Options Mentoring

[Magdoran]

Key Option Concepts: DELTA

This might simplify some of the concepts above:


Delta: The rate an option will change in value in proportion with the underlying.

• Calls have positive delta – expressed from +1 to 100 (% to underlying movement)
• Puts have negative delta – expressed from -1 to100 (% to underlying movement)
• At the Money options typically have a +/- delta of 50
• Way out of the money options have low deltas
• Deep in the money options have high deltas.

Increased volatility – call deltas move towards +50 and puts towards -50
As time passes – call deltas move away from +50 and puts away from -50


Hope this helps


Magdoran
P.S. Based on Sheldon Natenberg "Option Volatility and Pricing"

 

[Magdoran]

Key Option Concepts: GAMMA

This might simplify some of the concepts above:


Gamma: The rate an option’s delta changes as the underlying price changes.

• Gamma is expressed as +/- delta points gained/lost when the underlying rises/falls
• Calls and puts must have positive gamma.
• Gamma of an ATM option can increase dramatically as time moves closer to expiry, or volatility decreases (or both).

As time to expiration is increased and/or volatility is increased, options tend to become more ATM, with call/put deltas approaching +50/-50.

As time to expiration is decreased and/or volatility is decreased, option call/put deltas tend to move away from +50/-50.

An option which is ITM will tend to move further ITM, and an OTM option will tend to move further OTM. ATM options with deltas near 50 tend to maintain delta despite time and volatility.

ATM in this case assumes the option most likely to end near the actual underlying price at expiration, and assigns a value of around +/- 50 to it.



Hope this helps


Magdoran
P.S. Based on Sheldon Natenberg "Option Volatility and Pricing"

 

[wayneL]

Hello Wayne,


I’m pleased to see the great job you are doing with options. You’ve come a long way indeed from when we chatted on the SG site a few years ago about options, well done!

So, are you trading options in the US mainly, or Australia, or both? I also note you made some comments on silver on another thread, are you trading options on futures too?

Hi Magdoran,

Welcome to ASF, your contributions will be a bonus for members here

I am trading exclusively US options, and moving steadily over to futures options (as well as straight futures). Though will always try to have a hand in the stock market till.

There are several features of futures options that I am enjoying a lot, not the least of which is margin requirements. SPAN rocks.

I’m curious about what kind of strategies you’re into these days too... like are you doing any ratio positions, perhaps with mixed strikes and mixed expiry dates?

I'll put on any and every strategy. First point of analysis is IV/SV, then market view, various black swan scenarios and go from there. I'll lean towards the simplest strategy that will get the job done initially, and will leg in to more complex stuff if required for defence & or optimizing. This may include ratios mixed strikes/expiries etc.[/QUOTE]

Pretty amazing what you can do, isn’t it?

Indeed. I've ended up with some pretty creative positions from time to time. I've been an active campaigner for folks thinking beyond what some of the more asinine seminar presenters teach as "magic moo cows" and similar silliness (all fine strategies in their rightfull place, but not the traders panacea as presented)

Anyway, I hope you don’t mind me posting a few observations and slightly alternative viewpoints on your thread for general interest.

Fire away!! This game is so multifaceted that there is ALWAYS an alternative viewpoint. Re-reading through this thread, I also have alternative viewpoints to myself! LOL

Open discussion on options is "class A" learning IMO.

Folks,

Mag' knows his stuff, so listen up.

Cheers

 

[Magdoran]

US Market Vs Australian Market


I’d like to give a slightly different perspective on the appraisal earlier on the thread.

A lot depends on your trading style and preferences. Yes the US market is more liquid, but there is a subtle reason for this other than just more volume being traded per se.

What a lot of new options traders fail to grasp at first is the difference in gradation of the strikes. The US stock option gradation of strikes is either at $2.50 or $5.00 increments, while in Australia it is at $0.25 or $0.50. This is why each strike has potentially more open interest there because the range of choices is very limited.

So why is this important you may ask? Well, when selecting precise options based on a price and time objective, the risk and reward parameters become very different when you can select a strike which is likely to finish in the money at expiry as opposed to out of the money. This can mean a great deal of difference in risk/reward (a US return for a similar stock move could be say around 50% - 150% where in Australia depending on a range of variables you may make the same, or well in excess of this range – perhaps as high as a 500% return for a similar percentage move in the underlying).

Another factor is that the option value increments for US stock options is set at 0.05 (5 cents) as opposed to (half cent) 0.005 gradations for Australia (that’s 10 times as fine – this is significant to many positions, especially if you want to exit a loser).

