Using the option greeks to trade

[wayneL]

.....following on from the other thread https://www.aussiestockforums.com/forums/showthread.php?t=1366&page=1
and Dutchies question.....

Option greeks are all very acedemic an' all, but few option traders actually use them to trade options!

Why is that? Well one reason is that they are so bloody difficult to understand, and in my opinion, are poorly explained by options authors. This is not the authors fault as they are usually have very mathematical brains and the way they view, and expain the greeks flies over the heads of us mere mortals.

Hopefully, i won't have increased confusion with my explanations LOL

Another reason is than they are sometimes *completey ignored by the seminar industry...are at best, quickly brushed over.

So we mortals start our option trading from behind the eight ball and get worked over by the smarties. ( If you haven't yet, you will. Record low IV's have made it easy to be an option buyer...wait til IV's start bouncing around a bit ) Let me be the first to admit that I started off knowing SFA as well. It was from being defeated by MM's that made me go and learn some more.

So here are the greeks (plus extra considerations) that I use to trade.

implied volatility
delta
gamma
theta
vega
implied volatility skew (thanks for the heads up Possie )

There is one other, Rho, that won't affect us in the current interest rate environment.

I'll work through how to use these in trading as I have time/motivation.

 

[dutchie]

Great Wayne - looking forward to your explanations and examples.
I agree that for beginners the Greeks are ignored as they are too hard to understand as far as their affect on an option trade is concerned.

 

[DTM]

Look forward to your posts Wayne.

Just out of interest, here's a link giving insight to a day in the life of a market maker.

http://www.derivativesstrategy.com/magazine/archive/2000/0700fea1.asp

It's confusing as it is so can't wait for Waynes explanations.

 

[tigeroz84]

Hi Wayne, do u still have the time/motivation to explain the greeks. Please do

 

[BSD]

Record low IV's have made it easy to be an option buyer...wait til IV's start bouncing around a bit )

I would say this lesson would be getting learnt across the board at the moment! Nothing worse than being right and wrong at the same time.

Buyers of vol would be enjoying this market - for the first time in some time.

Do you know many private punters that specifically trade vol though?

 

[wayneL]

Do you know many private punters that specifically trade vol though?

There wouldn't be a lot. But that's because most people are "educated" by "educators" who studiously avoid the subject.... or worse, actively discourage their students even considering it, along with greeks

In reality, whether they realize it or not, they are trading volatility.

 

[mit]

I'm curious then. If the educators ignore teaching the greeks, I can't understand why you wouldn't just trade CFDs because you'll get bitten pretty badly using options solely as a leveraging tool.

MIT

 

[wayneL]

I'm curious then. If the educators ignore teaching the greeks, I can't understand why you wouldn't just trade CFDs because you'll get bitten pretty badly using options solely as a leveraging tool.

MIT

Mit,

Options sound much more mysterious and sexy, so they can charge more... and with CFD,s you can't promote Magic Moo Cows and Share Renting and other such silliness.

You wouldn't believe some of the BS that some option "educators" spew forth.

Cheers

 

[wayneL]

You wouldn't believe some of the BS that some option "educators" spew forth.

Cheers

Some examples regarding covered calls (AKA magic freakin' moo cow & Share Renting, FFS)... Direct quotes:

1/Since the short call is covered by the stock,this strategy has no downside risk. The only upside risk is that you give up the price appreciation above the strike price of the call; however, the call premium paid at the outset may compensate for this risk....

2/Complicated and speculative? NOT AT ALL. Writing covered calls is one of the most conservative investment strategies.... When you buy a stock and sell a covered call against it, you know exactly what the monthly return on that investment will be before you actually buy the stock. The cash shows up in your account the next morning, for you to withdraw or reinvest according to your investment needs and objectives.

3/Writing covered calls is perhaps the safest of all option strategies and possesses minimal risk.

4/ While the covered call writer has no risk of losing huge amounts of money, there is an attendant risk of missing out on large gains.

FFS!!!!! Absolute BS!

 

[sails]

Yep - shout it from the rooftops, Wayne!

One analogy they use that is only partly true is that covered calls is like "renting" shares. However, when one owns a rental property, receiving rent does not cap capital growth - but sold calls can do just that and, under certain circumstances, can actually lock in a loss - but they don't tell you that...

Certainly not for novices imo and like any options position, one needs to know how to manage it properly - just my

 

[professor_frink]

I was given a book last christmas that is choc a block full of this kind of rubbish- won't mention the book but here are some comments he makes-
When describing how a put option(he calls it buying insurance) works-
" say you buy an option for 30c when the stock is at $16 because you think the price will fall. Say it falls to $13, then that insurance will be worth $3.30. In other words you have outlayed 30c can now sell that insurance for $3.30. That's not 10%,or even 100%, but in excess of 1000% on your money and that could occur in a few days or a few weeks."

