We all know options are derivatives, and their prices are derived from the underlying stock, index, or ETF. But with other factors at work - implied volatility, time decay, etc. - how can you know how much an option is going to move with respect to said underlying? Very simple - check out its delta.
Delta is arguably the most heavily watched Greek, as it offers a quick-and-dirty way of telling us what to expect from our option positions as we watch the price action of the underlying. Calls have positive deltas, as they typically move higher on a rise in the stock, and puts have negative deltas, as they typically move lower when the stock rises.
While some investors view delta as the percentage chance an option has of expiring in-the-money, it is really more of a way to project expected appreciation or depreciation. A delta of 50 for a call suggests the option should move 50 cents higher when the stock jumps a dollar, and lose 50 cents for every dollar loss in the stock.
But delta is only foolproof when all other factors hold static, which is rarely the case (and certainly never the case for time decay). If an option is moving more (or less) than its delta would suggest, it is likely because other variables are shifting. For example, buying demand might be pushing implied volatility higher, raising the price of the options. Still, this king of all Greeks is a good starting point for gauging how your options are likely to move.
lundi 28 novembre 2011
dimanche 13 novembre 2011
Ce que tout débutant devraient savoir aus sujet des options
What Everybody Ought to Know About Options...the biggest pitfalls rookie Option Traders Make
Two (2) big pitfalls that novice option traders make and easy ways to not make those mistakes.
When an investor realizes the great leverage power of options and begins to dabble (se mouiller) in them in their brokerage account or IRA...we always see them make the same mistakes time and again.
1. Those who are new to options are immediately attracted to the very cheap "lottery ticket" type Out-of-The-Money (OTM) options.
By this we mean the options that are priced at 0.25 ($25) or below, for example. These are the OTM Calls and Puts that can potentially give very big gains, but have a low probability of success. These options tend to have a very low Delta (which is an Option Greek that can be interpreted as a probability of the option expiring In-The-Money (ITM)).
Additionally these options have no "intrinsic value" and are 100% "time premium", so you will lose value on the them due to time decay as the clock ticks towards expiration. And you may also lose value due to decay in implied volatility (Vega option greek).
So you should tend to prefer ITM options. These generally have a lesser amount of time premium and implied volatility built into them and have a higher Delta — so basically you normally get more "bang for the buck" with an In-The-Money option. Additionally your overall volatility should be less when trading these versus very cheap OTM options.
2. Traders enter positions without a gameplan, or specific targets and rules for taking profits and limiting losses.
Letting a winning trade turn into a loser, or letting a small moderate loser become a big loser.
This comes down to discipline and having a organized set of rules. For example, if a trade doubles (goes up 100%), you may have a rule that you exit half of your position immediately, then you basically have a "free trade" on the remainder of your contracts.
You also could have specific targets for the underlying stock/ETF/security and when those are reached you exit part or all of your position, regardless of where the option price is. Another valuable strategy is to have a trailing stop-loss for winning positions, so that you can stay in the winners and let them run, but if it pulls back by a certain amount you still lock in your profits. Or you can have set rules such as taking partial profits at 25%, 50%, etc.
But the bottom line is that without having systems, rules, indicators, and discipline you are somewhat trading "blind".
And for the losing trades…we've all had them. First, I've learned through experience that the best trades tend to go your way quickly. If a "perfect" setup is just sitting there and not going your direction, it may be time to cut bait and move on to the next opportunity.
Next to the problem of "hope and wait" on losing trades (also known as "Hopeium"), this is how a small 15% or 20% loser can turn into a 50%, 75% or even 100% losing trade. And those can put a big damper on your portfolio and create a trading hole that you then have to dig out of.
So limit your losses to small amounts. The goal in general is to have winning trades be 2x to 3x the size of losing trades, depending on the win/loss ratio of your strategy. Have rules and discipline in place on your option trades. For example, have a specific stop-loss, or a technical indicator that when violated gives an immediate exit on the position.
In general, having a clear trading plan with systems, rules, indicators and goals will provide more confident and successful trading results over the long run.
Two (2) big pitfalls that novice option traders make and easy ways to not make those mistakes.
When an investor realizes the great leverage power of options and begins to dabble (se mouiller) in them in their brokerage account or IRA...we always see them make the same mistakes time and again.
1. Those who are new to options are immediately attracted to the very cheap "lottery ticket" type Out-of-The-Money (OTM) options.
