# What is the economic purpose of put and call options?



## Tysonboss1 (7 July 2011)

Does the options market have a real economic purpose, Is their a genuine need to have an options market attached to a sharemarket, does it create move stability or does it exist solely to act as a conduit for people to leverage up their speculative positions.

Don't get me wrong, I sell both put and call options regularly. I have a very conservative stratergy of selling out of the money Calls on stocks I own and are a little over priced and wouldn't mind selling at the strike and I sell Puts on stock i wouldn't mind buying if the hit the strike. 

But by selling the calls and puts am I generating any real benefits to the rest of the share market or economy as a whole, are the contracts i am writting doing any good for the wider society, Is the person buying my puts getting any real value other having a bet on.


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## wayneL (7 July 2011)

*Re: What is the economic purpose / of put and call options.*



Tysonboss1 said:


> Does the options market have a real economic purpose,




Yes, the transfer of risk similar to insurance



> Is their a genuine need to have an options market attached to a sharemarket,




Yes, see above.

As a purported property guru, you should be aware that call and put options are used extensively in the property development market. Exactly the same mechanics and exactly the same purpose, hedging and transference of risk.



> does it create move stability or does it exist solely to act as a conduit for people to leverage up their speculative positions.




Leverage of speculative positions, though widely used via options, is a poor use of the instrument IMO. IOW this is not the main purpose of options.

Again see above



> Don't get me wrong, I sell both put and call options regularly. I have a very conservative stratergy of selling out of the money Calls on stocks I own and are a little over priced and wouldn't mind selling at the strike and I sell Puts on stock i wouldn't mind buying if the hit the strike.
> 
> But by selling the calls and puts am I generating any real benefits to the rest of the share market or economy as a whole, are the contracts i am writting doing any good for the wider society, Is the person buying my puts getting any real value other having a bet on.




Who gives a rat's? Use them for your own purpose and if some muppet wants to take the other side, all the better.

Capitalism 101


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## Tysonboss1 (7 July 2011)

*Re: What is the economic purpose / of put and call options.*



wayneL said:


> Yes, the transfer of risk similar to insurance
> 
> As a purported property guru, you should be aware that call and put options are used extensively in the property development market. Exactly the same mechanics and exactly the same purpose, hedging and transference of risk.




I can see how options can be used as insurance, That is actually my preferred way of thinking about it that way I feel I am providing someone a real service by selling them an option . I can't help but think though that there are many more people insuring "Houses" they don't own rather than insuring their own property.

I again see how options can be used in property, for example westfield has bought 12 month options on peoples houses in the past when they were planning a shopping centre expansion, this is different to some one buying a call option on a stock, or maybe it's not.

I don't know, I guess I just want to feel like I am offering a real service.


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## mazzatelli (7 July 2011)

*Re: What is the economic purpose / of put and call options.*



Tysonboss1 said:


> But by selling the calls and puts am I generating any real benefits to the rest of the share market or economy as a whole, are the contracts i am writing doing any good for the wider society, Is the person buying my puts getting any real value other having a bet on.




We've been down this path numerous times before, just because someone has bought your calls doesn't mean they are gambling\losing. 

You're selling your calls and puts at less than fair value while the sell-side has completed the arbitrage (short synth\long natural). You don't care/know about this as your target is the strike price.

As wayne has already stated, but people always seem to miss it, no one who knows anything about derivatives are solely buying calls/puts for a speculative play. 

Options are used a lot for hedging. If you've ever worked professionally in interest rates, energy, fx and commodity space, then you'd be thankful options are around.

Didn't the golden boy sell SPX puts?


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## ROE (7 July 2011)

Give fund managers another way to be creative and keep a lot employ

Look at those protected share portfolio, how do you think they do it ?

Charge you crazy fees, they turn around buy puts on that portfolio


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## mazzatelli (7 July 2011)

ROE said:


> Give fund managers another way to be creative and keep a lot employ
> 
> Look at those protected share portfolio, how do you think they do it ?
> 
> Charge you crazy fees, they turn around buy puts on that portfolio




ASX equity option market is by no means representative of how these derivatives are used and the variety that is available.