Also, the volatile movement in the US can see the underlying jump past your preset contingent orders, and unless you trade all night (or get up early to adjust in the morning before 6.00 AM during winter), you can wake up the next day to a huge loss. Using market orders for contingent sell orders is probably the only way to ensure you get a fill, but at the real risk of getting a paltry sum for your position on stoploss contingent orders – especially vulnerable to intraday spikes.

The main problem in Australia is that there is the lower open interest, and problems with getting set in stocks designated “flex” (where the market maker doesn’t have to provide a market, and only had to show a market for a reduced period at their discretion). You can trade these markets, but the spread is often going to favour the market maker more, hence you’re looking for a high probability trade with sufficient risk reward parameters to justify the spread risk undertaken).

From my experience, you have to keep a good armoury of strategies and tactics to select the right approach for each market. It is important to be aware of these key differences when trading either market.

Hope this is of interest.


Regards


Magdoran

 

[Magdoran]

Hello Wayne,


Thanks for the welcome, and gratifying to see how much you’ve expanded your capabilities. Futures are an interesting arena, one I more watch than trade currently. I also moved more to the Australian market since I found my performance was better than in the US (I like my sleep – and try not to overtrade). How are you finding the US market at the moment?

I’ve been doing a lot of work recently on hedging strategies combining options and futures (options on futures perhaps more precisely), but it’s pretty involved when you’re trying to work out a range of instruments to work in concert – still getting my head around how to automate this more. So I share your enthusiasm for the breadth of opportunities, the things you can do are almost endless, aren’t’ they?

Nice to hear you are progressing well. Over some time now, I’ve found that sometimes it’s better to keep things simple and not get bogged down in complexity… simple bullish strategies like bull puts when volatility is high combined with longer dated OTM calls and then selling current month calls a strike or two towards the money works well in a bullish market. The danger being that the sold call may end up in the money at expiry, so have to manage these carefully.

The key is, “does it work in reality?”, isn’t it? As T.S. Elliott said “between the theory and the practice falls the shadow”.

Thanks for the salutation too, much appreciated.


Regards


Magdoran

 

[wayneL]

US Market Vs Australian Market

What a lot of new options traders fail to grasp at first is the difference in gradation of the strikes. The US stock option gradation of strikes is either at $2.50 or $5.00 increments, while in Australia it is at $0.25 or $0.50. This is why each strike has potentially more open interest there because the range of choices is very limited.

This is a good point Mag' and this can adversely affect the flexibility of what you can achieve in the lower priced stocks. Anything below say $15 is generally a waste of effort.

However:

1/ Many US stocks are much higher priced, making those $2.50 - $5.00 (and sometimes $10.00) intervals relatively closer together (in % terms) . Consequently, I look for stock prices with a bare minimum of $20, and generally much higher. This alleviates this interval problem to a large extent.

Also there are the Index tracking ETFs such as SPY DIA IWM and QQQQ, all of which have strike intervals of $1.00. This make these quite sweet contracts to trade. ( there are also true index options as well, SPX OEX NDX etc)

In addition, futures option intervals are much more reasonably spaced. Another reason of my growing fondness for them.

2/ There is vastly more choice of optionable stocks to trade. If the interval is proving to be adverse to your intentions for the trade (and this does happen frequently enough), just move on to something else.

Another factor is that the option value increments for US stock options is set at 0.05 (5 cents) as opposed to (half cent) 0.005 gradations for Australia (that’s 10 times as fine – this is significant to many positions, especially if you want to exit a loser).

My comment regarding this largely reflect my comments on interval. It definately can be a disadvantageous factor, particularly in lower priced shares and WOTM options.

However there is some talk of moving on to 1c value increments. The exchanges are not keen on the idea, but I strongly feel this will happen at some point in the not-too-distant future. This will be a huge improvement when it happens.

**

As always, horses for courses and folks can certainly do well from the OZ options market. On balance though, I personally much prefer trading options in the Evil Empire. Mag' oobviously prefers the ASX. Both have advantages and disadvantages. In the end it may come back to style of trading as to which market is more suitable for an individual.

Cheers

 

[wayneL]

Hello Wayne,


Thanks for the welcome, and gratifying to see how much you’ve expanded your capabilities. Futures are an interesting arena, one I more watch than trade currently. I also moved more to the Australian market since I found my performance was better than in the US (I like my sleep – and try not to overtrade). How are you finding the US market at the moment?

I’ve been doing a lot of work recently on hedging strategies combining options and futures (options on futures perhaps more precisely), but it’s pretty involved when you’re trying to work out a range of instruments to work in concert – still getting my head around how to automate this more. So I share your enthusiasm for the breadth of opportunities, the things you can do are almost endless, aren’t’ they?