By this we mean the options that are priced at 0.25 ($25) or below, for example. These are the OTM Calls and Puts that can potentially give very big gains, but have a low probability of success. These options tend to have a very low Delta (which is an Option Greek that can be interpreted as a probability of the option expiring In-The-Money (ITM)).
Additionally these options have no "intrinsic value" and are 100% "time premium", so you will lose value on the them due to time decay as the clock ticks towards expiration. And you may also lose value due to decay in implied volatility (Vega option greek).
So you should tend to prefer ITM options. These generally have a lesser amount of time premium and implied volatility built into them and have a higher Delta — so basically you normally get more "bang for the buck" with an In-The-Money option. Additionally your overall volatility should be less when trading these versus very cheap OTM options.
2. Traders enter positions without a gameplan, or specific targets and rules for taking profits and limiting losses.
Letting a winning trade turn into a loser, or letting a small moderate loser become a big loser.
This comes down to discipline and having a organized set of rules. For example, if a trade doubles (goes up 100%), you may have a rule that you exit half of your position immediately, then you basically have a "free trade" on the remainder of your contracts.
You also could have specific targets for the underlying stock/ETF/security and when those are reached you exit part or all of your position, regardless of where the option price is. Another valuable strategy is to have a trailing stop-loss for winning positions, so that you can stay in the winners and let them run, but if it pulls back by a certain amount you still lock in your profits. Or you can have set rules such as taking partial profits at 25%, 50%, etc.
But the bottom line is that without having systems, rules, indicators, and discipline you are somewhat trading "blind".
And for the losing trades…we've all had them. First, I've learned through experience that the best trades tend to go your way quickly. If a "perfect" setup is just sitting there and not going your direction, it may be time to cut bait and move on to the next opportunity.
Next to the problem of "hope and wait" on losing trades (also known as "Hopeium"), this is how a small 15% or 20% loser can turn into a 50%, 75% or even 100% losing trade. And those can put a big damper on your portfolio and create a trading hole that you then have to dig out of.
So limit your losses to small amounts. The goal in general is to have winning trades be 2x to 3x the size of losing trades, depending on the win/loss ratio of your strategy. Have rules and discipline in place on your option trades. For example, have a specific stop-loss, or a technical indicator that when violated gives an immediate exit on the position.
In general, having a clear trading plan with systems, rules, indicators and goals will provide more confident and successful trading results over the long run.
jeudi 10 novembre 2011
Gamma Boosting
Again what is Gamma? Well as you may know it is one of the 'Option Greeks', mathematical functions that are part of the option pricing formula. Specifically, Gamma refers to the rate of change in Delta in the option per each $1.00 move in the underlying security.
But Gamma has many uses outside of options trading - this ancient Greek symbol is used in probability, engineering, physics and many other sciences. In popular culture, remember that the Incredible Hulk (trademark Marvel) was formed when Dr. Bruce Banner, a mild mannered scientist, was exposed to a "Gamma bomb".
This Gamma exposure brought out a very strong side to Banner in the form of the Hulk; it magnified parts of his personality and basically was a massively "leveraged" form of himself.
Similarly, the way you utilize Gamma in your aggressive option selection is designed to accelerate the leverage for you with as little cash outlay as possible. What is the technique to utilize in order to maximize profits with aggressive directional trade?
Basically, you will focus on the "high Gamma" options in the 1 week to 1.5 month expiration area. These offer the biggest 'bang for the buck' with a relatively small cash outlay. This provides a great risk/reward package.
Normally the Gamma Booster options that you should choose are near-the-money, usually a bit out-of-the-money (OTM) ... although they can also be at-the-money (ATM) or even in-the-money (ITM). But we're finding that the optimal 'sweet spot' between Delta, Gamma, Theta and Vega is often 1 or 2 strikes OTM in the front month options.
But Gamma has many uses outside of options trading - this ancient Greek symbol is used in probability, engineering, physics and many other sciences. In popular culture, remember that the Incredible Hulk (trademark Marvel) was formed when Dr. Bruce Banner, a mild mannered scientist, was exposed to a "Gamma bomb".
This Gamma exposure brought out a very strong side to Banner in the form of the Hulk; it magnified parts of his personality and basically was a massively "leveraged" form of himself.
