Options Mentoring

[sails]

Hi Guys,

I sold 5 covered call contracts for WDC with a strike of $13.50 for 16c / share.

WDC traded well over $13.50 today but closed at $13.51.

Do you think the options would have been exercised, and if they were how and when will I find out.

Yes, highly probable, but not a certainty!

You will know in the morning - how you find out will depend on your broker - some send an email or notification of the sale of your shares. If nothing from your broker, check your account in the morning to see if your shares are no longer in your account. Hopefully you have a fee friendly broker...

And, if unsure about the process, contact your broker.

 

[cutz]

Hi Guys,

I sold 5 covered call contracts for WDC with a strike of $13.50 for 16c / share.

WDC traded well over $13.50 today but closed at $13.51.

Do you think the options would have been exercised, and if they were how and when will I find out.

Hi Tysonboss1,

Looks like you got out of that one unscathed, well done.

 

[sails]

Sounds like you did OK with that one, Tysonboss1.

Also, my apologies for not reading your question properly - I simply assumed you were 1c ITM when I said it was highly probable - when your calls were actually 1c OTM. My mistake...

 

[Fox]

Can I ask for help with interpreting this screen shot?

1. Is this commonly referred to as volatility "smirk" as opposed to a "smile"?
2. Why does this happen?
3. Could this mean that the market believes that the spot will be falling and therefore the lower strikes are in demand? Thus causing IV of lower strikes to go up?

Thanks.

 

[mazzatelli]

Smile infers higher vol for both upper and lower strikes in reference to atm vols.

Various reasons but common themes in equity/index markets:
1) demand for portfolio hedging
2) stock returns exhibit kurtosis and skewness. Strike skew is to adjust for assumptions of [log]normal densities and constant vol in pricing
3) Dealers/makers hedging to protect short puts

 

[wayneL]

Smile infers higher vol for both upper and lower strikes in reference to atm vols.

Various reasons but common themes in equity/index markets:
1) demand for portfolio hedging
2) stock returns exhibit kurtosis and skewness. Strike skew is to adjust for assumptions of [log]normal densities and constant vol in pricing
3) Dealers/makers hedging to protect short puts

IMO (and it is opinion) 2) is the overriding factor in this Fox. A 5% (or whatever) down day is far more likely than a 5% up day. The option pricing model does not know how to account for this this, so MM's crank up IVs a bit to reflect the risk.

If you have a look at event sensitive commodity vols (gold oil, coffee etc), the skew is often to the upside.

 

[Fox]

2) stock returns exhibit kurtosis and skewness. Strike skew is to adjust for assumptions of [log]normal densities and constant vol in pricing

Thanks Mazz/Wayne. I learnt so much from this one line Mazz wrote. Took a bit of googling and Natenberg, but I got there.

I had not noticed or known about this before. I had a quick look at BHP and NWS. As per your statement, they both exhibited the same strike skew as well. I must adjust my modeller to handle this.

I've always heard about the volatility smile. As such, I assumed that ITM and OTM strikes will have higher IV's. I did not realise that the smile applied to WITM and WOTM strikes only. Thank you.

 

[cutz]

Hi Fox,

FWIW forget about what i said about SPI futures being too big to use, depending on how big XJO positions you have on you can get back to within ~ +/-1 delta then fine tune with options if you so desire.

I'm still coming to grips on this concept myself, don't seem to have the luxury of massive time decay to mask deficiencies in technique these days.

It's seems like the experienced guys dynamic delta hedge awaiting big moves as opposed to getting rid of negative theta which was the impression i was under.

Any comments on this ?

 

[Fox]

It's seems like the experienced guys dynamic delta hedge awaiting big moves as opposed to getting rid of negative theta which was the impression i was under.

Any comments on this ?

From where I'm standing, it appears to me that "dynamic delta hedge awaiting big moves" and "getting rid of negative theta" mean the same thing ie. they don't contradict each other.

Just to make sure we are on the same page, let's use the example a long straddle which can be described as such:

• The underlying is at $50.
• We buy a $50 call and buy a $50 put.
• Theta is most negative when the underlying is at $50.
• The straddle is profitable if the underlying moves rapidly above $70 or falls below $30.
• Theta is around $30 per day and increasing by the day.

1.The "dynamic delta hedge awaiting big moves" interpretation
As long as the underlying hovers around $50, we dynamic delta hedge by shorting shares when the price goes above $50, and buying shares when the price drops below $50. This is also known as gamma scalping. We profit from every scalp. Theta still remains around $30 per day after each scalp ie. theta is independent of each scalp.

