U already know all about Options!
How much did you pay for 3-Idiots on first day?
How much will you pay for the next Himesh Reshammia movie on its first day?
On its 10th day?
That is all about Options!
You know it all!!
Still doubtful!
Ok, let me ask some questions.
Assume you are a Halwaii (Sweet maker).
Assume today is 13th March.
Also, assume that today's cost of one sack of sugar (1000 kg) is Rs.5150/-
How much booking premium will you pay for one sack of sugar which you intend to buy on the 25th
March ?
It all depends on whether you expect the price of sugar to go up or down in the next 12 days.
If you think the price is going to go up, you will be happy to pay the premium and lock the price today.
If your understanding is that the price is going to go down, why will you pay the premium?
Now, lets assume that you think the price is going to go up to Rs.5300/- per sack from the current price of Rs.5150/-, up by 150/-.
Will you pay Rs.150/- premium?
Why should you pay that much now when you expect the same price on 25th?
So, obviously you will pay lesser premium.
Would you pay Rs.50/- premium?
I think you will not mind that!
But, would you be surprised if I told you that the actual premium in the sugar market for 5300/- rate for sugar sack (25March) was just Rs.14/- !
Surprised!!!
Well, the reason is not difficult to understand.
While you think the price on 25th is likely to be 5300/- not everyone in the market shares your estimate.
There is a broad consensus of the bullish traders that the price will increase but not as much as 5300/-.
So, the average premium rate people are willing to pay is 14/-.
But assume there is a news after one hour that the Govt is working on a policy that will increase the cost of sugarcane, people will be willing to pay much more premium for 5300/-
And what if there is a news that Govt is considering to import 100 shiploads of sugar?
Well, I told you, you know it all.
Also, any ideas what premium will you be willing to pay to a gentleman who bought a sack sometimes in the past at 4800/- and wants to sell it on 25th Mar.
Would you be surprised if the actual market premium for that sack was 358 (5150-4800+Premium).
The premium of Rs.8 is close to the premium of 14/- being paid above.
Now you know,the premium depends on
- Expectations whether the price is going to go up or down
- How many people share your expectation
- The reality
The first two are highly influenced by sentiments, rumours, liquidity and perceptions.
The third is core fundamentals.
Now what premium will you pay for the first day first show of the next Amitabh movie?
Remember, 20 years ago people used to pay in gold for that chance!
What premium will you pay for meeting him in person?
(Also, replace "sugar" in the above discussion with "nifty")
Happy Options!!!
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