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## Tysonboss1 (7 July 2011)

*Re: What is the economic purpose / of put and call options.*



mazzatelli said:


> Didn't the golden boy sell SPX puts?




who is the golden boy


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## pixel (7 July 2011)

Sure - all the idealistic examples you've all provided may be sufficient raisons d'Ãªtre for options. However, from a decade of collating and analysing distribution of Open Interest around expiry time, I can most definitely say *options are an effective means to manipulate* entire markets.

And I'm not only referring to those really obvious machinations of a Solomon Lew, who years ago used an extraordinary number of Coles-Myer options to state a point. It's noteworthy that time and again the share price of a mother stock will "magically drift" to within a hair's width either side of the strike price that denies the greatest number of holders the right to exercise. Or it may lure the holders to exercise for the sake of a cent - and within days, the share has "magically" resumed a position at the other side of that strike price.

As an example, look at this chart, showing the distribution of ANZ options expiring on 27/01/2011. The Closing price ended between the highest strike with an excess of Puts ($23.50) and the lowest strike with excessive Calls ($24.00). That resulted in writers of Calls not having to sell their shares for $24 or more. Now check what ANZ's share price did immediately after the 27th: Correct! It rose, having been held back for about a week before snapping higher to $26.





So, the cynic in me remains convinced that it's one more tool to separate suckers from their shares or dough - usually both. If buying a Put option is likened to paying an  insurance premium against the price dropping, then what we're observing is: The company that sold you the Put (insurance) and makes sure the share closes a cent above the strike, is akin to an insurer, who makes certain your property stays dry, but opens the floodgate the day after your policy expires.


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## mazzatelli (7 July 2011)

pixel said:


> However, from a decade of collating and analysing distribution of Open Interest around expiry time, I can most definitely say *options are an effective means to manipulate* entire markets.




In that ten years of analysis, you've never heard of strike pinning and dynamic hedging?


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## tothemax6 (8 July 2011)

*Re: What is the economic purpose / of put and call options.*



Tysonboss1 said:


> I don't know, I guess I just want to feel like I am offering a real service.



Someone wants to buy an option, and you sell it to him. That's all the service he wanted, and all you have given .


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## village idiot (8 July 2011)

not sure about the point of the ANZ example as far as conspiracy theories.

 a glance at ANZ reveals that its average price during the 2 months before expiry was around  $23.27, so ending up at 23.58 is hardly an outlier. Where would you expect it to end up?

since it spent most of the previous two months around that level, it is a given that there will be excess calls slightly above and puts slightly below. That ANZ remains somehwere between those two strikes on a given day is such bog standard behaviour it would only be noteworthy if it had moved significantly into that area just before expiry and then moved away again just afterwards

It is not exactly pinned either, unless you are going to count at least 32% of possible outcomes as pinned

There may well be examples of markets being manipulated to suit open option positions (rather than options manipulating the market), but this isnt one of them.


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## cutz (8 July 2011)

*Re: What is the economic purpose / of put and call options.*



Tysonboss1 said:


> I don't know, I guess I just want to feel like I am offering a real service.




Welcome back Tysonboss,

We have actually been through this before but it's the other way round, the professionals are providing you (and me) liquidity for a fee.

I think the golden boy mazza may be referring to was an acquaintance of N.T. who blew up an equity fund selling OTM puts but i'm sure he will correct me if i'm wrong


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## wayneL (8 July 2011)

mazzatelli said:


> In that ten years of analysis, you've never heard of strike pinning and dynamic hedging?




Mazza would have a better idea about this than me, but I don't believe there is any conspiracy in the max pain (pinning to the strike with most open positions) phenomenon.

According to one ex options market maker, this is merely a by-product of the delta hedging of their book AKA dynamic hedging.

IME, max pain is just as likely to NOT happen as happen and in my trading I can safely ignore the purported max pain level.

Just my thoughts and stand to be corrected.