2.The "getting rid of negative theta" interpretation
As long as the underlying hovers around $50, theta will increase each passing day. The profit we collect from scalping will help offset the amount we lose due to the effects of theta. Eg. if theta is -$30 per day, and our scalping profit is $30, then we got rid of negative theta for that day.

3.The "awaiting big moves" interpretation
If the underlying moves to $70, then we can exit profitably. If we choose to exit the game, we sell both put and call options. If we want to have some more fun, we morph our position into a $70 put and a $70 call. This way, we are delta neutral again and face a new round battling negative theta.

It's hard to communicate effectively via a forum, but interpretation (1) and interpretation (2) mean the same thing to me. Does the above scenario portray your question correctly?

 

[Hyperion]

Hi all,

I was wondering if anyone could recommend some websites which explain the black scholes option pricing model with reasonable depth.

Thanks

Hyperion

 

[mazzatelli]

I was wondering if anyone could recommend some websites which explain the black scholes option pricing model with reasonable depth.

For explanation of underlying intuition
If you actually want to learn derivation [stochastic calculus involved], which can help explain BSM, I'd look at Hull's book.

 

[cutz]

Thanks Fox,

I see what your getting at, in my case i need to gamma scalp if the index starts heading down and my funny wrangle starts picking up deltas, something that's pretty pronounced in the final week, not so obvious at first because the delta curve is quite flat with heaps of time remaining.

Actually mazza pointed this out some time ago when we were talking backspreads.

Fingers crossed we see some action tonight.

 

[Fox]

IIRC, Black Scholes et al underestimates risk of American options close to expiry so MMs compensate by jacking prices a bit. Not 100% sure on this point, but I recall a discussion on it from somewhere.

Natenberg Chapter 18, Page 398, paragraph 2 discusses this very point and agrees with the view that the models undervalue ATM options as expiration approaches.

 

[Hend0]

Hi All,
First post I guess - just picked up McMillans Options as a Strategic Investment - and my, what a book it is! You could do some serious damage to someone with it hehe
I'm sure over time I will have many a question. Getting ready to make my first trades - and as all say, the more education you have, the better your chances for success

I'm sure I'll have some questions along the way as this is an excellent thread.

Cheers,
H

ps
Natenburg next? Here
Or Cottles Shoulda, woulda coulda? Here

 

[cutz]

ps
Natenburg next?
Or Cottles Shoulda, woulda coulda?

Hi Hend0,

Get both of them, 2 good reads from two different angles.

I especially enjoy reading Cottle's insights from the trading floor.

 

[wayneL]

Hi All,
First post I guess - just picked up McMillans Options as a Strategic Investment - and my, what a book it is! You could do some serious damage to someone with it hehe
I'm sure over time I will have many a question. Getting ready to make my first trades - and as all say, the more education you have, the better your chances for success

I'm sure I'll have some questions along the way as this is an excellent thread.

Cheers,
H

ps
Natenburg next? Here
Or Cottles Shoulda, woulda coulda? Here

Hi Henda

Always nice to have new inmates at the asylum McMillan sure can defend life and property if necessary.

I Agree with Cutz, get both.

I reckon this a better place to buy Natenberg however.

 

[Fox]

In general terms, can it be said that IV rises before company earnings report and IV falls subsequent to that? I would be interested to know if this is the case from you personal observations or from studies conducted. In the meantime, I look at the top few Oz companies during the last cycle and I'll report my findings here.

 

[Fox]

CBA, TLS and BHP IVs around earnings report date is shown below. Drops in IV for CBA and TLS are significant.

 

[wayneL]

In general terms, can it be said that IV rises before company earnings report and IV falls subsequent to that? I would be interested to know if this is the case from you personal observations or from studies conducted. In the meantime, I look at the top few Oz companies during the last cycle and I'll report my findings here.

As a general rule of thumb ====>>> YES!

But as with anything in the real world, not necessarily. LOL

It boils down the the question of whether traders expect the ER to move the stock and to what magnitude.

Here's GOOG, guess where the earnings are :

 

[Fox]

Here's GOOG, guess where the earnings are :

Wow! You can devise a calender by observing GOOG IV spikes. I was recently teaching my kids how they can tell time using cycles of the moon and the sun. I'll need to add ER to that list. I smell strategies to exploit this. Thanks for the info Wayne.