Nice to hear you are progressing well. Over some time now, I’ve found that sometimes it’s better to keep things simple and not get bogged down in complexity… simple bullish strategies like bull puts when volatility is high combined with longer dated OTM calls and then selling current month calls a strike or two towards the money works well in a bullish market. The danger being that the sold call may end up in the money at expiry, so have to manage these carefully.

The key is, “does it work in reality?”, isn’t it? As T.S. Elliott said “between the theory and the practice falls the shadow”.

Thanks for the salutation too, much appreciated.


Regards


Magdoran

One thing I've noticed with professional/successful options players is the vast diversity in the ways in which money can be extracted from the market.

As you know, there are currently 4 greeks that can be traded either with an independant view or in combination with each other (excluding only Rho in this currently stable interest rate environmnt. That could change though)

This makes for a bewildering array of long, short, and neutral combinations of greek positions that can be exploited.

It's like 3d chess and a lot of fun to learn, grasp and implement.

...and the learning never stops.

Cheers

 

[Magdoran]

Hi Wayne,


All the points you make are valid. You are quite right, it is horses for courses, very much so, and I respect each trader has their own path to walk, couldn’t agree more. That’s the beauty of these instruments – the ability to express each individual’s strengths (and perhaps weaknesses).

The US has vastly more optionable stocks, quite true, and the index and futures options are certainly better graded than the stocks. Fully agree here (I was referring to stocks – no argument about indexes and futures). The problem I do have with the indexes is that it is hard to get a good spread trade based on a range of factors – you rarely see a skew in the strikes for the indexes for instance, which limits opportunities other than to trade straight option positions.

Where the gradations in strikes have an impact is when you compare Australian stocks that are around or above $20 (e.g. COH, MBL, CBA, WPL, RIO) compared to similarly priced US stocks, the potential reward for a similar percentage move in each underlying is different given you can precisely choose a mildly OTM option which moves into the money before your time exit, gaining significantly in raw percentage returns (say 500% as opposed to say %150). Makes a big difference to your bottom line when the market is trending nicely.

The difference also in value gradations can shave value off your entries and exits since you can’t move more finely, and I would argue that this adds up (in the market makers favour). It would be great if the US exchanges embraced a 1 cent standard!

This assumes that the US $5.00 increment strike has a lower probability of moving into the money, and of course the delta on an Australian option that moves into the money (ITM) appreciates significantly as the underlying moves further into the money, hence the major difference in both the potential for significant rewards as well as the probability of success, wouldn’t you agree?

Great chatting Wayne!


Regards


Magdoran
P.S. You’ll be in trouble if my wife sees your comment on the “Evil Empire” – she’s from the US! She’ll probably want to join me on my trip to Perth soon, to wrap you over the head with a newspaper (or one of my options books), so watch out! Hehehe. Mag

 

[wayneL]

Where the gradations in strikes have an impact is when you compare Australian stocks that are around or above $20 (e.g. COH, MBL, CBA, WPL, RIO) compared to similarly priced US stocks, the potential reward for a similar percentage move in each underlying is different given you can precisely choose a mildly OTM option which moves into the money before your time exit, gaining significantly in raw percentage returns (say 500% as opposed to say %150). Makes a big difference to your bottom line when the market is trending nicely.

The difference also in value gradations can shave value off your entries and exits since you can’t move more finely, and I would argue that this adds up (in the market makers favour). It would be great if the US exchanges embraced a 1 cent standard!

Yes, I can see exactly what you are saying Mag. This perhaps highlights that, depending upon your philosophy of trading, one or the other may be better. I tend to think of my positions in terms position delta, position gamma, defence capabilities and total spread to exit if all goes pear shaped. I also think of profit/loss in terms of total capital, rather than individual positions.

If I am going to initiate a long options position, based on the factors present in my market, I am more likely to go ATM or slightly ITM. Theta is at a maximum at this point, but so is vega and gamma and we are long these. Therefore I am pretty concious of IV levels relative to their recent history and avoid potential IV crush like the pox. In fact I like the potential of IV "rush" and will seek out those opportunities.

Otherwise, If I' keen on a particular opportunity and want a delta position, I'll just spread off straight away.

In general though, unless IV's are low and the outlook is for increasing volatility, I would prefer to have long theta (+) positions.

....and of course the delta on an Australian option that moves into the money (ITM) appreciates significantly as the underlying moves further into the money, hence the major difference in both the potential for significant rewards as well as the probability of success, wouldn’t you agree?

I assume you are refering to higher gamma, due to lower IV in Oz options?

Assuming that realised volatility reflects IV it shouldn't make a helluva lot of difference should it? The higher IV (and therefore lower gamma) stock should move proportionately more, realising simmiar gains in terms of capital employed?

