DAY 1: 25400% Surge in a Single Day! Why Are Option Prices So Volatile?

Hello， everyone!

Welcome to Tiger Academy - 「Options Academy Column」 first issue.

Are many friends interested in options that will doubt: Why are option returns so volatile?

Today I will solve this problem for you:

Taking SVB stock options as an example, on March 31, SVB stock price fell about 60%, while SVB's April 21 expired put option with an exercise price of $150, the daily rise was as high as 25,400%!

Data source:Tiger trade app

Data source:Tiger trade app

254 times a day, I believe that many people have demonstrated in their minds: if they seize this opportunity, they can achieve financial freedom with one month's salary!

However, before we eagerly invest in options, we need to figure out a problem first. Why are option returns so volatile? Many people think it is because of leverage (what we call margin trading), but in fact, it is not.

In general, there are two main situations where a financial product has high return volatility:

1.capital leverage

For example, if Tesla's current price is $100, but I only invest $10 of my own capital and borrow $90, raising a total of $100 to buy this stock. The next day, when the stock price rises to $110, without considering financing interest, my gain is $10 (110-100), while the investment amount is $10. Therefore, although the stock price increase is 10% (110/100-1), the rate of return is 100% (10/10).

So, capital leverage can amplify returns, but at the same time, financing also has costs. Just now, we did not consider the interest on borrowing $90. If we consider the interest, it will reduce the actual return.

2.Derivatives

Taking options as an example: If I buy Tesla stock directly, I need $100. But if there is such a call option contract: the buyer of the contract only needs to pay $1 to obtain the right: the next day he can exercise the option to buy Tesla stock at a price of $100 from the seller.

So, if the stock price rises to $101 the next day, the buyer will already break even: buy Tesla stock worth $101 at the price of $100, minus $1 option premium, neither gain nor loss.

If the stock price rises to $102, deducting $1 option premium, the net gain is $1. The option return is 100% (1/1), while the stock return is only 2% (2/100)

So on and so forth, if the stock price rises to $103, the option return is 200% and the stock return is 3%. If the stock price rises to $104, the option return is 300% and the stock return is 4%.

Therefore, with the same stock price fluctuation, the stock return is far less than the option return. Do you see the difference?

The root cause is the difference in investment amount. If you buy Tesla stock, you must spend $100, but if you buy Tesla stock call options, you only need $1.

Therefore, for the same $1 gain, the former has a return of only 1%, while the latter has a return of 100%. And if it is a loss, theoretically, the maximum loss for stocks can be $100, but for options, it is only $1.

That's why option return volatility is so high. Do you understand?

However, why are option premiums so cheap? In the above example: How was Tesla's $1 call option priced?

I will reveal the secret in the next issue. In addition, for tiger friends interested in option investment, here is a free Tiger Options Tour for you to learn.

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