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## sails (8 July 2011)

I agree Wayne.  I  have studied it, collected data and calculated all sorts of different formulations to see if there was any consistency, but found it to be too unreliable to trade on it's own.


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## village idiot (8 July 2011)

I am a bit confused by the dynamic hedging theory.

dynamic hedging a long premium position would tend to 'pin' it near a strike, (since price moving above a  strike would require selling stock to remain delta neutral and vice versa). 

But conversely, delta hedging a short premium position would have the opposite effect ie price moving up would require buying stock to remain dn.

for a stock to be pinned as a result of dynamic hedging therefore implies that the market makers and professionals would have to be heavily net long options in the run up to expiry, which i find unlikely. if anything they are more likely to be net short which should have the opposite effect ??


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## wayneL (8 July 2011)

village idiot said:


> I am a bit confused by the dynamic hedging theory.
> 
> dynamic hedging a long premium position would tend to 'pin' it near a strike, (since price moving above a  strike would require selling stock to remain delta neutral and vice versa).
> 
> ...




Spec longs are more likely to be OTM (at inception at least), whereas there is a lot of retail selling ATM (CCs etc), ergo much long gamma ATM.

Again stand to be corrected.


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## mazzatelli (8 July 2011)

Tysonboss1 said:


> who is the golden boy



This is all you got from the post? lol



cutz said:


> I think the golden boy mazza



I'm such a narcissist, this is how I read it - just joking



village idiot said:


> But conversely, delta hedging a short premium position would have the opposite effect ie price moving up would require buying stock to remain dn.



 What about ATM combos atm - i.e. short straddle? Where are they pushing that? How would they dynamically hedge that?


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## village idiot (8 July 2011)

mazzatelli said:


> What about ATM combos atm - i.e. short straddle? Where are they pushing that? How would they dynamically hedge that?





not sure I understand the question mazza?


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## mazzatelli (8 July 2011)

village idiot said:


> not sure I understand the question mazza?




hey vi, if I read that last bit of the post correctly - insto's and MM are likely to be net short so unlikely for pinning because of dynamic hedging?

Originally edited my post because I was going to discuss about some funds that build trading [algos] around the expiration dates and other players re-balancing. Basically some are conceptually short the atm straddle on expiration [as part of vol arb engine] - in this case, they would like the atm strike pinned.

But heed what wayne and sails have said. Conspiracy theories everywhere - its not always retail on the opposite side of insto's/MM/funds.

The only place I've seen blatant manipulation is with dealer markets involving barrier ops.

As to providing an economic purpose using options - those loans that Tysonboss takes out to invest in his properties - I wonder how the interest rate risk is managed by the provider to enable them to provide the loan?


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## Tysonboss1 (9 July 2011)

mazzatelli said:


> This is all you got from the post? lol




Ahhh, no. 

Thats just the only question I had. The rest was clear.


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## Tysonboss1 (9 July 2011)

mazzatelli said:


> those loans that Tysonboss takes out to invest in his properties - I wonder how the interest rate risk is managed by the provider to enable them to provide the loan?




I heard an interesting fact today, During the GFC $2 Trillion worth of credit default swaps purchased were purchased over and above the actuall debt they were insuring, 

Thats like having 5 houses on an island, but having 10 hurricane insurance policies bought.

The analyst talking said alot of the credit default swaps that caused aig to flounder were not even held by people that owned the debt and needed to insure it in the first place.

As I said no judgement here, just trying to understand how it all works, and where I fit in.


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## cutz (9 July 2011)

Tysonboss1 said:


> Thats like having 5 houses on an island, but having 10 hurricane insurance policies bought.




That's like owning no stock but loading up on WOTM long index puts.


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## village idiot (9 July 2011)

mazzatelli said:


> hey vi, if I read that last bit of the post correctly - insto's and MM are likely to be net short so unlikely for pinning because of dynamic hedging?
> 
> Originally edited my post because I was going to discuss about some funds that build trading [algos] around the expiration dates and other players re-balancing. Basically some are conceptually short the atm straddle on expiration [as part of vol arb engine] - in this case, they would like the atm strike pinned.




mazza, just to clear up what i meant;

1) yes, i was suggesting the MM and institutions would be more likely to be net short, which you seem to be somehat agreeing with? Indeed an effective short straddle was what i was thinking of re the delta hedging

2) I can obviously see why they would *like* it pinned to the ATM strike,but...

