Analyzing option strategies is always recommended to do before you actually place the option trade so that you can check how worthy it might be.
Analyzing Option Strategies Using Risk Graph Profiles
To analyze option strategies you can create a risk graph profile right on your computer screen by using an option calculator. You should get an option calculator as part of your trading platform when you sign up with an online broker.
To create a risk graph profile, all you have to do is select all the individual options that make up your option strategy by using an option chain (a listing of call and put options having different strike prices and expiration dates) and then simply click on “risk profile” or “profit and loss calculator” or something similar in order to create the risk graph profile.
And, since option strategies are created by combining different types of individual options, with each having their own set of option greeks (delta, gamma, theta, vega and rho), the option calculator will net all the individual option greeks together.
This is important since some option strategies (like non-directional option trading strategies) are closely monitored on a netted basis and adjustments are made to them when some of the netted option greeks get out of balance during the trade. For instance, in delta neutral option trading, your overall netted delta should be zero (or close to). As delta moves away from being at zero during the trade, adjustments are then made to the trade to bring the delta back to zero (or close to).
Risk Profiles Of Option Strategies
Creating a risk profile of your option strategy will allow you to analyze important aspects of it including:
- A Visual Graphical Representation of the Option Strategy
- Net Cost Outlay or Net Proceeds Received of Doing the Option Strategy
- Profit and Loss Zones
- Break-Even Points
- Theoretical Impact of Time Decay (Theta)
- Theoretical Impact of Changes in Implied Volatility (IV)
- Netting of all the Individual Option “Greeks”
Once you have created a risk profile of your option strategy, it will then help you to decide if whether (or not) the strategy is worthwhile doing as to your expectations. If it’s not, then you can always modify the strategy to make it worthwhile or you can just build a new option strategy from scratch all together.
After doing risk profiles on option strategies for awhile and getting use to how they are created and calculated, you will be able to mentally do risk graphs in your head for some of the more basic option strategies.
“What-if” Scenarios
You can even do “what-if” scenarios to your option strategy and see the resulting effects that it has on it when changing any one of the following elements:
- Price Movements of the Underlying Financial Instrumental
- Strike Prices
- Time to Expiration
- Implied Volatility
- Swapping Out Different Options to the Strategy
Doing what-if scenarios to your option strategy will allow you to immediately gauge whether or not making such changes would be worthwhile.
