What Makes a Great Trader Part I

With summer ending and trading volume expected to rise, it might be a good time to give yourself a mental break and reflect on your trading before the fall.  Are you the great options trader you thought you would be by now or have you ever wondered what  truly makes a great options trader? I mean not a options trader that does pretty well, but one that you envy and want to be? Are great options traders just born that way? Does being smarter necessarily give you an advantage in options trading? Is studying charts until you are bleary-eyed from looking at them the secret; or is it just dumb luck on who succeeds and who fails? 

The qualities that you will need to succeed in my opinion are a commitment to success, having a options trading plan and the most important, mastering your emotions-or the psychology of options trading. I believe that options trading is the hardest job in the world (quite possibly the best, but the hardest). That's why it will probably take you a lot longer than you think before you really get a solid grip on it.

So let's first talk about your commitment to success. This essentially sounds like the easiest of the three qualities to master doesn't it? Why does anyone want to become a options trader in the first place? Probably, because they want to become wealthy and very successful. Who isn't committed to that, right? All you need is some money, charts, and a platform and you are on your way. Almost everyone says they are committed but most people are not because when they find out options trading is work-and it is. They tend to lose their focus and their original goals when the going gets though.

If you are committed to success then you must be committed to reaching your goals. The most important part of having goals is to write them down. If you never write them down they are simply just dreams. We don't want to dream we are a great trader we want to realize that we are! Only about 2% of Americans write down their goals. Is it really shocking to know that most people never achieve what they want out of life? As "corny" as it may seem, when you write something down no matter what, your thoughts are transformed from the subconscious to the conscious and are now tangible. Your goals have become something you can see and say out loud. If you never write them down they never exist outside of your thoughts.

Let me leave you with this before I end this introduction on how we are going to build a great options trader out of you. I think everyone can agree whether you are a beginning options trader or a more experienced options trader that there are several key components you will need to do to become a standout. Having said this I also know that most of you will not be committed to do this at first. I know I wasn't. I thought to myself I am too smart and I know how to options trade. I knew it would not be easy but I was unprepared for the results that followed. I'll give you a hint, they weren't good. After I decided to fully commit myself and write down my goals did my results finally change. Let's face it; options trading is a realm like no other. Options trading looks easy and which in turn makes you lazy to work at it. Be committed to your success and write down your goals right from the start will only help you achieve the success you are after that much quicker.

 

 This article is proposed by John Kmiecik - (Senior Options Instructor) at Market Taker Mentoring

The Three (3) Types of Volatility, an explanation...

Understanding The 3 Kinds of Volatility
With recent market activity in assets like Bonds, Gold and Japan, it reminds traders that prices can go down as well as up — and we're suddenly starting to hear more about volatility again.  Today we'll discuss the different types of volatility related to stocks and ETFs.

1) Historical Volatility -  The first type of volatility is Historical Volatility, or HV, which may also be referred to as Realized Volatility.  Historical volatility is something that we can observe and measure based on the past price movements of a security.  It is typically calculated as the standard deviation of the security's daily returns over some lookback period.  For example, the 30-day historical volatility, or HV(30), calculates the standard deviation of the daily gain or loss from each of the past 30 trading days.

Volatility is almost always expressed in annual terms, regardless of the lookback period.  Therefore, if a stock has an HV(30) value of 45, it means that if the stock continued to move as it has for the past 30 days, it would likely experience a total price change of 45% (up or down) over the next year.  If we assume that daily returns are normally distributed, then we can infer that there is approximately a 68% probability of the price landing somewhere in this range.

Although HV is an expression of how much a stock's price may change in a year, it's more typically used as a way of comparing the recent price behavior of two securities.  If XYZ has an HV(100) value of 25 and PQR has an HV(100) value of 75, then we know that PQR has experienced more extreme price changes over the past five trading months.

2) Relative Volatility – Sometimes you'll hear Beta used as a measure of Relative Volatility.  From a mathematical standpoint, Beta is the correlation coefficient between two price series.  The Beta value of a stock or ETF is most often computed relative to the market as a whole, which in most cases means the S&P 500 (SPX) (SPY) for the US market.

A Beta value greater than 1 means that the stock generally moves more than the market, while a value of less than 1 means that the stock typically moves less than the overall market . Negative values, i.e. negative correlations, mean that the stock price has a tendency to fall when the market rises, and vice versa.

3) Implied Volatility – The final type of volatility that we'll address today is Implied Volatility, or IV.
Implied volatility cannot be calculated from historical prices of the stock, but rather is the byproduct of an options pricing model.

In simplest terms, IV is an expression of the market's expectation of the future volatility of the stock price between now and the option's expiration.  Market participants "express" themselves via the prices they are willing to pay for option contracts.  Like HV, implied volatility is always annualized to make comparison of values more straightforward.

Each unique option contract, i.e. combination of put or call, strike price, and expiration date, will generate a different implied volatility value.  These values are often combined to provide some sort of "consensus opinion" of the IV of the stock.  For example, your trading platform may display an IV value for each expiration date, which was likely calculated with some type of weighted average of all the different strike prices for that expiration.  The different IV values for each expiration date will indicate whether the market is expecting more volatility in a specific time-frame, like when quarterly earnings are announced.
You might also see IV expressed over a constant lookahead period such as 30 days.  The CBOE Volatility Index, or (VIX) (VXX), is the most popular metric of this type.  While a full discussion is beyond the scope of this article, the basic idea behind the VIX and similar measures of this type is to use front month and second month option prices to create a synthetic ATM option contract that expires in exactly 30 days.  This synthetic contract can then be used to generate an implied volatility value.  Note that in the case of VIX and related indices, 30 days means 30 calendar days (approximately one month), not 30 trading days.

