Section 10 - Chapter 8 - Options - CMT Level 1 Chapter Wise Short Notes

Section 10 - Chapter 8 - Options - Presented by Rohan Sharma - The CMT Coach - Chartered Market Technician CMT Level 1 Study Material - CMT Level 1 Chapter Wise Short Notes - CMT Level 1 Course Content - CMT Level 1 2025 Exam Syllabus

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1. Chapter 8 – Options SECTION 10 - COMPARATIVE MARKET ANALYSIS Presented By : This Content is Copyright Reserved Rights Copyright 2025@PTAIndia

2. Agenda What Are Options? Benefits for Investors Options Terminology Using the Options Market Major Components of Options Prices Implied Volatility (IV) Options Strategies Pricing Models Warrants What Does a Technical Analyst Need? This Content is Copyright Reserved Rights Copyright 2025@PTAIndia

3. Options Presented By : This Content is Copyright Reserved Rights Copyright 2025@PTAIndia

4. Options Options are financial derivatives that give the holder the right, but not the obligation, to buy or sell an underlying asset (like a stock) at a predetermined price within a specified period. They are commonly used for hedging, speculation, and income generation. Types of Options: 1. Call Options – Give the holder the right to buy an asset at a set price before or at expiration. 2. Put Options – Give the holder the right to sell an asset at a set price before or at expiration.

5. Options Key Terms: • Strike Price – The price at which the option allows you to buy or sell the asset. • Premium – The price paid to purchase the option. • Expiration Date – The last day the option can be exercised. • In-the-Money (ITM) – When exercising the option would result in a profit. • Out-of-the-Money (OTM) – When exercising the option would result in a loss. • At-the-Money (ATM) – When the strike price is equal to the current market price of the asset. Example: • If you buy a call option on Apple stock with a strike price of $150 and the stock rises to $170, you can buy it at $150, making a profit. • If you buy a put option with a strike price of $150 and the stock drops to $130, you can sell it at $150, making a profit.

6. Options Options Terminology 1. Call Option – A contract that gives the holder the right (but not the obligation) to buy an asset at a specific price before or on the expiration date. 2. Put Option – A contract that gives the holder the right (but not the obligation) to sell an asset at a specific price before or on the expiration date. 3. Strike Price (Exercise Price) – The predetermined price at which the option holder can buy (for calls) or sell (for puts) the underlying asset. 4. Premium – The price paid to buy an option. This is the cost of the contract. 5. Expiration Date – The last date on which the option can be exercised. After this date, the option becomes worthless if not exercised. 6. Intrinsic Value – The real value of an option if exercised immediately. It is calculated as: o For Calls: Max(Current Price - Strike Price, 0) o For Puts: Max(Strike Price - Current Price, 0)

7. Options Options Terminology 7. Time Value – The portion of an option's price that accounts for time remaining until expiration. Options with more time until expiration generally have higher time value. 8. In-the-Money (ITM) – When an option has intrinsic value. o Call Option: If the current stock price is above the strike price. o Put Option: If the current stock price is below the strike price. 9. Out-of-the-Money (OTM) – When an option has no intrinsic value. o Call Option: If the current stock price is below the strike price. o Put Option: If the current stock price is above the strike price. 10. At-the-Money (ATM) – When the stock price is equal to or very close to the option's strike price. 11. Option Chain – A listing of all available option contracts for a given security, showing their strike prices, expiration dates, premiums, and other details.

8. Options Options Terminology 📖 12. Open Interest (OI) – The total number of outstanding options contracts that have not been settled. High OI indicates strong market interest. 13. Implied Volatility (IV) – A measure of the expected volatility of the underlying asset based on options pricing. Higher IV generally means higher option premiums. 14. Delta (Δ) – Measures the sensitivity of an option’s price to a $1 change in the underlying asset. • Call options: Delta is between 0 and 1. • Put options: Delta is between -1 and 0. 15. Theta (Θ) – Measures the rate at which an option’s value declines over time, also known as time decay. 16. Gamma (Γ) – Measures the rate of change of delta as the stock price moves.

9. Options Options Terminology 📖 17. Vega (ν) – Measures an option’s sensitivity to changes in implied volatility. 18. Rho (ρ) – Measures an option’s sensitivity to changes in interest rates. 19. Exercise – The process of using an option to buy (for calls) or sell (for puts) the underlying asset at the strike price. 20. Assignment – When an option seller is required to fulfill the contract obligations (selling or buying the underlying asset). 21. Covered Call – A strategy where an investor owns the stock and sells a call option against it to generate income. 22. Naked Option – Selling an option without holding the underlying asset, which can be risky. 23. LEAPS (Long-Term Equity Anticipation Securities) – Options with expiration dates longer than one year.

