Controversial Option Discussion Of The Day - Calls and Puts

[jackson8]

Hi Guys,

I have another topic for today,

Option trading is a zero sum game, if the market makers are making money, who's losing money ?

hi cutz
an article i have just read gives this definition to zero sum trading

Zero-sum Game
: A situation where one person's gains matches another person's losses.

Definition: Zero-sum games involve situations in which one person's gains are the result of another person's losses. No wealth is created (or destroyed) in these games.

Examples: Examples of zero-sum games include options and futures. If a person makes money on an options or future contract, it means the person who sold it to him lost money. Another example is gambling: either you or the house win.

What about the stock market? The stock market is not a zero-sum game because stocks are not simply investments traded from one party to another. Rather, they're representative of the underlying business. So if the business creates value, the stock will do so for the investor as well.

and a link to the article

http://www.stockjargon.com/dictionary/z/zerosum.html

 

[Grinder]

I remmember having a heated discussion about this with a guy in a bar last year. Can't remmember exactly what was said as too much grog was drunk but heres my take on it.

In theory it can be classified as a zero sum game or even negative sum game if you include fees, slippage etc but how I see it is from a practical perspective if I sold an option it does'nt mean whoever takes the other side will neccessarily lose. I might have the stock assigned to me which the buyer may have profited from making the buyer a winner but I might have sold the stock at a later date for a profit making me a winner also, thus we both win.

Even if it is a MM on the other end it still does'nt mean one of us has to lose. My intention might be different from what a MM is trying to acheive, thus there is no reason for us to be in competition with each other.

Let us all be winners

 

[wayneL]

Yep Yep & Yep

Options are two sided contracts, so if we ring fence options from all other considerations, they are unequivocally a zero sum game; actually a negative sum game as Grinder said (and I think that's what skyquake was trying to say).

But... options were designed as insurance products and should be considered alongside stock positions as appropriate.

Consider: Trader A buys a call to speculate with limited risk on the stock rising. The trader who wrote the call, Trader B, did so as part of a buy/write and also wants the stock to rise (or stay still dammit! )

If the stock duly rises, they both get what they want, they both win. Remember, going back to the start of the thread, a call is a put and a put is a call. By virtue of converting the short call into a synthetic short put (the covered call), both have positive deltas.

Hence it is possible for both to win.

The married put stock hedge is the same situation. In fact synthetically identical. This time a synthetic long call (the long stock + long put) and the natural short put. Both long deltas and both happy for the stock to rise strongly.

Zero sum? Yes AND No.

 

[wayneL]

The points earlier about the whole long or short vega/IV reminded me of a couple months ago as I think both of you have pointed out that its not a hard and fast rule. i think put i/v was much higher than call I/V some stocks that let me put on some nice sythetic time long positions. Pretty much financed all of the long call and in many cased collected a credit because of the skew.

I attached a chart for some discussion of 30 day I/V of puts and calls on the options on the VIX. Now offcourse with a floor of 0, we would naturally see the call I/V higher at lower VIX readings, but in a non scientific study(eyeballing the I/V call/put chart) there is some dicussion to be had about buying calls on the VIX when I/V is a) showing a big gap between, and b) when I/V is spiking.

Vice versa for when the puts are on top. When Puts reach a highest high in I/V buy puts.

Anyway, check out the chart and wouldn't mind some banter on the subject.

cheers

Derek

Derek

I thought there was something dodgy about that VIX IV chart... the disparities beteen put and call IVs.

Dean Mouscher has a great video on VIX options and deals with this phenomenon http://masteroptions.com/?p=82

For anyone ineterested in trading the VIX this is a MUST VIEW.

 

[Grinder]

ta for the link Wayne, DMOs explains it's well. I'm staying well away.

 

[wayneL]

ta for the link Wayne, DMOs explains it's well. I'm staying well away.

Well its like anything, as long as you know where the thorns are, it's possible to smell the roses.

I don't trade VIX, but will probably give it a go someday.

 

[Grinder]

I've got enough headaches with Cottles Hidden Reality, re-reading butterfly disection.

 

[mazzatelli]

Controversy

"Never trade unlimited risk positions. Only play with limited risk"

Reference is to short straddles/strangles, short puts/calls and ratio spreads.

 

[cutz]

Controversy

"Never trade unlimited risk positions. Only play with limited risk"

Reference is to short straddles/strangles, short puts/calls and ratio spreads.

**** yeah,

I used to play with unlimited risk (to zero) but an experience with MQG mid last September changed that, luckily the short sell ban caused the stock to gap up in a big way, i got out unscathed but the lesson is still etched in my mind.

As for ratio spreads I'm in two minds, i reckon they may be safe on index positions, should be able to exit in an orderly fashion, what do ya reckon.

Mazza it that still you, i've notice you've changed you name, nice pic BTW.

 

[mazzatelli]

cutz, it's still me

I found short backspreads difficult to hedge, especially when :fan. Memories of a short call ratio on IBM gives me the shudders.
Plus I am not keen on its [d]gamma structure.
Maybe the others can elaborate

I occasionally short naked [synthetic] straddles, but cover it later on.

Good to hear you survived MQG (I know you have a love relationship with it )

I guess the controversial point I am trying to raise is: can LR be more dangerous than UR?

 

[cutz]

I guess the controversial point I am trying to raise is: can LR be more dangerous than UR?

Ah,

I see the point your making.

LR can be dangerous if not played right, i guess a novice can take comfort in the fact that he's not losing more than his initial stake but theta will him alive eventually, well that's how i see it .

BTW, funny i should say that, last Friday i put on my first pure long gamma position, seems to contradict what i just said.

EDIT, LOL a long synthetic straddle of all things.