From Matt Radtke - tradingmarkets.com

The 3000 Year History of Options

A 3,000 year History of Options, Derivatives, and Futures Trading.

1700 BC – The history of derivatives is very long, there is even a reference in the Bible - Genesis 29 where Laban offers Jacob an option to marry his youngest daughter Rachel in exchange for seven years of labor.  After seven years Laban reneged and only offered his eldest daughter Leah.  Luckily for Jacob, polygamy was allowed in those days so he was able to marry Rachel as well later on.

580 BC – The History of Derivatives goes back to ancient times.  Thales of Milesia, a pre-Socratic Greek philosopher and considered one of the seven sages of Greece, was thought to have bought options on olive presses.  His prediction was for good weather and a bumper crop, which ended up making him a fortune.

1637 – One of the celebrated events in the history of derivatives is the Tulip Bubble, which was facilitated by forward contracts on Tulips.  As the price of tulip bulbs increased Dutch dealers also started tulip bulb options trading, so that producers could sell the rights to owning tulip bulbs in Call Options. This means of hedging risk turned into speculative frenzy, as the price of tulip bulbs skyrocketed between the end of 1636 to February of 1637.  The contracts were OTC and in the absence of legal enforcement personal reputation was what the trading was based on.

1697 – Dojima Rice Exchange was the first to to trade standardised futures in the history of derivatives contracts and had two types of rice markets – the shomai and choaimai (spot and futures respectively).  Different grades of rice were contracted with standardized agreements.  No cash or vouchers were exchanged; all relevant information was recorded at a clearinghouse.  The contract period was limited to four months at a time and had to be settled prior to contract expiry.  Settlement of the differences in value between the current spot price and the contract had to be done with cash or an opposing contract position.  With a few interruptions and updates, the rice exchange operated until 1937.  Participants in the exchange were required to establish lines of credit with a clearinghouse.  The clearing house assumed the risk of the various counterparties – very similar to today.

1720 - South Sea Bubble – The South Sea Company was a trading concern with interests in South America, and was important also as an important marker in the history of derivatives.  They had a monopoly on trading in this region after the War of Spanish Succession.  In return for this concession the company assumed some of the national debt of England.  Enthusiasm for the share led to the price moving from $100 to $1000 in under a year.  It also fell back equally quickly when expectations about the company became more realistic.  Options and Futures were used widely during this era in London.

1848 – Chicago Board of Trade created, marking a really important date in the history of derivatives.  Chicago was a hub for the storage and transport of grain from the Midwest.  Grain prices rose and fell sharply seasonally.  Storage was also often at a premium following the harvest.  To cope with all these vagaries the “to-arrive” contract was created.  The idea was that the farmer could lock in the price and the deliver the grain at a future date.  This allowed farmers to hedge against price moves and protect themselves.  The contracts became standardized in 1865 and by 1925 a clearinghouse was formed to take away the credit risk element.  That is pretty much the modern commodity future that we still use to this day.

1872 - Russell Sage created the first OTC options in New York, and is a major figure in the history of derivatives.  His business model relied on using the principles of Put-Call Parity.  He would buy the stock and a put from the customer and then sell them a call back – while fixing the put, call and strike prices.  In effect he was creating a synthetic loan, which allowed him to charge much higher rates of interest that the prevailing usury laws allowed.  What is interesting is that he had in 1867 been convicted and fined for usury, so he had just found a very clever way around it.

1972 – The collapse of the Bretton-Woods System and the advent of free floating currencies meant that currency futures became very quickly a necessity.  This was another step in the development and history of derivatives.  This is when the Chicago Mercantile Exchange created the IMM in 1972.  These were the very first time futures were traded on non-physical commodities.  By 1975 there were Interest Rate Futures, initial attempts (based on the Ginnie Mae) did not succeed until one was created based on a Treasury Bill underlying.  It was not till 1982 that an Index Equity future was introduced (on the S&P 500).

1973 – The Chicago Board of Options (CBOE) was created.  This was the first time standardised options were traded through a central clearing house and the prices were listed in the press.  On the first day of trading there were 911 contracts across 16 underlying stocks.  This could again be pointed to as one of the seminal events in the history of the derivatives markets.

1973 – Fisher Black and Myron Scholes introduced a mathematical framework to price options.  This is what we know today as the Black-Scholes equation and this formed the basis for much of the financial engineering that would happen in the next few decades.  In 1973 the first equity Index Options was introduced following hot on the heels of the equity index future.  Without a doubt, the introduction of the Black-Scholes was one of the crucial points in the history of derivatives as it introduced a more scientific framework for the pricing of options. This was the starting point for further developments in the academic and practical study of options.

40th birthday of options trading

Today (April 26, 2013), we celebrate the birthday of options by looking back at the evolution and game-changing innovation of an industry.

Forty years ago, in 1973, the Chicago Board Options Exchange (CBOE) was founded. The first options traded on 16 stocks -- just 911 contracts, all calls -- on April 26, as market makers watched from the "trading floor," which was actually the 4,300-square-foot smoking lounge of the Chicago Board of Trading (CBOT).