10. Options Major Components of Options Prices 1. Intrinsic Value • The portion of the option price that reflects the difference between the current market price of the underlying asset and the option’s strike price. • Only in-the-money (ITM) options have intrinsic value. • Formula: o Call Option Intrinsic Value = Max(Current Price - Strike Price, 0) o Put Option Intrinsic Value = Max(Strike Price - Current Price, 0) ✅ Example: • A call option with a strike price of $50 when the stock is trading at $60 has an intrinsic value of $10 ($60 - $50). • A put option with a strike price of $50 when the stock is trading at $40 has an intrinsic value of $10 ($50 - $40).

11. Options Major Components of Options Prices 2. Extrinsic Value (Time Value) • The portion of the option price that accounts for factors other than intrinsic value, such as time until expiration and market conditions. • Extrinsic value decreases as expiration approaches due to time decay (Theta decay). 💡 Extrinsic Value = Option Premium - Intrinsic Value ✅ Example: • If a call option costs $12 and has $10 intrinsic value, the extrinsic value is $2 ($12 - $10).

12. Options 3. Key Factors Affecting Options Prices Several factors influence an option's price, including: A. Underlying Asset Price • For calls, as the stock price increases, the option price increases. • For puts, as the stock price decreases, the option price increases. B. Strike Price • The further an option’s strike price is from the stock’s current price, the cheaper the option (for OTM options). C. Time to Expiration (Theta Decay) • Options lose value over time, especially in the last few weeks before expiration. • Longer expiration = Higher premium due to more time for the stock to move in a profitable direction.

13. Options 3. Key Factors Affecting Options Prices D. Implied Volatility (Vega Effect) • Higher implied volatility (IV) = higher option prices because there is a greater chance of large price movements. • Example: Before earnings, IV increases, causing option prices to rise. After earnings, IV drops, leading to a potential volatility crush. E. Interest Rates & Dividends • Higher interest rates slightly increase call option prices and decrease put option prices. • Dividends lower call option prices and increase put option prices since stock prices typically drop by the dividend amount when paid.

14. Options 3. Key Factors Affecting Options Prices (Summary) Factor Effect on Call Price Effect on Put Price Stock Price ↑ Increases 🔼 Decreases 🔽 Strike Price ↑ Decreases 🔽 Increases 🔼 Time to Expiration ↑ Increases 🔼 Increases 🔼 Implied Volatility ↑ Increases 🔼 Increases 🔼 Interest Rates ↑ Increases 🔼 Decreases 🔽 Dividends ↑ Decreases 🔽 Increases 🔼

15. Options Options Greeks Cheat Sheet Greek What It Measures Effect on Calls Effect on Puts Who Benefits? Delta (Δ) Sensitivity to stock price movement Positive Negative Buyers when correct direction Gamma (Γ) Acceleration of Delta Increases Delta Increases Delta ATM traders (higher accuracy) Theta (Θ) Time decay effect Negative Negative Option sellers (premium income) Vega (ν) Sensitivity to volatility Positive Positive Option buyers when IV rises Rho (ρ) Sensitivity to interest rates Positive Negative Call holders when rates rise

16. Implied Volatility (IV) Presented By : This Content is Copyright Reserved Rights Copyright 2025@PTAIndia

17. Implied Volatility (IV) What is Implied Volatility (IV)? Implied Volatility (IV) represents the expected future price movement of an asset, based on options prices. It does not predict direction (up or down) but reflects the anticipated magnitude of price changes. ✅ Higher IV = Larger Expected Moves ✅ Lower IV = Smaller Expected Moves IV Cheat Sheet IV Level Market Condition Best Strategy? Low IV Stable market, small moves Buy options (long straddles, strangles) Rising IV Uncertainty, upcoming news Buy options before a major move High IV Earnings, crisis, big event Sell options (Iron Condors, Credit Spreads) IV Crush After earnings/news drop Avoid long options before events

18. Implied Volatility (IV) Key Facts About IV 🔑 1. IV is Based on Market Expectations 📊 o It’s derived from option prices, not historical performance. o High option demand = Higher IV (expensive options). o Low option demand = Lower IV (cheaper options). 2. IV Rises Before Major Events 📈 o Earnings reports, economic data, Fed meetings, and news events can increase IV as traders expect volatility. o After the event, IV often drops (IV Crush). 3. IV Affects Option Prices (Vega Impact) 📉 o Higher IV = Higher Option Premiums o Lower IV = Lower Option Premiums o Buy options when IV is low and expected to rise. o Sell options when IV is high and expected to drop.