 

[mazzatelli]

The comparison I'm trying to convey [poorly ] e.g.

short 1x naked call [atm] vs. short 10x call spreads [otm]
Applying the original statement would favour the 10x short otm call spreads [LR]. Thus, still short gamma.
What are people's opinions?

Awesome!! this is the first time I have heard your purely long options!!
Nice time to be long vol though

 

[cutz]

Ah gotcha,

If i had to choose out of your two examples I'd go for the 1 by naked call, although i may get more credit for the bear call spread there's not much margin for error ( i.e. it expands to it's max loss fairly quickly ), at least with the naked call it is more probable that i can exit with a lesser loss.

(Have to admit i cheated with the above, ran it past hoadleys , nice lesson though.)

 

[mazzatelli]

You should compare the two with equal credit received.

But your right, I'd rather sell 1x atm than replicate the atm premium with wotm gamma.

When option deltas converge to 1, that y lot of otm premium is in trouble [where y > 1]. Upside curvature is a b*tch

 

[cutz]

Good to hear you survived MQG (I know you have a love relationship with it )

Actually a love/hate relationship, i keep getting my fingers burn't but i'm always going back for more.

Dunno what it is, some sort of magnetic allure.

 

[mazzatelli]

Actually a love/hate relationship, i keep getting my fingers burn't but i'm always going back for more.

Dunno what it is, some sort of magnetic allure.

Like a hot ex-gf with a bad personality. Nothing but trouble and you tend to lose money, while the gains are only satisfactory

I know how you feel brother...LOL jk

 

[wayneL]

You should compare the two with equal credit received.

But your right, I'd rather sell 1x atm than replicate the atm premium with wotm gamma.

In most cases, me too.

Adding to cutz's point, naked can be morphed into all sorts of positions, OTM credit spreads are very difficult to morph into something useful that you'd want.

On the other hand, it really depends on the instrument.

Naked call on some small miner? No sirree! No way! Index or commodity when I've worked out my stats and probabilities? Yes sir, thank you very much.

Actaully, I use a totally different reasoning and psychology with these two strategies. The situation I would use is completely different for each.

As such, I find the comparison incompatible... but a very useful talking point nontheless.

 

[Grinder]

From a pyschological perspective LR spreads provides that mental comfort thats reassuring, but as we know they can be more dangerous when put on with size. I just can't bring myself to go naked.

 

[mazzatelli]

Actaully, I use a totally different reasoning and psychology with these two strategies. The situation I would use is completely different for each.

As such, I find the comparison incompatible... but a very useful talking point nontheless.

I guess my point was to argue the myth that LR is always safer, not to use the comparison as a basis to pick UR over LR, so I agree with your last statement. Sharp as always

I remember back there was a blogger trading GOOG
Implied vol was ~ 70%
He could have shorted 1x atm straddle, but choose to short 20x IC's >1.5 sigma out. GOOG rallied and he lost much more than he would have with the naked combo due to the greater dgamma leverage in the IC [as Grinder points out].
Although the error was probably also related to the structure of the trade. He wanted to be short vol only, so choosing options that far otm was not optimal.

The leverage is the killer I guess .

 

[Tradesurfer]

Quote:
Originally Posted by Tradesurfer
The points earlier about the whole long or short vega/IV reminded me of a couple months ago as I think both of you have pointed out that its not a hard and fast rule. i think put i/v was much higher than call I/V some stocks that let me put on some nice sythetic time long positions. Pretty much financed all of the long call and in many cased collected a credit because of the skew.

I attached a chart for some discussion of 30 day I/V of puts and calls on the options on the VIX. Now offcourse with a floor of 0, we would naturally see the call I/V higher at lower VIX readings, but in a non scientific study(eyeballing the I/V call/put chart) there is some dicussion to be had about buying calls on the VIX when I/V is a) showing a big gap between, and b) when I/V is spiking.

Vice versa for when the puts are on top. When Puts reach a highest high in I/V buy puts.

Anyway, check out the chart and wouldn't mind some banter on the subject.

cheers

Derek


Derek

I thought there was something dodgy about that VIX IV chart... the disparities beteen put and call IVs.

Dean Mouscher has a great video on VIX options and deals with this phenomenon http://masteroptions.com/?p=82

For anyone ineterested in trading the VIX this is a MUST VIEW.
__________________
WayneL's Options Blog

Yeah, the trading platforms can be a challenge.I can probably get a better answer but with stock firms, they would have to pay for futures data feed, exchage fees etc. Also, they are set up to have one underlying symbol, not say an AUG VIX, Sep VIX etc, so a little data feed issue and a systems deal. VIX is a little odd in that its a listed option but is based on a future. Stock firms don't for instance offer calls and puts on Orange Juice futures. But anyway...

Since the underlying can be off (Cash vs Future)

For example the VIX cash is about 23, the future about 25 currently.

The Aug 25 put is showing IV at 9% and should be about 50%.

Aug 25 call showing IV at 131% and should be 95%

I think what I was really getting at though is deriving some trading signal off of the data.

There is still a seperation gap in the iv of puts vs calls. Mainly due to the reversion to the mean aspect of VIX. With it "lower" now, we would expect the market expectation to have a bias to the upside.

But looking at the graphs (albeit with IV's that are off), my on scientific theory is that when you have a wide seperation gap and a higher high by one of the sides (call it an IV spike)- once there is a lower high buy theoretically buy the option whose IV is higher.

I wasn't able to overlay a chart of near month VIX futures prices over that graph, but if I could we would see that the move was generally favorable for those holding the higher IV instrument.

anyway...thx for the discussion.

we'll save the "why are they showing theta values on VIX options on their pricing models" for another time