The idiots way to options riches

[wayneL]

I'll separate the rocket science into a different thread later on. Missus has me doing some confounded chores for the moment

 

[wayneL]

I'll separate the rocket science into a different thread later on. Missus has me doing some confounded chores for the moment

I can't think of an elegant way to separate this into two threads without messing up the conversation flow. Perhaps rename the thread... Joe?

 

[wayneL]

Any beginner reading this thread for education purposes might actually get the idea that one has to be extremely intelligent to trade options successfully. However, the most successful traders I know personally get to the point where they only trade up to a handful of stocks or patterns continuously and at key times. Decisions and trades are made and executed rapidly. From my own experiences and observations of colleagues, limited selection, key times and quick decisions seem to be defining characteristics.

Cheers
Happytrader

Hi HT,

There are of course a myriad of approaches in trading options, each as defined by the greeks.

From the sounds of it your (and friends) style is primarily trading delta, both long and short, with long gamma and vega, negative theta.

There is nothing wrong with that, but folks should understand that that is but one approach.

By far my most profitable approach has been delta neutral, short gamma and vega, with positive theta... almost the direct opposite to you. There are others of course.

Which is best?

Neither! There is no best appraach to options, and I contend that ALL approaches are the best... in the right circumstances.

For instance in this current expiry cycle, I haven't put on my favourite strategy on the SP (the one above) because the IV conditions did not offer an edge in that strategy. As it is shaping up, it looks as though it will have been profitable anyway (sans any big move next week) but risk/reward was just not to my liking.

In fact I have been long delta, gamma, vega, theta negative (in other word I bought calls) on the grains because there was a bit of an edge I thought from being long vega. I also did the same with hogs last month, but also was able to enhance that position by doing a couple of morphs along the way.

Re having to be intellegent. hmmmm not a prerequisite but, I certainly recommend the struggle to learn all this stuff...and though of only average intellegence I must admit to enjoy the challenge of getting as far as I can with this.

In the end, horses for courses, and certainly there is no room for looking down the nose at simple approaches, so long as risk is known.

Cheers

 

[wayneL]

Magdoran & enzo



Agreed.
To progress the model we need to;
*ask enzo to reconstruct the initial valuation model [with amended vega]
*or, take a new, real time example, and provide a dual analysis & valuation.

If option #2 is undertaken, we will need an example that includes a non-linear event that will provide a similar scenario for valuation as the previous litigation in the FRX example.

Anyone interested?

jog on
d998

I'm not sure we could reconstruct the FRX trade faithfully without live data. Also, as the result is now known, surely this would taint said reconstruction.

I will try to find a new scenario... so what we want is some pending unknown known. e.g. litigation, FDA announcement or similar, right? This is what will give us the enourmous IVs and time skews we are looking for.

 

[happytrader]

Hi Wayne

I absolutely agree with you that there is more than one approach.
However, whatever the strategy successful trading is dependent on making decisions one can commit to and manage the outcome of.

I have known many ' trading course junkies' who have paid dearly for all the best info from some very successful people and yet they can't bring themselves to take a trade. The library and the internet abound with great free info.

But the fact remains most people can't make decisions and as with the majority are comfortable as employees.

Managers are the goal oriented thinkers and the employees are generally the feelers. Two totally different views and accompanying behaviours along with results are observeable. This appears to have its roots in experience e.g the family unit, mum, dad and the kids.

Traders, like good parents and managers are foremost decision makers and the easiest way to build this ability is to narrow down the field to timeframes, necessary information and limited choices to reduce being overwhelmed.

Cheers
Happytrader

 

[Bobby]

...and though of only average intellegence I must admit to enjoy the challenge of getting as far as I can with this.

Wayne if you think your of only average intelligence then may I say :bs:

I think your on the way to have savoirfaire characteristics

You already possess certain savant powers!

Take care.
Bob.

 

[ducati916]

enzo

I'm not sure we could reconstruct the FRX trade faithfully without live data. Also, as the result is now known, surely this would taint said reconstruction.

I will try to find a new scenario... so what we want is some pending unknown known. e.g. litigation, FDA announcement or similar, right? This is what will give us the enourmous IVs and time skews we are looking for.

As to tainting, or biasing, the result, certainly, but this of course is a problem with analysis in hindsight unless allowed for. However as an initial experiment, it has certain characteristics that are helpful when building a new model.

Irrespective, in essence as to what we are looking for.......correct.

We want a trade that the greeks have priced as attractive for strategy XYZ
But that has a;
*known event
*unknown timeframe
*unknown magnitude
*unknown result

These, [and possibly some I haven't thought of] types of risk are not accurately, or even adequately priced via the greeks.
I am looking for a quick, easy, methodology, to use as a pricing mechanism as a cross-check on the price generated via the greeks.

