# How Option Premiums Adjust With Market Volatility

One of the most frequently asked questions today is, what the best way to deal with market volatility? Although, high volatility should act as an opportunity for vanilla option traders, they are mostly challenged by the lack of understanding, how the option premiums are impacted with the change in the Implied Volatility.

In today’s article we shall break that jinx and discuss how retail traders can use option greeks to solve this challenge.

To begin with, let us
first understand the options delta (**Δ**). We
all know that, **Δ **captures
the rate of change of option price with respect to the price of the underlying
asset. In essence, **Δ** is
actually measuring the slope of the curve that connects the option price to the
underlying asset.

Take for example, you are standing at a bus stop with a speed gun and a bus whizzes past at 90KMPH. The speed gun will immediately tell you that the speed of the bus was 90KMPH. Now imagine you have boarded the bus. Now you use the same speed gun, and the bus is travelling at 90KMPH. The speed gun will tell you that the relative speed of the bus is zero. The question is why?

In the first case, you
were standing at the bus stop, therefore your speed was zero. So compared to
your speed, the bus was at 90KMPH. In the 2^{nd} case, since you are
inside the bus, your speed is also the same as the bus. Hence the speed gun
shows a relative speed of zero. Now imagine you start running inside the bus. What
you have just done is added a twist to this simple story. You’ve incorporated
Implied Volatility in this equation. Therefore, the speed gun will incorporate
the change in the magnitude of your velocity and adjust the relative speed accordingly.
That is exactly how the Delta of an option is correlated to the Implied
Volatility at any given time.

The options gamma (**Γ**) is also an important indicator. The **Γ **measures the rate of change of **Δ**. In our case,
we can imagine Gamma as the quantum of momentum generated depending on the
magnitude of our velocity inside the bus. This is what adds a twist to the options
story. If the **Γ **is** **small, **Δ** will readjust
slowly. However, if the absolute value of **Γ** is large, then the **Δ** drift is highly sensitive to the
price of the underlying. This is what, market makers measure, to gauge the
possibility of trend continuation or reversal.

Take for example, under normal
circumstances, when Nifty moves from 11250 to 11300, then, a specific Call option
premium must move from C to C1. However, during a high volatile scenario, when
market moves from 11250 to 11300, the same Call option premium jumps from C to
C2. The expansion or contraction of the spread between C1 and C2 decides
whether the market direction should continue or reverse. The reversal point
depends on coefficient of the curvature between the option price and the
underlying. Hence it is fair to conclude, that when IV rises or falls sharply,
it will impact the **Γ** curvature leading to an expansion or contraction
in the spread between C1 and C2. This in turn will offer a leading edge to
option traders in catching the zone of reversal or trend continuation.