Great chatting Wayne!

Yes aways fun getting into the nitty gritty of options

P.S. You’ll be in trouble if my wife sees your comment on the “Evil Empire” – she’s from the US! She’ll probably want to join me on my trip to Perth soon, to wrap you over the head with a newspaper (or one of my options books), so watch out! Hehehe. Mag

I'm a yank originally too, so I'm allowed

I'll still remember to duck though... just in case

 

[Magdoran]

Hello Wayne,


So, which part of the states are you from? I suppose you’ve been in Australia for a while then?

Ok, the point I was making about US Vs Australia is this:

Say we have two stocks trading at $40 (hypothetically let’s say DOX and CBA were trading at $40).

We project that each stock will hit $44.50 by 30 days to expiry.

DOX has a $40 and $45 call available ($5 increments).

CBA has literally 14 strikes available between these increments.

I used July calls for both, and added days for the US options to match the theta decay (I set the time to expiry and the entry and exit price to the same numbers for each stock).

I trailed a few different variables, and came up with a range of results where the CBA trade was making around 1000% ROI for several OTM strikes mid way between 40 and 45, while the DOX returns were more like 400% ROI for the two strikes available.

This is consistent with my experience trading both markets. Trading OTM positions is more aggressive, but the rewards are far higher when the trade is correct. Also, the delta effect is less if you are wrong for OTM positions.

I deliberately wanted to make the US look bad however, by selecting a price range which would show up the divergence clearly, so the difference is not always as great, it really depends on the entry and end price, and the time frame.

If the US stock entry and exit line up favourably with the strike prices, the difference reduces. But this range is affected by the width between the strikes, and severely limits the range of strategy choices in comparison, and waiting for the right movement in line with the limitations of the US strikes is restrictive in comparison. Just think it through– 14 strikes available compared with 2. Everyone reading this, please do the math yourself and have a play – see what you find.

Another factor to consider which options model you are using. I prefer American exercise/ Binomial over European exercise Black and Scholes, I think the former gives a more accurate forecast on average.

Admittedly volatility is another key aspect to this equation, and on average the US has had much higher stock implied volatility than in Australia, hence credit positions are generally effective in the US, hence straight calls and puts work better on average in Australia than the Us since the implied volatility has been lower (although of course this can change).

Anyway, this is food for thought, isn’t it?


Happy modelling!


Magdoran

OTM = Out of the Money
ATM = At the Money
ITM = In the Money
ROI = Return on Investment

 

[sails]

Hi Magdoran,

Welcome to ASF! It is a real pleasure to find someone else with such an interest in Aussie options!

I've been trading Aus options for about 3 years now having started with SPI futures a few years previously. In these 3 years of studying options and lots of testing and strategy experiments, live trading and general observations, I have found the best way for me to make money is simply being long premium but very short term - usually not too far OTM and mostly front month. With some of our stocks being so chronically low in IV, I'm far more comfortable being long gamma. For the short time I'm in a trade, theta is really not an issue. So really interesting that you have come up with similar observations on the Aus options market.

For a long time I tried to make +ve theta work for me in the form of credit type spreads, butterflies and all the variations I could find using Aus options, but without much success. Also worked hard on delta neutral positions so didn't need to know where the stock might go, but in the end got back to work on the charts and let gamma work for me.

I do agree with you that it is great to have so many strikes on higher priced shares - but did you know that the ASX stated some time ago now that they are changing CBA, RIO and MBL to $1 strikes? CBA usually only averages a $2 range per month (exception this month!) so it will take the shine off it a bit. I have noticed now that any new strikes added are in $1 increments - already started in June with 4050 being the last 50c strike. Can understand with RIO and MBL being much higher priced shares, but think it's a bit mean on CBA.

Cheers,
Margaret.

 

[wayneL]

Hello Wayne,


So, which part of the states are you from? I suppose you’ve been in Australia for a while then?

I'm from the "New" New Mexico. i.e Southern California. And yes I've been here long enough that my relatives no longer understand a word I say! LOL

Ok, the point I was making about US Vs Australia is this:

Say we have two stocks trading at $40 (hypothetically let’s say DOX and CBA were trading at $40).

We project that each stock will hit $44.50 by 30 days to expiry.

DOX has a $40 and $45 call available ($5 increments).

CBA has literally 14 strikes available between these increments.

I used July calls for both, and added days for the US options to match the theta decay (I set the time to expiry and the entry and exit price to the same numbers for each stock).

I trailed a few different variables, and came up with a range of results where the CBA trade was making around 1000% ROI for several OTM strikes mid way between 40 and 45, while the DOX returns were more like 400% ROI for the two strikes available.

