curve #1and Curve #2 on illustration
2 for an illustration of this "fall" or decay.
What traders do not see is that the entire ESPDC
also moves up down unrelated to any market condition that we can find. The
only conclusion we can therefore arrive at in our opinion is that someone
is manipulating this ESPDC for their own benefit.
The "OSCC Total Option
Premium" will be different at 100 or 90 days to expiration.. In
order to be able to compare these totals we adjust these "OSCC Total Option
Premiums" for time. We call this the "OSCC Adjusted Total Option
Premium" (ATOP). This is now a relative number that can be used for comparing the ESPDC at
two different times, such as 100 days to expiration and 90 days to expiration. If
the ESPDC moves up or down this number measures that movement. the ESPDC
vale would remain
constant for the life of the contract and would be a straight line on our
charts if it was not moved up or down.. (you can look at Curve #1 and curve #3 as being adjusted ATOP
curves even though the underlying ESPDC would be lower for Curve #3) This
would indicate that the ESPDC changed from the standard value. This would be
indicated by a "Steady" value of the ATOP. If a trader is looking at a contract at 100 days to expiration ,
he needs to know if it looks like this entire
ESPDC is rising or falling faster (being over sold) or slower (being over
bought) than it should. If our
data point falls, it is decaying faster than normal it is over sold and all options are
losing premium faster than a trader anticipates. If the ATOP is rising it
indicates that the ESPDC is decaying slower than it should and is being
over bought. If the momentum is high , it could in fact indicate that the
ESPDC is actually increasing such that all the options have greater value,
These ATOP points are
the data point numbers on our charts.
Her is how our ATOP helps traders the most. If
a trader believes that the future is going up and buys an out of the money
such as Data point 1 on illustration 2 and then the future went up as the
trader expected, but ATOP dropped to Curve #2 his option value would the
be at Data point 2 and he would have lost money even though he was correct
on the futures. However, had he looked at our charts and saw that the ATOP
was falling he could have skipped the purchase or had his broker construct
a different strategy.
As a trader can see these ATOP points move all
over and different contracts can and do move in different directions. This
shows that these entire curves are not related to the futures. You will see some commodities that have some monthly
contracts rising and another one falling.
See illustration #4
Mis-priced contracts.
You will notice that not all our data points for he "OSCC Adjusted Total Option
Premium" (ATOP). are on the same area of chart as most of the rest
of the data points. When we adjust the "OSCC Total Option
Premium" for the same
risk the number we publish would be exactly the same for all contracts on
a commodity. However, this is seldom true. many times the ATOP is
significantly different for some contracts. This is the changing of the
ESPDC issue. The
mis-pricing shows up on our charts as different
contracts having their own line, either above or below the others. What you are
looking for are humps and valleys in these lines. Valleys are a good place
to ask your broker about buying a long call or put. This may not always be
the best thing, so listen to your broker. Once you see a valley, the
lowest line should always be the most undervalued. Be aware that option
prices change extremely fast, so that what may look good on one of these
charts may in fact be bad when the market opens. Look to see if the
current average is above or below the 1 year or 3 month averages. This
will help guide your decisions. Our over bought/sold list has a scale for
this mis-pricing. Over the years we have seen very few instances when a
mis-priced contract did not eventually get in line with the rest of the
contracts, but it has happened.
Tables that show:
Options that in our opinion are over
bought with a rating of +1 to +5
Options that in our opinion are over
sold with a rating of -1 to -5
Options that in our opinion are steady with a rating of 0.
with special
notes on some commodities.
Go to this page for our rating
definitions.
Frequently asked
questions
If you still have questions make
comment in our blog.
About Option Premium Momentum
The average option premium has the same characteristics as a future.
Therefore it also has
"Momentum". That is, when most of
the traders see the risk in the options
getting higher or they perceive the under lying
future is getting unstable, they push up their offer bids (over buying). This gives Momentum to the option premiums and
all of the contracts for that commodity start to rise to some degree. If traders see
nothing happening, they lose interest in the options
on that commodity and quit bidding. This drives down
momentum and it can actually move to the
negative side (over sold).
Be careful, watch the scales on the right as some
have a history of very little momentum and some a great
deal of momentum.
See our discussion of
Future's momentum. See
other changes we have made recently.
For continued information please read our Option
Overview page.
We also have a new
"chart explanation page" to help explain
what these charts show and how to use them.
For a better understanding of what we do please read these
pages.
--- About Us What we found
that prompted us to develop our option program.
--- The OSCC overview of option trading.
--- The
OSCC Option Model.
--- Products
--- The Accuracy of the OSCC Option Model.
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