Options in Practice: basic questions

RPEX

Active member
Messages
162
Likes
7
Hi,
I have been investing in equities for a few years, and i tried covered warrants but wasn't too keen on their liquidity or how they're issued, now i'm looking at trading well known options strategies. I've done a fair amount of research over the last year or so, but there are still a few things which textbooks and online guides don't really explain.

1. The long straddle: sounds like a fairly straight forward strategy and all the textbooks introduce its basic parts, however few give worked examples, could someone show me? I looked at a straddle usinf ESX ftse100 options ATM, and the break evens were ridiculously far apart - i guess that's at expiration, but how are you supposed to unwind a long straddle position? (sell both parts when the going's good, or trade them separately).

2. Guides describe shorting put as having potentially unlimited losses, but surely the loss cannot be bigger than strike-0 ?

3. I've only recently gained access to watching price movements so please bear with me. The quotes seem to move pretty swiftly (for say near month ATM index options) but the number of fills seems to be quite low, is there something wrong with this picture?

4. I am told that many dealers simply quote volatilities instead of prices, and my broker IB displays many quotes like this through the TWS. I see where the text-book theory comes in, BS and all that, but how can dealers form such a specific view of volatility to 2 dp with such frequency?

5. And this is just a general interest one: how do institutions avoid paying stamp duty? During a brief spell at a hedge fund, a guy told me how no one in the City pays stamp duty, but i wasn't listening cos he had enormous man-boobs.

These are really naive questions, but i'd really appreciate any help on any of these.
 
Rpex,

I'm not familiar with Abottml's recommendation but it certainly looks good. I would also recommend

Amazon.co.uk: Fundamentals of Options Market (Fundamental of Investing): Michael Williams, Amy Hoffman: Books

When I was learning about options I had to reference between 3-4 books simultaneously (although my interest was the theoretical underpinning). So I wouldn't just depend on one book. I would recommend buying both books (good books are always a good investment, and you'll find yourself referring back to them repeatedly).

The good thing about my recommendation is the exceptional clarity with which the greeks are explained.

Look for secondhand versions.

Grant.
 
Cheers for the recomendations guys, maybe i'll trade in my copy of Hull, which is good, but as i say - it glosses over the basic strategies and doesn't describe how to trade them properly.
 
. . .
1. The long straddle: sounds like a fairly straight forward strategy and all the textbooks introduce its basic parts, however few give worked examples, could someone show me? I looked at a straddle usinf ESX ftse100 options ATM, and the break evens were ridiculously far apart - i guess that's at expiration, but how are you supposed to unwind a long straddle position? (sell both parts when the going's good, or trade them separately).
In practice, I've never seen the point in a long straddle for exactly this reason
2. Guides describe shorting put as having potentially unlimited losses, but surely the loss cannot be bigger than strike-0 ?
Exactly right. I remember my firm getting into a big argument with the FSA (or whatever it was originally called) with the Registered Rep exam question "Which of these option stratagies is the most risky . . . ", they thought a short put was riskier than a short call!
3. I've only recently gained access to watching price movements so please bear with me. The quotes seem to move pretty swiftly (for say near month ATM index options) but the number of fills seems to be quite low, is there something wrong with this picture?
All the major IB's exchange -traded equity option prices are quoted automatically these days ie a computer adjusts the option price as and when the underlying move. It's mot uncommon for only 2-3 "traders" to be able to cover the whole of europe these days.
4. I am told that many dealers simply quote volatilities instead of prices, and my broker IB displays many quotes like this through the TWS. I see where the text-book theory comes in, BS and all that, but how can dealers form such a specific view of volatility to 2 dp with such frequency?
In practice, the many desks are simply "flow-trading" ie let supply = demand and attempt to capture the bid/offer spread. It's implied vol that's important here rather than historic vol with in-house models of the skew used to adjust the OTM strikes.
5. And this is just a general interest one: how do institutions avoid paying stamp duty? During a brief spell at a hedge fund, a guy told me how no one in the City pays stamp duty, but i wasn't listening cos he had enormous man-boobs.
dunno, guess it's a privelidge (sp) of being a member firm just as a ltd company doesn't pay VAT
 
Rpex,

Keep the Hull - it provides the theoretical bases (but it is acceptable to skip the calculus sections, isn't it DB?)

I would suggest a lot of option strategies are presented as "simple" solutions to simple expectations, ie movements on the underlying - limited move (range-bound), massive move either way, one way move (up or down).

However, what isn't addressed is where additional danger/exposure may lie and how it may actually compound. For this you need to be able to determine volatility risk (vega), delta risk (rate of change), gamma (rate of change for delta), theta (time decay). The Williams book cited above seems to cover these pretty well. In the final analysis, many simple strategies are actually very complex in terms of expectations/conditions to realise a profit.