This is consistent with my experience trading both markets. Trading OTM positions is more aggressive, but the rewards are far higher when the trade is correct. Also, the delta effect is less if you are wrong for OTM positions.

I deliberately wanted to make the US look bad however, by selecting a price range which would show up the divergence clearly, so the difference is not always as great, it really depends on the entry and end price, and the time frame.

If the US stock entry and exit line up favourably with the strike prices, the difference reduces. But this range is affected by the width between the strikes, and severely limits the range of strategy choices in comparison, and waiting for the right movement in line with the limitations of the US strikes is restrictive in comparison. Just think it through– 14 strikes available compared with 2. Everyone reading this, please do the math yourself and have a play – see what you find.

Another factor to consider which options model you are using. I prefer American exercise/ Binomial over European exercise Black and Scholes, I think the former gives a more accurate forecast on average.

Admittedly volatility is another key aspect to this equation, and on average the US has had much higher stock implied volatility than in Australia, hence credit positions are generally effective in the US, hence straight calls and puts work better on average in Australia than the Us since the implied volatility has been lower (although of course this can change).

Anyway, this is food for thought, isn’t it?


Happy modelling!


Magdoran

OTM = Out of the Money
ATM = At the Money
ITM = In the Money
ROI = Return on Investment

Cox, Ross & Rubinstein all the way

Ok your scenario is most certainly true for a certain set of conditions. For those figures to works as posted:

*IV would be lowish... say ~15% or less.
*A $4.50 move would be a move not indicated by IV. I'm guessing it would be > 2 sigma, perhaps > 3 sigma. In other words a big move for this stock(s) (without knowing the exact time frame we are speaking of)
*Higher IV's would temper this markedly

Now I have a couple of problems with OTM options... and one of them IS more apparent in the US market.

*Position size would need to be increased exponentially the further we get away from the money to maintain position Delta
*Contest risk (transaction costs plus entry/exit spread) is increased... already double at 42.50 strike. This alone destroys any advantage OTM has with the range of returns that are within the high probability range. The move MUST be strong
*We are moving INTO or THROUGH an area of maximum theta, and beacuse of inreased position size, time will be of the essence. The longer we take to get to target the more or ultimate profitability is compromised. This may be alleviated by vega, but we don't know that.
*We don't get the benefits of gamma until we get a substantial move. The more probable range of returns will not benefit hardly at all.

All that said though, if the stock moves even further... say $45 -$48 You will kick one huge goal with the OTM call.

At the end of the day (or more accurately, at the end of the year) it is all comes back to the expectancy equation to see which is better. Because we are dealing with a highly chaotic subset of market dynamics, this can only be done accurately in parallel and in retrospect on real returns.

What tickles your fancy?...risk...reward....probabilty, in any combination you like!

Great brain exercise! (but I've got lactic acid build up, need to go do some warm down )

Cheers

 

[Magdoran]

Hello Margaret,


Thanks for the welcome. It is nice to find someone who is on your wavelength isn’t it?

Hmmm, it is a shame that the options are moving to $1 Increments for the higher priced stocks, most annoying really, but the percentages are still better than $5, wouldn’t you agree?

I certainly agree about the non directional and volatility plays being less effective over the past couple of years in the Australian market compared to straight positions on average. You still could have entered a lot of bull puts though, and done very well.

Butterflies work well in sideways market (hence more effective in the US), so I can understand you not using them in such a strongly trending/volatile market in Australia from 2003 onwards.

With the higher volatility now though, maybe it’s time for a few credit positions – I’ve been thinking about ratio spreads recently, but never tried them in practice.

As for theta, agree, not an issue for short term long options. But crucial for longer term plays, both credit and debit. Have a look at my comments to Wayne I will post below for some of my musings, and see what you think.


Once again thanks for the warm welcome.


Regards


Magdoran

 

[Magdoran]

Hello “Mr NEW Mexico” (Wayne),


I bet your family back home can’t understand you with a Geraldton accent!

Now, you raise a lot of valid points:

Low IV:
Implied volatility is usually lower in Australia, around 15-20, some times lower, sometimes higher – this is certainly an important criteria to factor in to decide to go long a call or put, so agree here.

Significant move:
Why I chose a significant move is because it highlights the effect of a finer gradation in strikes. Certainly entering an OTM long option requires a sufficient move to make a good profit (although you can still make 30-100%with a more common move as long as you don’t go too far OTM and ride the IV favourably).

The idea is to look for patterns where you are expecting an explosive move, and position accordingly to capture significant profits (partly to offset the times you get it wrong and do 30%, 50% or even 100% losses, plus the spread slippages and brokerage you correctly refer to). You have to get 3 elements reasonably right – time frame, magnitude, and direction.