Similarly, the way you utilize Gamma in your aggressive option selection is designed to accelerate the leverage for you with as little cash outlay as possible. What is the technique to utilize in order to maximize profits with aggressive directional trade?
Basically, you will focus on the "high Gamma" options in the 1 week to 1.5 month expiration area. These offer the biggest 'bang for the buck' with a relatively small cash outlay. This provides a great risk/reward package.
Normally the Gamma Booster options that you should choose are near-the-money, usually a bit out-of-the-money (OTM) ... although they can also be at-the-money (ATM) or even in-the-money (ITM). But we're finding that the optimal 'sweet spot' between Delta, Gamma, Theta and Vega is often 1 or 2 strikes OTM in the front month options.
Minimiser le "Bid/Ask Spreads"
Minimize Bid/Ask Spreads to Maximize Your Profits. What is the True Price of an Option ?
The bid/ask pricing on an equity, index or ETF option can vary from a couple cents to a couple dollars these days. In general, bid/ask spreads are narrower than in the past due to multiple exchanges, the prominence of electronic trading and market makers competing for retail option order flow.
It’s important to remember that you don’t always have to pay the offer or sell the bid when you trade options. Especially when the spread between the bid/ask is wide, you can quite often successfully “work” a limit order that is much closer to the option’s true value.
What is an option's true value? Well … there are theoretical values based upon implied volatility and the other greeks which are readily available on many trading platforms these days — but the rule of thumb I often use is to take the mid-price between the bid & ask as the “fair price” at that moment in time for the option. Be sure to check a couple strikes around the one you are interested in as well, to make sure that one particular option is not out of line in terms of pricing and implied volatility.
The primary obligation for market makers is to provide a liquid market and fill customer order flow. The key to remember is that the one of the main profit generators for delta-neutral market makers is the bid/ask spread — because they “hedge off” the deltas that they buy/sell when they take the other side of an order. For every option buyer, there is a seller, and vice-versa. The market making firm is on the other side of your transaction.
So the wider a bid/ask spread is, the more the theoretical (and often actual) profit margin that a market maker gains. For example, if an option is bid 2.00, offered 2.50 … the MM is paying $200 and selling for $250. In a perfect world, he/she would buy and sell the exact same amount of those options for those exact prices … leaving a net position of 0 at the end of the day and a risk-free arbitrage profit of $50 per contract traded.
In that hypothetical example, the overall profit margin of the bid/ask spread is 25% … also based on the mid-price (aka the estimated fair value) of 2.25, if you pay the straight ask or sell the bid, you’re giving up about 11% “edge” on both sides of the transaction to the market makers. So as a retail options trader, it’s in your best interest to narrow the spreads as much as possible.
In this example if you paid 2.40 for the option, you’re lowering your cash outlay and maximum risk by $10 per contract, or about 4% from the 2.50 price. You’re also reducing the edge over fair value you give up to $15 from $25 … down to only 6% profit margin on each side of the trade (much more reasonable in my view).
The good thing is that nowadays with so much competition for option volume (and with $1 strikes, 0.01 price increments, etc), you are much more likely in an example like the above to get filled on a limit order below the ask or above the bid.
In the “old” days of fraction option pricing when I was a CBOE floor market maker, the minimum increment on options was generally 1/8 on options over $3 (1/16 below that) — equating to $12.5 or $6.25 — today you see 0.02 ($2) bid/ask pricing on the SPYders for example, a much better deal for retail investors.
When you are dealing with “multi-legged” trades (those with more than one option involved) such as debit spreads, calendar spreads, credit spreads, butterflies and condors, the effect of the bid/ask spread is multiplied. You are dealing with 2x the bid/ask spread on most 2 legged trades for example. So it is even more important there to calculate a fair value and then work your order to not give up too much to those taking your trade.
Let’s look at a case study example of this : We had nice profits on the Regional Banks ETF (RKH) with a bearish Put debit spread. RKH is one of those equities where the quoted prices on the options are often much more wide than the “real” prices where you can get filled.
In this situation, our 5 point debit spread was priced at 2.80 by 4.00 (our subscribers paid 2.20). In this case you take the bid/ask average of 6.80/2 or 3.30 to garner what is the estimated real value at that moment in time. So we issued our exit price alert to sell half the position at 3.20 … giving up only $10 below what looked to be the fair value (additionally this position was fairly deep in-the-money at this time, which made it more likely to be filled near the true value).