I would hazard a guess that 99% of options traders on this site utilize an online calculator, or software to do the calculations in a Black/Scholes, or Cox/Rubenstein calculation.

Nothing wrong with that after you have done them long-hand for a year or so as you will then fully understand your greeks, and you will notice that certain elements of risk are ignored, or not built into the models [in specific scenarios].

jog on
d998

 

[happytrader]

Hi Ducati

Quote:
I would hazard a guess that 99% of options traders on this site utilize an online calculator, or software to do the calculations in a Black/Scholes, or Cox/Rubenstein calculation.

I don't know or have ever known of any trader that actually uses these models to trade. Many do however, take a peak at the days trade history of a particular option and most definitely assess open interest. The usual method is actually to identify a key time, make a trading decision and commit to an entry. This is made by several methods:

1. make an offer at the last price (might get a bargain)
2. make an offer halfway between the spread (high chance of success)
3. buy at market (entry assured)

Models are all very good for theoretical pricing but things can move very quickly and the pricings can be way off the mark. This is after all an auction and the market is always right.

Also there is absolutely no reason why you can't get accurate pricing by free trialling option software and using the above methods to test your models. In fact thats how we of the same school and teacher were all taught to paper trade for a period of 6 weeks on low volatility stocks.

Cheers
Happytrader

 

[ducati916]

happytrader

Quote:
I would hazard a guess that 99% of options traders on this site utilize an online calculator, or software to do the calculations in a Black/Scholes, or Cox/Rubenstein calculation.

Actually, this is just my sense of humour.
The above is an example of an heuristic viz. a generalization, made without any quantifiable methodology.

I don't know or have ever known of any trader that actually uses these models to trade. Many do however, take a peak at the days trade history of a particular option and most definitely assess open interest. The usual method is actually to identify a key time, make a trading decision and commit to an entry. This is made by several methods:

Oh Oh.
While I would not say that I know a lot of Options traders, all of the ones I do know, utilize the greeks in some shape or form. Without doing the necessary work, you are at the mercy of market makers, who of course have your best interests at heart.

1. make an offer at the last price (might get a bargain)
2. make an offer halfway between the spread (high chance of success)
3. buy at market (entry assured)

I real hit/miss, amateur hour methodology.

Models are all very good for theoretical pricing but things can move very quickly and the pricings can be way off the mark. This is after all an auction and the market is always right.

*The market is a peanut.
*The market can move quickly, thus providing better, or increasingly prohibitive pricing in regards to the valuation ascertained via modelling.
*Without a price/value calculated in any shape or form, you have no bench-mark by which to calculate your risk/reward assumed.

Also there is absolutely no reason why you can't get accurate pricing by free trialling option software and using the above methods to test your models. In fact thats how we of the same school and teacher were all taught to paper trade for a period of 6 weeks on low volatility stocks.

And then the total contradiction.
Of course volatility is a constant.......................

In the final analysis, there are only two variables that count.
*Direction
*Volatility

If you can predict these with 100% accuracy, you can make money trading anything that you choose to. If however you can't, then, like the rest of the capital markets you need a methodology to;
*Recognise
*Price
*Assume
*Manage
*RISK
*REWARD

jog on
d998

 

[ducati916]

If you are trading ASX Options, in the manner previously described, then you had better think again.

http://lightning.he.net/cgi-bin/suid/~reefcap/ultimatebb.cgi?ubb=get_topic;f=6;t=000171;p=1#000001

Unless you have a pretty good idea of what risk you are assuming, you could be the patsy.

jog on
d998

 

[happytrader]

Thanks for your reply Ducati

Quote
I would hazard a guess that 99% of options traders on this site utilize an online calculator, or software to do the calculations in a Black/Scholes, or Cox/Rubenstein calculation.

Its like you said, you are indeed a 'guesser'
and a searcher of the holy grail too.
Good luck with that.

Just my sense of humour

Cheers
Happytrader

 

[wayneL]

enzo



As to tainting, or biasing, the result, certainly, but this of course is a problem with analysis in hindsight unless allowed for. However as an initial experiment, it has certain characteristics that are helpful when building a new model.

Irrespective, in essence as to what we are looking for.......correct.

We want a trade that the greeks have priced as attractive for strategy XYZ
But that has a;
*known event
*unknown timeframe
*unknown magnitude
*unknown result

These, [and possibly some I haven't thought of] types of risk are not accurately, or even adequately priced via the greeks.
I am looking for a quick, easy, methodology, to use as a pricing mechanism as a cross-check on the price generated via the greeks.

I would hazard a guess that 99% of options traders on this site utilize an online calculator, or software to do the calculations in a Black/Scholes, or Cox/Rubenstein calculation.