Implied Volatility:
Yes, IV is key. If it is too high, this effects your strategy options, hence you start to consider either ignoring the opportunity, finding a different instrument, looking at credit spreads (like bull puts or bear calls for instance). But it also requires analysing the IV history, and projecting IV pretty much as you project stock movements, although the logic is different (as you know). I try to project what is likely to happen in tandem with the underlying, and especially how it will affect the chosen strategy. In fact, I have been known to spend more time working through the volatility scenarios than I did on the underlying chart.

Position Size:
Excellent point Wayne (MNM). You are right, you have to balance the position size with the risk, take into account the likely slippage and transaction costs, work out the probability of success, and look at the ramifications if you get it wrong (as well as if you get it right of course too).

When I trade this kind of high risk trade, I accept I may make significant losses (up to 100%). But if I can make higher returns from a sufficient number of successful trades, enough to counteract the costs and losses, I’m ahead. But this is still a work in progress, and far from a proven methodology – it will probably take me another 2-3 years to fully develop it. It is not for newbies, that’s for sure.

One point here is that the further OTM you go, the more time you should consider buying if long. You can play diagonal/calendar strategies here sometimes to help fund the position by selling at the same strike if conservative, or strike or two towards the money if more agressive in the current month (aiming to sell the most premium possible, usually with around 30 days to maximise theta decay in the sold position). Again not for newbies, but works nicely in an orderly trending underlying.

Contest Risk:
Can’t say I really understand this. I didn’t think the transaction costs were that great in the Australian market when the contract size is 10 times that in the states (1000 vs 100). This also has a marked advantage for the Australian market.

As for theta decay, the rules are straight forward. If long look to exit by the time the option is hitting 30 days (exception is to hang on when you bought OTM and it is deeply ITM – the theta decay and time value are often then a negligible component – one trick is to exit partial positions to lock in profit, say half, one third, or if conservative two thirds).

If short, try to sell with under 45 days time value and above 20 days if possible, also looking for IV skews in your favour.

Another trick in the book is to also enter a bull put or bear call at the same time as the single series long option – but only if you’re really sure it will either go sideways or in your direction, otherwise your exposure is much higher. The idea is that if your OTM position does nothing for a month, the credit spread helped to negate the theta decay, and finance holding onto the long option If still confident of a move (if not wind it out on the trading plan criteria – time, stop loss, profit stop, or partial /complete exit). The risk though is you get it really wrong, but at least your risk is limited in both cases.

Gamma:
Do you really use this a lot independently from all the other variables? I don’t, it just factors in with my model, so I know what things are likely to look like within a range, based on price action and time (includes forecasting IV too by the way). Gamma just helps to calculate how quickly the delta will change if your position moves in or out of the money, doesn’t it?

Significant moves in actuality:
Yes, if the underlying does move substantially in the direction you think it will, in the time you think it will, OTM positions really rake in the big profits, and this is really the challenge with this style of trading – time, direction, magnitude (and correct forecasting of IV).

What tickles my fancy???
Many things Wayne. I’m not a “satisfiser” by nature, but a “maximiser”. The ultimate objective is quite complex actually (funny, no one has asked me that for a long time), but in trading involves longer term targets, job satisfaction (I actually get a kick out of what I do), I like being able to recognise my errors and correct them (ala Soros), but it’s certainly nice to be right sometimes (which is probably universally true for everyone).

How about you?




Hope your lactic acid build up abated!


Regards


Magdoran

 

[wayneL]

Hope your lactic acid build up abated!

Remarkably, the body can use lactic acid for aerobic energy production. Unfortunately the brain runs exclusively on glycogen, so had to resort to a steady jog. (of course, the brain doesn't produce lactic acid anyway : )

***

Well what an interesting discussion! I don't think we've converted each other, but I don't think the goal was proselytization anyway. But certainly an appreciation of trading philosophy has been achieved.

Contest Risk:
Can’t say I really understand this. I didn’t think the transaction costs were that great in the Australian market when the contract size is 10 times that in the states (1000 vs 100). This also has a marked advantage for the Australian market.

Just for clarification, contest risk is the immediate cost of a simultaneous entry and exit of position i.e. (spread x 100(or 1000) x contracts) + (commish x2)

A larger position size to achieve adequate delta increases contest risk.

Commish: costs me $0.75 per contract.

What tickles my fancy???
Many things Wayne. I’m not a “satisfiser” by nature, but a “maximiser”. The ultimate objective is quite complex actually (funny, no one has asked me that for a long time), but in trading involves longer term targets, job satisfaction (I actually get a kick out of what I do), I like being able to recognise my errors and correct them (ala Soros), but it’s certainly nice to be right sometimes (which is probably universally true for everyone).