19. Implied Volatility (IV) Key Facts About IV 🔑 4. IV is Different for Each Strike Price (IV Skew) 🎯 o OTM Puts usually have higher IV than OTM Calls due to market fear (put protection demand). o Skew creates trading opportunities like Reverse Skew Trades and Risk Reversals. 5. IV Mean Reverts Over Time 🔄 o IV doesn’t stay extreme forever; it usually returns to its historical average. o Traders use Historical Volatility (HV) vs. IV to spot overpriced or underpriced options. Cheat Sheet IV Level Market Condition Best Strategy? Low IV Stable market, small moves Buy options (long straddles, strangles) Rising IV Uncertainty, upcoming news Buy options before a major move High IV Earnings, crisis, big event Sell options (Iron Condors, Credit Spreads) IV Crush After earnings/news drop Avoid long options before events

20. Options vs. Warrants Key Facts About Options vs. Warrants 🔑 1. Issuer & Availability 📜 • Options: Traded on exchanges (e.g., NYSE, CBOE) and issued by market participants. • Warrants: Issued directly by a company and typically tied to newly issued shares. 2. Underlying Asset 📊 • Options: Can be on stocks, indices, commodities, ETFs, etc. • Warrants: Usually tied to a specific company’s stock. 3. Expiration & Duration ⏳ • Options: Shorter lifespan (weeks to a few years, most expire within months). • Warrants: Longer lifespan (often years or perpetual).

21. Options vs. Warrants Key Facts About Options vs. Warrants 🔑 4. Trading Market 📈 • Options: Traded on regulated exchanges. • Warrants: Traded over-the-counter (OTC) or issued directly by companies. 5. Dilution Effect 🏦 • Options: Do not cause dilution because they involve existing shares. • Warrants: Can cause dilution because the company issues new shares when exercised . 6. Settlement Method 💰 • Options: Typically settled in cash or through share delivery. • Warrants: Usually settled in newly issued company shares.

22. Options vs. Warrants Key Facts About Options vs. Warrants 🔑 7. Pricing & Valuation 💲 • Options: Prices are affected by the Black-Scholes model, implied volatility, time decay, and market forces. • Warrants: Prices depend on company stock performance and corporate actions. 8. Exercise Price & Adjustments 🎯 • Options: Strike prices are fixed and determined at issuance. • Warrants: Companies can adjust terms (e.g., for stock splits, dividends, or mergers).

23. Options vs. Warrants Options vs. Warrants Cheat Sheet Feature Options 🏦 Warrants 🏢 Issuer Exchange (market participants) Company issuing stock Trading Market Public exchanges (CBOE, NYSE, etc.) OTC or stock exchanges (for some warrants) Underlying Asset Stocks, ETFs, Indices, Commodities Single company's stock Expiration Short-term (weeks to months) Long-term (years or perpetual) Dilution Effect? No dilution Causes dilution (new shares issued) Settlement Cash or shares Usually new shares Adjustable Terms? No (except corporate actions) Yes (stock splits, mergers) Pricing Influence Market demand, IV, time decay Stock price, corporate events Who Issues It? Market makers & traders The company itself

24. Options vs. Warrants Options Cheat Sheet for Technical Analysts Market Condition Technical Pattern Options Strategy Bullish Breakout, Trendline Support Buy Calls, Bull Call Spread Bearish Head & Shoulders, Breakdown Buy Puts, Bear Put Spread Volatile Earnings, News Event Straddles, Strangles Sideways Consolidation, Range-Bound Iron Condor, Credit Spreads

25. VIX & Put-Call Ratio Presented By : This Content is Copyright Reserved Rights Copyright 2025@PTAIndia

26. VIX – Volatility Index 📌 What is the VIX (Volatility Index)? • The VIX is the "Fear Index," measuring expected volatility in the S&P 500 over the next 30 days. • A high VIX (above 30) = More uncertainty and fear in the market. • A low VIX (below 15) = Calm market, low volatility. ✅ Key Facts About the VIX: 1. Inverse Relationship with Stocks o VIX up → Stocks down (market fear increases). o VIX down → Stocks up (market confidence returns). 2. Mean Reverting Behavior o VIX spikes during crises but always returns to normal levels over time. o Traders use this to time reversals.