3) delta hedging a short straddle would tend to help push the price away from the strike, not towards it, so..

4) therefore *if* the big boys are net short and *if* there is some tendancy for the price to be pinned, it wouldnt be because of delta hedging .

I am not stating this as a fact, more as an "I dont understand this logic", so happy to be educated as usual......


but i am certainly not on the side of the conspiricy theorists; as stated in post  11 , I dont see anything suggesting manipulation here


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## mazzatelli (10 July 2011)

village idiot said:


> mazza, just to clear up what i meant;
> 
> 1) yes, i was suggesting the MM and institutions would be more likely to  be net short, which you seem to be somehat agreeing with? Indeed an  effective short straddle was what i was thinking of re the delta hedging
> 
> ...




Ah my apologies, I've discussed desirability for pinning instead  effect of dynamic hedging on pinning. Yes, you're correct - delta  hedging net long ops, will more likely result in pinning.

The  example I gave, its part of an expiry correlation arb, while short vol  in say indexes, they are long vol in the index components - so not  exactly short premium bias if their net position is considered. In this  case you'd might see some effects of pinning in the long vol components  [topical on strike and size], but not index (as far as I understand they  do not dynamically hedge this side of the arb).

So you can see  its difficult to discern the inventory and generally categorize who is  net long/short- but as Wayne has outlined retailers and funds are  in CC's (sell-side long), but there's put buyers (sell-side short) as  well as vol/skew-arb funds (sell-side could be net long) etc.


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## mazzatelli (10 July 2011)

Tysonboss1 said:


> I heard an interesting fact today, During the  GFC $2 Trillion worth of credit default swaps purchased were purchased  over and above the actual debt they were insuring,
> 
> Thats like having 5 houses on an island, but having 10 hurricane insurance policies bought.
> 
> ...




Well: 
1)  swaps don't have they same payoff/convexity as options - so is this  thread becoming a "What is the economic purpose of derivatives?" thread?

2)  I initially outlined interest rate risk, whereas CDS is meant for  credit/default risk - so I'm inferring interest rate options, swaptions  to manage this mismatch in providing you a long term loan, while their  funds come from short term sources.

3) Yes, there was speculation  going on with CDS - scenario you're outlining is naked CDS's. imo its  the use and regulations around CDS's (OTC, disclosure) that is/was the  problem rather than the derivative structure itself. There's also the  issue of them being priced with little risk of default (used with mbs) -  no one thought the housing market would decline. It's like pricing  options today with a flat vol skew. 

4) E.g in the energy space  hedging solutions solutions are custom designed for producers and  consumers of e.g.  oil and natural gas - taking into account their risk profile and  production/consumption schedule  (logistics->refining->distribution).

You're part in all  this? It would be minor. I am not saying there isn't speculation using  derivatives, but selling equity calls/puts is so basic and minuscule  compared to use of derivatives in the much larger interest rate and  energy markets.


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## village idiot (11 July 2011)

mazzatelli said:


> Ah my apologies, I've discussed desirability for pinning instead  effect of dynamic hedging on pinning. Yes, you're correct - delta  hedging net long ops, will more likely result in pinning.
> 
> The  example I gave, its part of an expiry correlation arb, while short vol  in say indexes, they are long vol in the index components - so not  exactly short premium bias if their net position is considered. In this  case you'd might see some effects of pinning in the long vol components  [topical on strike and size], but not index (as far as I understand they  do not dynamically hedge this side of the arb).
> 
> So you can see  its difficult to discern the inventory and generally categorize who is  net long/short- but as Wayne has outlined retailers and funds are  in CC's (sell-side long), but there's put buyers (sell-side short) as  well as vol/skew-arb funds (sell-side could be net long) etc.




Ok, that makes some sense, thanks. another piece of the jigsaw....


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