How about you?

Well... sticking strictly to trading matters.... I broadly catagorize option trades as a punt or a book and therefore traders as either bookies or punters. (purely from a philosophical standpoint. This is not to infer that the punter is a gambler. This is just to reflect the risk/reward/probabilities preferences of a trader ) The bookie side of things is what tickles my fancy. But I will readily punt when the opportunity arises.

A bookie (and this time I'm refering to the trackside species) is, as a matter of survival, a punter as well. Books often should, or need, to be hedged with a punt. (Now speaking of the trackside AND the screenside bookie)

What part of Rome Revisited does your wife come from? Have you visited? What did you think?

Cheers

 

[wayneL]

Gamma:
Do you really use this a lot independently from all the other variables? I don’t, it just factors in with my model, so I know what things are likely to look like within a range, based on price action and time (includes forecasting IV too by the way). Gamma just helps to calculate how quickly the delta will change if your position moves in or out of the money, doesn’t it?

Mag,

Not really independantly with a directional trade, but a big factor in delta neutral trades as it is gamma that manufactures delta in this case.

When short gamma, obviously we want as little of it as practical and the plan is that theta will overcome any unwanted delta developed through gamma.

When delta neutral and long gamma, gamma is very much the prime consideration....well, and vega, but primarily gamma... because we want those deltas showing up asap.

The trading strategy known as "gamma scalping" where delta is continuously hedged thus locking in profits at regular and preferably very short intervals, indicates that gamma is the basis. But as with all strategies, the other greeks will always show up to play their own little role.

Very egotistical those greeks, they always want to have a say... just as bad as ex-yank option traders

Cheers

 

[Ageo]

When I trade this kind of high risk trade, I accept I may make significant losses (up to 100%). But if I can make higher returns from a sufficient number of successful trades, enough to counteract the costs and losses, I’m ahead. But this is still a work in progress, and far from a proven methodology – it will probably take me another 2-3 years to fully develop it. It is not for newbies, that’s for sure.

Regards


Magdoran

Hi Mag (great discussions btw),

i believe the above post is simply "positive expectancy"

Where your win/loss ratio might be less than 50% but your risk/reward is much higher. Knowing that you can achieve a higher risk/reward is so important and basically takes off the pain off being "right" and will allow you to take losses with a smile.

Remember positive expectancy should be based on worst case scenario which means your not always going to have a worst case scenario are you?

Like you said if you use OTM bought calls (as with puts) and the moves your after make over 500%+ . Then basically you can afford to lose 4 times (as long as your position size stays the same). To me thats a 25% win/loss ratio but a 5:1 ROR (return on risk) ratio

So even if your so bad at picking entries you will still have fantastic system. And remember the higher your win/loss ratio the small the ROR ratio has to be in order to be profitable.

But imagine having a win/loss ratio of 50% and a ROR of 5:1 ratio?

hehe now we are getting somewhere!

Adrian

 

[Magdoran]

Hello Wayne,


My wife grew up in Kansas, but lived in LA for a while. Yes, I’ve been there – love it! It is freaky though how a whole country can drive on the wrong side of the road! (hahaha – when in “New Rome”). But like Australia, it is a big country, and I’ve only see a fraction of it I’m sure. I could spend lots of time there and still not see all I want to. We’re looking to go over for thanksgiving later this year… looking forward to that.

As for conversion, that was never my intention. I kind of think about individual preferences for markets and instruments along the lines of a smorgasbord – I like chicken and you like beef, and the next person is vegetarian… (Or I LOVE Chocolate, and someone else likes lemon cheesecake – better stop this, I’m getting hungry!).

My purpose was to offer a different perspective for other readers to consider giving them more choices, and an insight into the experiences from those that have done it. It is also a good vehicle for discussing the way that the different “Greeks” effect risk and reward, and illustrates just how important it is to really do the ground work about how options behave, and to develop the capacity to project/forecast potential results using this kind of instrument.


Contest Risk:
Aha, contest risk, I kind of remember this term now – sure, the cost to immediately enter and exit is certainly a factor with way OTM positions, and certainly options with wide spreads, so this is why this strategy needs careful planning and use only when being able to project in time, price, and direction accurately enough to select the best risk/reward parameters.

This is only one of many approaches I use, and only in specific situations. It is a tool in the shed. But the process involved in considering this kind of trade really highlights the greeks, and shows the effect that different strike gradations can have in different markets (also shows how important IV is).

Now on this point of position size, actually you don’t increase the value (although you may trade more contracts in comparison). Interestingly, I tend to keep these positions fairly small (under 10 contracts Australian); hence the only additional cost is the OCH fee in and out.