Nothing wrong with that after you have done them long-hand for a year or so as you will then fully understand your greeks, and you will notice that certain elements of risk are ignored, or not built into the models [in specific scenarios].

jog on
d998

NRPH?

http://finance.yahoo.com/q?s=NRPH&d=t

http://cboe.ivolatility.com/nchart....,R*1,period*12,all*4,schema*options_big&2=x:1

 

[ducati916]

enzo

Yes, this will work just fine.
Does your modelling, or whatever methodology you employ, provide a value or price? [if so make a note of it, and the two values can be compared later]

Possibly Magdoran & Sails might calculate their price or value, and we would have further values as a comparison.

We know happy's value, I've just removed the dart from the value selected.

jog on
d998

 

[happytrader]

Hi All

Actually I thought I would have a peak at NRPH when Wayne mentioned it and
paper trade it. However, the prices are taken from real trades.

'the idiot way'

Buy write strategy

Time frame 2 days

13 Sept 06 - Buy NRPH at 3.35pm for $24.85 and at the same time Sell to open option code QNCIE with Strike price 25.00 @ 80c expiring on 15 Sept 06 Open interest over 1000

Possible scenarios

Option expires worthless - Keep premium and shares pay brokerage one way.
Stock goes up and you are exercised - you keep the premium and make a small profit of 15c on the share and pay brokerage both ways.
Stock goes down - risk subsidised in part or entirely by receipt of 80c premium. Actual loss depends on you.

We here find you very entertaining Ducati. Its just like being home in NZ.

Cheers
Happytrader

 

[wayneL]

enzo

Yes, this will work just fine.
Does your modelling, or whatever methodology you employ, provide a value or price? [if so make a note of it, and the two values can be compared later]

Possibly Magdoran & Sails might calculate their price or value, and we would have further values as a comparison.

We know happy's value, I've just removed the dart from the value selected.

jog on
d998

Duc,

I don't think I can assign a "value" to these options.

1/ The OPM (whichever one is in use) requires a trader (or the market collectively) to make a projection of volatility likely for the term of the option. Due to the pending news, this is an impossibility. An educated guess at the best of times, this becomes an outright gamble in the current circumstances.

2/ The problem with all OPM's is the presumption of continuous markets... exactly what is virtually guaranteed NOT to be the case when the decision is ultimately released. A contraindication to the fundamental philosophy behind oprion pricing IMO

In other words, I wouldn't be game to try to actually value them. These sorts of situations I try to play on what certainties there are. i.e.

1/ IV skews, both time and price

2/ vega/volatility crush

The certainty is that there will be a significant shift in IV. What is not certain is where the underlying will move to, if anywhere.

If I can remove enough vega risk while spreading the theta as well as being positive gamma, or, have a favourable risk/reward (again a guess) jumbo jet spread (a very wide condor), then I have a trade. Otherwise I pass. I am looking for 90% probabilty of success with little risk.

Not many of these actually measure up. I can't get this one to work because of the spreads in the back month series.

Thats all I can really add at this stage unless a better candidate turns up.

 

[Magdoran]

Hello Ducati and Wayne,


Can I ask a dumb question here? What exactly are we trying to do here? Valuation of options is problematic in volatile market conditions because the market is trying to estimate the probability of a given option finishing in the money by expiry (although some players are estimating that the actual value of an option will move favourably within whatever strategy they determine to enter).

When market players try to factor in unknowns like important news events, volatility can rise significantly because the option sellers build more risk into the price of the options.

The strategy of using volatility and the resulting mispricing between different strikes to their advantage is an effective way to both reduce risk, and ameliorate adverse effects of volatility in the option prices.

I had a play around with various spreads with ratios and diagonals to name a few, but the volatility skews were odd.

Part of the problem was the potential behaviour of the stock: The chart is bearish in the daily, bullish in the weekly, but looks like it could retrace more, unless we get a good pattern higher low in place, or it may move strongly on the expected news...

So, when it comes to valuing the options, a lot would depend on what you would expect the stock to do, the time frame you expected it to take, and what your volatility expectations were.

A real problem with many of the positions I was looking at for interest for this thread, was that a volatility crush would adversely effect the long leg (bought option), and if using a diagonalised ratio back spread, the danger of an adverse exercise, or the negative prospects of the sold leg expiring at an unfavourable time were reasonably high.

This is assuming selling the front month, so to use the volatility skew (best buy in volatility was around 80, best sell was around 200), the danger was the stock did nothing, or moved to a price that would result in a loss if the volatility fell sufficiently.

Of course the loss was fairly small, and the potential gains unlimited (if using a call version), but the stock would have to move significantly for this to happen, and before the sold position got too near expiry.