I love the simplistic way this is described, no mention of selecting an appropriate option to trade, no mention of greeks or volitility. No mention of a strategy to try and find a stock that he thinks will move. Just buy an option- it's just that easy! I loved the way he casually mentioned a $16 stock moving down to $13 in a matter of days or weeks, like it happens all the time. A near on 20% fall on a share that you can leverage into an options trade to make a 1000% return is easy folks, didn't you know?

The section on share renting came after this bit, but alas, I didn't make it that far!

 

[wayneL]

I was given a book last christmas that is choc a block full of this kind of rubbish- won't mention the book but here are some comments he makes-
When describing how a put option(he calls it buying insurance) works-
" say you buy an option for 30c when the stock is at $16 because you think the price will fall. Say it falls to $13, then that insurance will be worth $3.30. In other words you have outlayed 30c can now sell that insurance for $3.30. That's not 10%,or even 100%, but in excess of 1000% on your money and that could occur in a few days or a few weeks."

I love the simplistic way this is described, no mention of selecting an appropriate option to trade, no mention of greeks or volitility. No mention of a strategy to try and find a stock that he thinks will move. Just buy an option- it's just that easy! I loved the way he casually mentioned a $16 stock moving down to $13 in a matter of days or weeks, like it happens all the time. A near on 20% fall on a share that you can leverage into an options trade to make a 1000% return is easy folks, didn't you know?

The section on share renting came after this bit, but alas, I didn't make it that far!

LOL No change in extrinsic value either!!

I think I know the one. Maybe this guy should go back to school after all.

 

[professor_frink]

good guess wayne. It's a shame his strategies were so dodgy, because the early part of that book showed a little bit of promise. Teaching people the first parts of the book that deal with goal setting, paying off debts, becoming financially intelligent, etc are all good ideas. I've got a couple of friends that could benefit from that part of the book, but I can't bring myself to recommend it to them because the strategies at the end of the book are so bad!

 

[hissho]

Hi Wayne

I'd like to hear how you use the Greeks to trade, with some examples and strategy analysis. Quite a lot of ppl are looking forward to it as well.

thanks a lot
hissho

 

[wayneL]

Hi Wayne

I'd like to hear how you use the Greeks to trade, with some examples and strategy analysis. Quite a lot of ppl are looking forward to it as well.

thanks a lot
hissho

Am doing some work on this

But briefly, There are six greeks as far as the retail trader is concerned.

Delta
Gamma
Sigma (volatility)
Vega
Theta
Rho

When you take on an options position you are actually taking six positions, represented by the above greek(?) letters (Vega is not a greek letter)

Most traders only consider Delta (Direction) and/ or Theta (time decay) and disregard the other greeks. This can be costly.

To describe all the consideration of trading with greeks would require a book sized tome to describe and must be done on a strategy by strategy, position by position basis. There are numerous hints and references in posts by myself, Sails, Magdoran and others throughout this forum. Keep your eyes skinned for references to greeks. There was a paper trade posted here on OSH somewhere (use the search function) that was an attempt to trade primarily Vega, with some Gamma as well. Although I lost track of it when returning to the US market it did turn out quite well in the end.

Cheers

 

[RichKid]

Am doing some work on this

But briefly, There are six greeks as far as the retail trader is concerned.

Delta
Gamma
Sigma (volatility)
Vega
Theta
Rho

When you take on an options position you are actually taking six positions, represented by the above greek(?) letters (Vega is not a greek letter)

Most traders only consider Delta (Direction) and/ or Theta (time decay) and disregard the other greeks. This can be costly.

To describe all the consideration of trading with greeks would require a book sized tome to describe and must be done on a strategy by strategy, position by position basis. There are numerous hints and references in posts by myself, Sails, Magdoran and others throughout this forum. Keep your eyes skinned for references to greeks. There was a paper trade posted here on OSH somewhere (use the search function) that was an attempt to trade primarily Vega, with some Gamma as well. Although I lost track of it when returning to the US market it did turn out quite well in the end.

Cheers

Yep, there certainly is a lot posted already in this forum, by Wayne in particular, I like to re-read the material from time to time, it certainly helps!

 

[Magdoran]

Hello All,


Salutations to Wayne for making the effort here to address what is probably the most involved area of options trading – understanding the nature and effect of the “Greeks”.

Since there are so many variables involved, perhaps it would be worthwhile to narrow down some areas of interest into modules. The options mentoring thread is effectively addressing the definitions for the Greek components, as well as addressing some strategies, hence it’s a great resource for information.