Punter Vs Bookie:
Interesting “track” analogy. I suppose I’m a bit of both under your definition, but I’d like to think that I’m the “casino” Mark Douglas style, in that I’m employing a technical analysis and options edge… Ageo/Adrian’s comment is along these lines (kind of has elements of “positive expectancy”).

Gamma:
Delta neutral concepts at the advanced end get very hairy (which is why I set up a model and let the computer do all the hard sums). The problem I have is that implied volatility really messes things up, along with theta decay if short an option under 30 days (which is often a primary focus of a market neutral credit spread). Sure, with things like butterflies and condors, and perhaps in ratio spreads (especially in different time frames) this is a consideration, but I still hold IV is key here, and theta decay.

I never did really get into gamma type trades, (just didn’t see this style as attractive as other approaches in this kind of market), but I’d be interested if there is a gamma player out there who’d like to share their knowledge (this is not a strong suit of mine, trading this way). Could be interesting… (We could also talk IV though; I think this is really relevant in all trades).

I found McMilan’s book “Options as a Stratgic Investment” to be invaluable for this kind of options theory... ever get to read it?


Regards


Magdoran

 

[wayneL]

We’re looking to go over for thanksgiving later this year… looking forward to that.

Have fun! But beware of constitution free zones (airports, and increasingly, everywhere else)

As for conversion, that was never my intention. I kind of think about individual preferences for markets and instruments along the lines of a smorgasbord – I like chicken and you like beef, and the next person is vegetarian… (Or I LOVE Chocolate, and someone else likes lemon cheesecake – better stop this, I’m getting hungry!).

My purpose was to offer a different perspective for other readers to consider giving them more choices, and an insight into the experiences from those that have done it. It is also a good vehicle for discussing the way that the different “Greeks” effect risk and reward, and illustrates just how important it is to really do the ground work about how options behave, and to develop the capacity to project/forecast potential results using this kind of instrument.

.....but I don't think the goal was proselytization anyway. But certainly an appreciation of trading philosophy has been achieved.

Gamma:
Delta neutral concepts at the advanced end get very hairy (which is why I set up a model and let the computer do all the hard sums). The problem I have is that implied volatility really messes things up, along with theta decay if short an option under 30 days (which is often a primary focus of a market neutral credit spread). Sure, with things like butterflies and condors, and perhaps in ratio spreads (especially in different time frames) this is a consideration, but I still hold IV is key here, and theta decay.

Indeed, IV is most certainly the key. The first point of analysis for me. This will immediately narrow down the selection of strategies I will employ in any given situation. This is where a lot of traders get into trouble. One must have a precise view of market direction (even if it is precisely imprecise). But then one must have a view of volatility within the term of the option. When all the planets line up, there is very high probability of profit.

I never did really get into gamma type trades, (just didn’t see this style as attractive as other approaches in this kind of market), but I’d be interested if there is a gamma player out there who’d like to share their knowledge (this is not a strong suit of mine, trading this way). Could be interesting… (We could also talk IV though; I think this is really relevant in all trades).

I don't think the technique is useable in the Aussie market, not in a gamma scalping context. I think gamma/VEGA delta neutral trades have possibilities. I posted a paper trade along these lines on OSH somewhere on this board that turned out quite good.

In the US Gamma scalping is a great technique. But as mentioned above, all the planets have to line up. It can't be applied indiscriminantly (as with any trade) But when the right conditions turn up, I'm in. They work VERY well.

I found McMilan’s book “Options as a Strategic Investment” to be invaluable for this kind of options theory... ever get to read it?

Almost unbelievably, I have never read it. Haven't read Natenbergs book either. I learned mostly from Charles Cottle. By an incredible stroke of good fortune, I ended up in an IRC chatroom with him and able to ask questions directly.

The guy is a savant and incredibly generous with his knowledge (it was a free , public chatroom), and while the process did involve several episodes of brain fission, I did manage to pick up lots of stuff... enough to be able to put the missing pieces of the jigsaw puzzle together myself. (Saved all the transripts ) I spend most of my time with modelling software and observing greeks real time (Ironically I used to enjoy observing certain types of Greeks:girl: while sitting in Melbourne cafe's before I started trading options )

McMillans book is on the to-read list, as is Natenbergs.

They are both highly regarded enough by people I respect for me to suggest them as must reads for any aspiring options trader.

Cheers

 

[Magdoran]

Hi Wayne,


Natenberg and McMilan are both on my shelf, and I refer to them from time to time. I don't lend these out - but I do let the Guy Bower book out for newer to intermediate options players...

All well worth reading.


Magdoran