Options in Practice: basic questions

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Old May 15, 2008, 10:26pm   #1
Joined Nov 2007
Options in Practice: basic questions

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.
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Old May 16, 2008, 12:14am   #2
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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

The key for me is to always limit the downside risk to a fraction of the upside potential. So even if you're only right on the direction of the underlying say 50% of the time, you're still up overall in the end.
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Old May 16, 2008, 12:25am   #3
Joined Jun 2006
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.
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Old May 16, 2008, 1:32am   #4
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RPEX started this thread 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.
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Old May 16, 2008, 10:16am   #5
 
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Quote:
Originally Posted by RPEX View Post
. . .
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
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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!
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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.
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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.
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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
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Old May 16, 2008, 11:36am   #6
Joined Jun 2006
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.
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Old May 16, 2008, 1:59pm   #7
 
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Keep the Hull - it provides the theoretical bases (but it is acceptable to skip the calculus sections, isn't it DB?)
yup, deffo, leave that for the quants
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Old May 16, 2008, 2:35pm   #8
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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.
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Old May 29, 2008, 11:50pm   #9
Joined Nov 2007
RPEX started this thread Nice one guys, thanks DB, i got the Williams book on order.
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Old May 30, 2008, 4:46am   #10
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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.
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