DB,

Is there a measure which looks at the change in theta for a change in implied?

Grant.
 
DB,

That made me laugh. Tried to Rep that but was told to spread it around. Sod that. Reputation for Mr Blade's post.

Grant.
 
RPEX,

Are you thanking DB for the William's recommendation? That was mine, not DB's. He'll be along soon to acknowledge it (I've shamed him into doing it now). Glory will be mine.

Grant.
 
Lucky,

Some people simply want it all. We'll see about that when I knock the smug look off his face ("Et tu, Grant?").

Grant.
 
Haha, sorry about that Grant,

When i become master options strategist of the universe, and i write my own manual (for traders not quants) i'll dedicate it to you!

Ambition, mother of all virtues.
 
Rpex,

That's fair enough (as long as my name is above DB's). Shall I accompany you on the book tour?

Grant.
 
I've done a fair amount of research over the last year or so, but there are still a few things which textbooks and online guides don't really explain.

If you are looking for an all-inclusive book detailing the many different Options strategies then the Below mentioned book (abottoml) Is really good. It even goes into minor adjustments needed when the trades start going against you. But like you said there are a few things Textbooks/Guides cant teach. And Experience will teach you that "canned options strategies" need operators watching to adjust for profitability.

Lets take the Collar (L-Stock, L-Put, S-Call) Monthly income is alittle worse than Covered Call (becuase of buying the Puts protection) But if you tweak it just so slightly.

With either the modifications of say (1000 shares L-Stock, 10 L-Puts, 7 S-Calls)
Or you learn Advanced adjustments (Example: Covering the Calls in a down market w/ Call ratio Backspread Or Buying back calls, then Selling your stock position, next Riding the Puts for profits, and then finally reentering Collar again at a new support level)

You would sacrafice monthly income for bigger Capital gains without sacraficing Protection.

I dont know much but what I do know I know well... Collars, IronCondors, and Support/Resistance


In terms of the strategies with options, I have found this book to be very informative (I'm fairly new to options strategies myself):

Amazon.co.uk: The Bible of Options Strategies: The Definitive Guide for Practical Trading Strategies: Guy Cohen: Books
 
Just looked through the Williams book, good practical stuff but hilariously short on any sign of technical detail: it only mentions Black-Scholes in an appendix, a 2 page discursive talk through with no signs of an equation or formula anywhere haha, love it! Not sure if that's cos american style options use BS in a different way, but i'm defnately glad i've got Hull to cover my knowledge of Calculus, Brownian Motion and everything in between!

Digression: Reading a book like this usually fills me with over-confidence, which is usually followed by massive losses, and i realise it was my own fault for not thinking things through etc. But every now and then i come across a site like this online option trading learn free covered call writing equity options and basically loads of instructive sites aimed at making everything seem straight like making a profit is as easy as sitting on yr Rse. The lead up to 2000 was pretty funny, i know quite a few people who thought buying any stock was a licence to print money, average UK folk are quite risk averse and i don't think we'll see this in quite a while (although the boiler rooms of Lisbon, Madrid and Frankfurt would clearly prove me wrong). I was in India at the end of January when everywhere took a pounding: turned out the new middle class over there had ploughed themselves into covered call writing pretty heavily. So i get really anxious when i see more sites like this out there, cos it wrings a bell on my 'soccer-mom' indicator (of noise traders>smart traders), or maybe its cos the author's a woman...dunno. What do you guys think.
 
RPEX,

Over-simplified bollox, and an expensive alternative to vertical spreads. And no mention of volatility. The kind of spiel to fill seminars.

If you want something technical (and I assume you mean 'theoretical', not TA) try Cox and Rubinstein, Options markets.

Grant.
 
Anyone know how LIFFE operates autoquote? I cack handedly did a ratio put spread on Taylor Wimpey last night, when i woke up this morning i should've been the richest man (in my house) but there were no quotes for any TW. options, at all. Then they appeared for about an hour mid-morning then disappeared off the face of the earth.

I know the FTSE Futures options stop trading around news events, (how crap is that), but i can't figure out the rules for smaller equity options.

Also, how much of your option trading is done at Market? With liquid front month ftse options i can usually get done by breaking an arb condition (by sitting in the middle of the spread), but i can't sem to get filled that way on smaller options.

Any help greatly appreciated
 
Last edited:
hey all quick q, if the correlation between two underlying securities (say currency pairs) is x%, does that also imply that the correlation between their implied vols is also x% ?
 
Not necessarily. They will be linked, but the correlation is backward looking, and implied volatilities are foward looking... If one firm had a major announcement coming up, it would most likely have a higher implied vol. Hope that helps.
 
Top