27. Options vs. Warrants ✅ Key Facts About the VIX: 3 Trading the VIX . o You can’t trade the VIX directly but can trade VIX futures, ETFs (VXX, UVXY), and options. o When VIX is high, consider selling options (high IV). o When VIX is low, consider buying options (low IV). VIX Levels & Market Sentiment VIX Level Market Sentiment What It Means? Below 12 Extreme complacency Low volatility, risk of correction 12 – 20 Normal market Moderate volatility 20 – 30 Rising fear Increased risk of sell-offs Above 30 High fear/panic Market crashes, potential reversals

28. Put Call Ratio (PCR) What is the Put-Call Ratio (PCR)? The Put-Call Ratio measures the number of put options traded relative to call options. It’s a contrarian indicator—when it’s too high or low, it can signal reversals. ✅ Key Facts About PCR: 1. Formula: PCR = Total Call Volume/Total Put Volume 2. Market Sentiment Indicator o High PCR (>1.0) = Bearish sentiment (more puts than calls) → Potential buying opportunity. o Low PCR (<0.7) = Bullish sentiment (more calls than puts) → Risk of a pullback.

29. Put Call Ratio (PCR) ✅ Key Facts About PCR: 3. PCR as a Contrarian Indicator 🚀📉 o Extreme readings suggest the crowd is likely wrong (e.g., if everyone is buying puts, a reversal might be coming). PCR Levels & Interpretation PCR Value Market Sentiment What It Means? Below 0.7 Extreme bullishness Market may be overbought, risk of a pullback 0.7 – 1.0 Neutral No strong signals Above 1.0 Extreme bearishness Market may be oversold, potential rally

30. Put Call Ratio (PCR) VIX & Put-Call Ratio Cheat Sheet Indicator Market Signal Actionable Trade VIX < 12 Low volatility (market too calm) Prepare for a correction (buy puts or hedge longs) VIX 20 – 30 Fear rising Expect increased volatility (sell straddles, strangles) VIX > 30 Extreme fear Market may bottom soon (buy calls, long stocks) PCR < 0.7 Overbullish Market may correct (short stocks, buy puts) PCR > 1.0 Overbearish Market may rally (buy calls, sell puts)

31. Put Call Ratio (PCR) 🎯 Key Takeaways ✔ VIX is a fear gauge—rises when markets fall, drops when markets rally. ✔ PCR is a contrarian indicator—extreme values suggest reversals. ✔ High VIX = Good for selling options, Low VIX = Good for buying options. ✔ PCR > 1.0 = Too many puts, possible market rally. ✔ PCR < 0.7 = Too many calls, possible market drop

32. Options Pricing Models Presented By : This Content is Copyright Reserved Rights Copyright 2025@PTAIndia

33. Options Pricing Models Black-Scholes Model (BSM) The Black-Scholes Model is a mathematical model used to price European-style options that can only be exercised at expiration. Assumptions of Black-Scholes Model ✔ No dividends during the option's life ✔ Constant risk-free interest rate ✔ European-style options (no early exercise) ✔ No transaction costs When to Use? ✅ Best for pricing European options (not American options) ✅ Works well in stable market conditions

34. Options Pricing Models Binomial Option Pricing Model 🌲 The Binomial Model breaks time into small steps and evaluates possible price movements in each step, making it suitable for American-style options (which can be exercised early). 🔹 Steps of the Binomial Model 1️. Create a price tree where stock moves up (u) or down (d) in each step. 2. Calculate possible option values at each node (expiration). 3. Work backward to determine present value using risk-neutral probability. 📌 Advantages of Binomial Model ✔ Works for American options (allows early exercise) ✔ Can handle dividends and changing volatility When to Use? ✅ Best for American options ✅ Works well in volatile markets

35. Options Pricing Models Binomial Option Pricing Model 🌲 Comparison of Pricing Models Feature Black-Scholes Model Binomial Model Option Type European options American & European options Early Exercise? ❌ No ✅ Yes Market Conditions Stable, no dividends Can handle dividends & volatility Computation Complexity Simple formula Step-by-step calculations

36. Options Pricing Models Options pricing models help traders determine the fair value of an option based on various factors like stock price, volatility, time to expiration, and interest rates. The two most widely used models are: 1. Black-Scholes Model (BSM) – Best for European options. 2. Binomial Model – Best for American options (early exercise possible). Comparison of Pricing Models Feature Black-Scholes Model Binomial Model Option Type European options American & European options Early Exercise? No Yes Market Conditions Stable, no dividends Can handle dividends & volatility Computation Complexity Simple formula Step-by-step calculations

37. Chapter 9 – Introduction to Relative Strength SECTION 10 - COMPARATIVE MARKET ANALYSIS Presented By : This Content is Copyright Reserved Rights Copyright 2025@PTAIndia