I found the volatility sometimes was not favourable to a spread buying a later dated strike. In fact straight directional spreads could be constructed that had better risk to reward ratios, but were subject to getting the direction and magnitude right.

Unless you have very good forecasting approaches, trying to select a viable position here would be fraught with difficulty since the volatility is so high and has been increasing heavily. If the stock then didn’t deliver any kind of move, or the news item the market was expecting either doesn’t eventuate or is revealed and priced in, the volatility may well fall significantly.

So, in my view the options are way overvalued from a nominal model, but this is because of an unknown news item, and the market pricing this into the premium. We’d expect a volatility crush once the news is known, but this may coincide with a strong move in the underlying on the expected announcement (of course we may not too).

Personally I just wouldn’t trade this kind of stock at all. I have no edge to tell me which way the stock might move, up down or sideways, or how far. My weekly gives me the feeling it is bullish but retracing some more, the daily shows a bearish drive, with an exhaustive bar down, and a few days of unclear inside days (maybe suggesting the downward momentum has halted).

With conflicting information like this, the wildly high volatility, and the uncertainly this represents I just don’t see a trade that is viable that suits my risk to reward profile, or within any measurable probabilities (not to say this can’t be done, just that I’m not geared for this kind of trade – there may well be an arbitrage in the static numbers, but during actual market conditions these may disappear quickly).

If I had to trade, I’d probably pick a direction, and look to sell ATM or slightly ITM and hedge with a bought position with a favourable skew. My directional guess would be going bullish with a bit of time probably the December strikes, or go out even further. Perhaps a bull put or bull call, but prefer to get a really good skew to protect the position from adverse price movements, or from volatility crush.


Regards


Magdoran

 

[wayneL]

Hello Ducati and Wayne,


Can I ask a dumb question here? What exactly are we trying to do here?

Mag,

The Duc was suggesting that the OPM's were missing a component of risk assessment and therefore flawed pricing in situations "Rumsfeldian" (known unknowns etc)

I agree. And not having delved into the actual mathematics of BS, BM, CR&R etc, I wanted to see where Duc was going with this.

Cheers

 

[ducati916]

enzo & Mags

I haven't really had time to look at the current example in respect to some of the numbers involved, but this is the basic gist;

You own an Option on a gold producer [medical company] exerciseable at $50 million, or $1.00/share. The mine has a value of $100 million if the price of gold = $600+ or $40 million if the price of gold = $400 or less.

You have no firm knowledge of whether the price will be high or low, but based on your calculations of [volatility, beta, Black/Scholes, charts, etc]
You have the odds at 75% high, 25% low

The mine will be depreciated [depleted] at the rate of $10 million/annum.
So what is the value of your Option?

Value of hold = [0.75*($100 - $10 - $50)] + (0.25*$0.0) = $30 million
Value of exercise = [-$50 + (0.75*$100) + (0.25*$40) = $35 million

Therefore, the value of exercising the option is greater than waiting.
If this quick cross-reference reinforces your existing analysis, then you would have further confirmation for the trade. If the value were lower, you may look at your values.

Obviously you need an estimate, or reasonably solid figures to work with.
If FRX wins the case, it is worth $X per share, if lose, $Y per share.
Still working through this area at the moment.

jog on
d998

 

[Hopeful]

RIG (a US stock) is currently trading at 70.45 , Oct calls with a 75 strike are selling for 1.90. So then I hit the bid and short the call then go buy the stock. If it goes down to 70.45 minus 1.90 = 68.55 then I exit with a small loss (brokerage). On the other hand if it ends up anywhere above 68.55 at expiry then I'm laughing (yes, American style means I can get assigned...).
.

The Octobers expired on the 20th with the stock finishing at 70.28. If I had held it until expiry I would have kept the premium (it never reached 75) of $190 . I would have sold the stock on the 20th for 70.28 to completely exit the position.

Entry:

Buy 100 RIG for -7045
Sell 1 Oct 75 call for +0190
Net -6855

Exit:

Sell RIG for +7028
Call expires 0000
Net +7028

NET PROFIT $173 ($165 after commissions with IB)

165/6855 is a 2.4% return in about 7 weeks. Annualised is about 50% return.

I like options . Of course, in this example I ignored the greeks / risk factors. But it's better not to think about risk because that leads to hesitation and hesitation leads to doing nothing *insert tongue-in-cheek here*.

 

[Hopeful]

165/6855 is a 2.4% return in about 7 weeks. Annualised is about 50% return.


No, 18% return - not so hot eh. (well, I did say "idiots guide" didn't I).

Anyho, continuing with this...

(Oct 30 at the close) I think with the market going so well there's a good chance RIG will start to follow along soon. Targetting $83 in about 2 months I propose to sell JAN 80 Calls for 2.20 covered by the stock at 71. See you again in January!