Why don’t some of the people who are interested in asking questions outline what they are looking for? Key notions are what kind of trader/investor are you? Here are some attributes to consider:

• Time Frame - Long term, swing/position trader, day trader?
• Risk tolerance – aggressive, conservative, moderate, etc?
• Analysis approach – fundamental, technical, other?
• Investment approach – growth, income, speculation, portfolio protection/diversification/hedging?
• Available time – how much effort will you commit?
• Tools – software/connection/hardware, texts, etc?
• Knowledge and experience – what do you need to know?

Why this is important is that there are so many elements to derivatives. Your requirements are unique. What the more experienced players can do is to relate their experiences, and point you towards knowledge that may be relevant to your situation, but requires a degree of application and study by people who are learning.

The area is so vast, it is unlikely anyone will know all the aspects that are relevant to you, but at least you can glean enough to form a foundation for developing key knowledge and skills.

So, let’s see some posts covering areas like hypothetical trade/investment scenarios, options questions, and trading/investing profiles. This would help to address what people really want to know… how does that sound?


Regards


Magdoran

 

[hissho]

Why don’t some of the people who are interested in asking questions outline what they are looking for? Key notions are what kind of trader/investor are you? Here are some attributes to consider:

• Time Frame - Long term, swing/position trader, day trader?
• Risk tolerance – aggressive, conservative, moderate, etc?
• Analysis approach – fundamental, technical, other?
• Investment approach – growth, income, speculation, portfolio protection/diversification/hedging?
• Available time – how much effort will you commit?
• Tools – software/connection/hardware, texts, etc?
• Knowledge and experience – what do you need to know?


Magdoran

Thanks Mag!
time frame--->days to weeks; but i don't wanna spend a whole day sitting in front of my computer; one hour for opening and one hour closing would be fantastic
risk tolerance--->moderate to aggressive
analysis approach--->70% fundamental and 30% technical
investment approach--->income
available time--->as many as required; the goal is to spend 1 hour when the market opens and 1 hour closes so that i can do other stuff during the rest of the day otherwise i would be finding myself another job...
tools--->Optus broadband; bought a few books; still deciding which software i need to purchase...
knowledge and experience--->not much; bull put spread is not the HolyGRail which i found out after doing 3 trades; wasted $$$ on expensive course etc. now decided to do whatever it takes to learn the real stuff.

I'd like to see an example of how a trade is done: what are the steps you take to find potential profitable trades, filter out and decide the trade you are most comfortable with---that is, i'd like to know the whole process(briefly). btw i'll share all the lessons i've learnt so far in another post. Be prepared to be shocked what a terrible trader was like.

again thanks a bunch for the time and help
hissho

 

[Magdoran]

Warning!!!: Options may or may not be suitable for different investment goals, and individuals may wish to seek suitable professional advice for more information.

Using options effectively is an involved process, and any of the examples used here may or may not yield the returns published in real market conditions – it is possible for substantial losses to be realised trading leveraged instruments, hence traders/investors should take this into account before investing.

Also, please consult the ASX website for documentation/courses on Derivatives: http://www.asx.com.au/index.htm


Hello hissho,


If you wouldn’t mind, could you give me a little more detail on your investment approaches please?

Experience/Knowledge:
• What were your previous strategies you used in the market?
• What was the time frame you held the above investments?
• Can you outline how you traded the bull puts?
• What were the key take away ideas from the course you attended?

Analysis:
• What kind of fundamental analysis do you use?
• What is your entry and exit criterion?
• Please describe the technical approach you use and how you incorporate this with your fundamental approach.

Risk:
How much are you prepared to lose on each trade (what is the maximum loss you can tolerate?)? Are you prepared to lose?:
• 50%?
• 100%?
• 20%?
• Another amount?

Tools:
How much funds are you willing to allocate to:
• Purchasing options software?
• Ongoing data costs?
• Further training?
• Text books?

Investment Goals:
• By income do you mean gaining profits from using short term directional option strategies, or are you aiming for longer term credit spreads for instance?
• Have you considered dividend strategies with endowment/instalment warrants?
• Do you have an existing portfolio – please expand if so (options for hedging?)
• How long do you want to be in the option position for?
• Will you need your trading capital for use in other areas?
• Are you aiming to make a sole living from trading?

Using Options strategies:
• Do you have a preference for directional or non directional approaches?
• What kind of returns are you looking for over what time period?
• What options texts do you have?
• Do you have any trading/investing software? If so, what is it?

Gee, this list has grown, hasn’t it? But please try to give me some information to allow me to formulate some approaches on several different levels which you may want to look at…


Regards


Magdoran

 

[Magdoran]

Hi All,


Sorry, shouldn't have asked such personal questions in a public forum... but working on a scenario for posting soon...



Magdoran