We got filled basically instantly at better prices than our limit order and the quoted bid/ask prices narrowed significantly as well for a time. You may wonder why don’t they leave the bid/ask prices narrower all the time?
Well, on a security like this, it sometimes looks like there may be an unspoken agreement among those who make markets in the options to leave the bid/ask prices wider than they really are (to take advantage of market orders and novice traders). I’m not saying this is a nefarious conspiracy, it can just be that the primary market making firm has a default bid/ask pricing in the computer with very wide bid/ask spreads.
Generally low volume on either the underlying or its options can contribute to these wider posted bid/ask spreads. They also don’t want to be caught off guard by a slew of electronic orders that may precede a big move in the stock, so they give themselves more slippage by posting wider bid/ask spreads. Nonetheless you don’t ever want to give up that much edge when trading.
Competition For Orders Can Narrow Bid/Ask Spreads
Bottom line, more and more options have $1 strike price increments and options that may have only a few cents between the bid/ask spread. This growing trend is beneficial to the retail trader. And if a security is moving very quickly (and has narrow spreads) you may not even want to work a limit below the offer or above the bid). But you must be aware of the bid/ask spread when trading, and don’t be afraid to work an order with limit prices closer to the mid-price, especially when spreads are wide.
Look at it as a % basis of the option’s cost, not the $ amount … for example, 0.40 on a 2.00 option is 25%, while 0.40 on a 6.00 option is only 6.7%. Keeping in your pocket that extra $5, $10, $20 or more per contract when the pricing seems out-of-whack can add up to $100s and $1000s a year that you will be saving and go to increasing your bottom line. And with the increased competition among market makers and exchanges, you will get filled at your good limit price much more often that you think.
Utiliser la volatilté
Three (3) Options Trading Strategies to Fight Volatility
One rule of thumb regarding the VIX is that it measures the expectation priced into options for the potential movement of the SPX over the next 12 months (based on 1 month of option pricing). So a VIX of 36 means that SPX option traders/market makers are pricing that the SPX could move up OR down 36% over the next 12 months quite a high volatility level on both a historical and a real basis, in my view.
Remember that for every option purchase there is a corresponding option sale so with implied volatilities high (which, combined with time value, comprise the premium in option prices), let's take a look at the basics of some option trading strategies that incorporate option selling. This way you can have a portion of your portfolio that receives time decay and can benefit from volatility going down.
Here are a few strategies that will allow you to sell implied volatility/option premium, as well as buying it:
1. Selling Covered Calls/Covered Puts
The simplest of these 3 strategies, this is basically selling an out-of-the-money (OTM) Call against a long stock position you may own. This can be done at the time of the stock purchase (Buy/Write), or against an existing stock position (to protect gains and/or lower cost basis).
On the flip side, against a short stock position, you can sell an out-of-the-money "Covered Put". In both of these situations, you end up collecting a "credit" for selling an option, putting yourself "short" time premium and implied volatility. The tradeoff for receiving a credit and lowering your cost basis is that you will limit your potential upside gain to the strike you sold. You will receive the benefit of time premium decay ("Theta") and also potentially gain if the implied volatility on the option you sold comes down.
2. Credit Spreads
Without going into too much depth, a Credit Spread (also known as a "Vertical Bull or Bear Spread"), involves selling an option and buying another option of the same stock in the same expiration month, but of a different strike.
Normally on a credit spread we would be selling an at-the-money (ATM) or OTM strike and buying a further out strike. So, for example, a Bearish December Credit Spread on XYZ stock (with XYZ shares at 52) might be to sell the December 55 Call while simultaneously buying the December 60 Call.
3. Horizontal Calendar Spreads
The most advanced of the strategies I'm discussing today is Calendar Spreads. This involves trading an option in the Front or Second month for example, and hedging with an option of the same stock, same strike, but in a further out Expiration month. The further out option can be as far out as LEAPs out a year or two ahead.
A Calendar Spread can in effect be a "Vega" trade, but it can also be done as a "Theta" collection trade. The far out options are basically all Vega, so if you are banking on implied volatilities coming down, you would be looking at Buying the Front or Second month option and Selling the Further out option, such as a LEAP.
Another simpler version of a Calendar Spread would be to flip this around by selling a Front Month as it approaches Expiration and buying a Second Month, in order to collect the rapid time decay of the final two weeks heading into Expiration.
These kinds of strategies are fairly complex and should be evaluated in an Options Position Analytic software of some sort (most option brokers offer these in their trading platforms nowadays) – in addition you will want to track how the further out implied volatilities move in relation to the front months, as they will not move at the same rate.
If you are interested in trading these kinds of advanced options strategies and more, you will generally need a Margin Account with your Brokerage House, as well as the proper Options Trading Approval to trade a variety of option strategies. Contact your Broker for more info.
And as I mentioned, I am just touching on the basics of these multi-leg advanced trading strategies. There are many other strategies where you can benefit from moves in implied volatility and receive time decay, such as Diagonal Spreads, Ratio Spreads, Butterflies, Iron Condors, etc.
Most often utilized strategies utilized are Debit Spreads (good with ETF's) and Diagonal Spreads. Research "white papers" available at no cost on these two specific strategies.
One rule of thumb regarding the VIX is that it measures the expectation priced into options for the potential movement of the SPX over the next 12 months (based on 1 month of option pricing). So a VIX of 36 means that SPX option traders/market makers are pricing that the SPX could move up OR down 36% over the next 12 months quite a high volatility level on both a historical and a real basis, in my view.
Remember that for every option purchase there is a corresponding option sale so with implied volatilities high (which, combined with time value, comprise the premium in option prices), let's take a look at the basics of some option trading strategies that incorporate option selling. This way you can have a portion of your portfolio that receives time decay and can benefit from volatility going down.
Here are a few strategies that will allow you to sell implied volatility/option premium, as well as buying it:
1. Selling Covered Calls/Covered Puts
The simplest of these 3 strategies, this is basically selling an out-of-the-money (OTM) Call against a long stock position you may own. This can be done at the time of the stock purchase (Buy/Write), or against an existing stock position (to protect gains and/or lower cost basis).
On the flip side, against a short stock position, you can sell an out-of-the-money "Covered Put". In both of these situations, you end up collecting a "credit" for selling an option, putting yourself "short" time premium and implied volatility. The tradeoff for receiving a credit and lowering your cost basis is that you will limit your potential upside gain to the strike you sold. You will receive the benefit of time premium decay ("Theta") and also potentially gain if the implied volatility on the option you sold comes down.
2. Credit Spreads
Without going into too much depth, a Credit Spread (also known as a "Vertical Bull or Bear Spread"), involves selling an option and buying another option of the same stock in the same expiration month, but of a different strike.
Normally on a credit spread we would be selling an at-the-money (ATM) or OTM strike and buying a further out strike. So, for example, a Bearish December Credit Spread on XYZ stock (with XYZ shares at 52) might be to sell the December 55 Call while simultaneously buying the December 60 Call.
3. Horizontal Calendar Spreads
The most advanced of the strategies I'm discussing today is Calendar Spreads. This involves trading an option in the Front or Second month for example, and hedging with an option of the same stock, same strike, but in a further out Expiration month. The further out option can be as far out as LEAPs out a year or two ahead.
A Calendar Spread can in effect be a "Vega" trade, but it can also be done as a "Theta" collection trade. The far out options are basically all Vega, so if you are banking on implied volatilities coming down, you would be looking at Buying the Front or Second month option and Selling the Further out option, such as a LEAP.
Another simpler version of a Calendar Spread would be to flip this around by selling a Front Month as it approaches Expiration and buying a Second Month, in order to collect the rapid time decay of the final two weeks heading into Expiration.
These kinds of strategies are fairly complex and should be evaluated in an Options Position Analytic software of some sort (most option brokers offer these in their trading platforms nowadays) – in addition you will want to track how the further out implied volatilities move in relation to the front months, as they will not move at the same rate.
If you are interested in trading these kinds of advanced options strategies and more, you will generally need a Margin Account with your Brokerage House, as well as the proper Options Trading Approval to trade a variety of option strategies. Contact your Broker for more info.
And as I mentioned, I am just touching on the basics of these multi-leg advanced trading strategies. There are many other strategies where you can benefit from moves in implied volatility and receive time decay, such as Diagonal Spreads, Ratio Spreads, Butterflies, Iron Condors, etc.
Most often utilized strategies utilized are Debit Spreads (good with ETF's) and Diagonal Spreads. Research "white papers" available at no cost on these two specific strategies.
Inscription à :
Articles (Atom)