A simple question to the experts

[Martinghoul]

Everybody cares about margins, even if you have oodles of cash. Risk management is never a waste of time.

The most common methodology used, in one way or another, in the industry is VAR, which is just a fancy name for a statistical way to calculate E[drawdown] for a portfolio of assets, given a bunch of volatilities and correlations (normally historical from a given sample period). This works fine for options. Exchanges actually use more sophisticated and customized versions of the same basic approach. Obviously, as Taleb never stops reminding you, the method has its flaws. To enhance VAR people normally also look at the performance of a portfolio in various extreme historical scenarios. However, two issues still exist: a) historical performance in your sample period doesn't necessarily predict all possible future scenarios; b) liquidity (slippage) is something that just doesn't fit into the framework. As a result, you always have to look at various hypothetical extreme scenarios.

I think that should about cover it...

 

[arabianights]

Basically the way forward would be to add time as a dimension

 

[jontyxxxx]

Thanks guys

 

[charliechongdai]

jontyxxxx,

I know your post is a little old (5 months to be exact) but I feel I want to share something with you. Selling options a good "business" in low volatility environment (VIX below 30 etc), so like last year until early 2009, many professional option sellers (on CTA side, not hedge fund side) lost big 20-40% one month during Sep, Oct of 2008. On the other side, those people make money consistently every month since 2004 forward. So my opinion on this is "do not trade when VIX is high", which is unsurprisingly during recession period. The price can go up or down dramatically and most hedge methods would still lose you money OR increase your margin(risk).

So my suggestion to you is to sell options (either call or put) only when VIX is subdued like now; pay attention to the market sentiments. People who tell you that selling options still makes money even market is down are lying in the sense that price drops 3-4 times faster than going up.

I am interested in discussing more with you if you around.

CD

 

[jaspertrademaster]

It seems you have answered your own question by asking a question.

 

[benmaya]

In my view most people do lose money with options so the clever way is to sell them! but having said that you really need to have a tight money management and run a way as soon it goes against you. The problem I see is with 24 hours market.
If you sell a FTSE 5000 put when the FTSE is 5500 and you decide to close your position at 5300 you can wake up in the morning only to find that because Japan went down the FTSE is already 5200 and you are risking more than you wanted.

I think it is a clever way to make money but you need nerves of steel and you will never sleep well at nights...

 

[gooseman]

In my view most people do lose money with options so the clever way is to sell them! but having said that you really need to have a tight money management and run a way as soon it goes against you. The problem I see is with 24 hours market.
If you sell a FTSE 5000 put when the FTSE is 5500 and you decide to close your position at 5300 you can wake up in the morning only to find that because Japan went down the FTSE is already 5200 and you are risking more than you wanted.

I think it is a clever way to make money but you need nerves of steel and you will never sleep well at nights...

what the hell is this sh1t?

 

[Dommo]

jontyxxxx,

I know your post is a little old (5 months to be exact) but I feel I want to share something with you. Selling options a good "business" in low volatility environment (VIX below 30 etc), so like last year until early 2009, many professional option sellers (on CTA side, not hedge fund side) lost big 20-40% one month during Sep, Oct of 2008. On the other side, those people make money consistently every month since 2004 forward. So my opinion on this is "do not trade when VIX is high", which is unsurprisingly during recession period. The price can go up or down dramatically and most hedge methods would still lose you money OR increase your margin(risk).

So my suggestion to you is to sell options (either call or put) only when VIX is subdued like now; pay attention to the market sentiments. People who tell you that selling options still makes money even market is down are lying in the sense that price drops 3-4 times faster than going up.

I am interested in discussing more with you if you around.

CD

Surely one dimension of option selling is that an opportune time to sell is precisely when implied vol is at a high level; you then buy them back when vol drops.
If you sell an option when implied vol is low, then vol spikes up, it is going to hurt.

 

[dealer911]

Surely one dimension of option selling is that an opportune time to sell is precisely when implied vol is at a high level; you then buy them back when vol drops.
If you sell an option when implied vol is low, then vol spikes up, it is going to hurt.

Most money from options is made by selling premium it's true.. but dommo here is right you want to sell high volatility and buy low.. now that takes balls of steel! if you do it the other way around you will be carried out if you are wrong once.

 

[gooseman]

that's like saying you want to buy low prices, sell high prices. jesus guys, you must be trading gods.

 

[Dommo]

that's like saying you want to buy low prices, sell high prices. jesus guys, you must be trading gods.

Yes, it is exactly like that

 

[gooseman]

thanks for clearing any confusion i may have had

 

[Dommo]

thanks for clearing any confusion i may have had

No probs, and many thanks for the constructive commentary

 

[tripleogstar]

that's like saying you want to buy low prices, sell high prices. jesus guys, you must be trading gods.

lol mate i think there are too many amateurs on this thread, they are stating the fuc**ng obvious.

 

[Dommo]

lol mate i think there are too many amateurs on this thread, they are stating the fuc**ng obvious.

Also Sprach Zarathustra

 

[Splitlink]

I trade far OTM options without any protection. As far as I can see, the only stop loss I can take is to buy similar options at a lower/higher price depending on whether I am selling puts or calls. Is this flawed thinking, or is there any easier way of getting protection?

Thanks

Jonty

The problem is that you don't know when the "Swan" is going to come. Shorting covered options is the only way to go.

I.e. An investor who has "X" shares, that he bought for 200p and have now doubled to 400p, maybe he considers them to be a buy and hold investment that, nevertheless, may go down in the short term. So he uses them as cover and shorts them for an exercise price of 400, pocketing the option money, which he gets at once. If he is exercised, hard luck. He keeps the money and sells the shares for 400p, but he hopes to be able to buy the options back for next to nothing as wasytage sets in.

This is the way options started. Of course, smart cookies worked out how to hedge with vertical and calendar spreads, plus straddles etc. and this started a whole new ballgame, all favourable to the brokers , who pockets all the commissions.

If you are considering naked selling/buying of calls and puts, then you are on to a dangerous game. I, and others, said the same to Socrates some years ago, when he started it.

 

[meanreversion]

Options were created in order for companies to hedge, not as a vehicle for speculation. For example, currency options first became big in the States back in the 70's, when they were traded on the IMM in Chicago. Exporters would want to hedge their foreign currency exposure, so the market quoted on foreign currency amounts. So traders spoke about CHF calls or JPY puts, rather than USD puts and USD calls, because the contract size was measured in CHF and JPY respectively. To this day, the OTC FX options market (which is enormous) still uses the convention of call/put on CHF and JPY, when using the USD would be more logical (to further illustrate this point, if you were buying calls on Barclays, you wouldn't think of them as GBP puts, even though they are).

It seems to me that most individual traders think of the premium as "in the bag" once the option is sold. It's a very skewed way of thinking about it. It's no different from selling insurance. Do you think that Direct Line consider every insurance policy taken out as 100 pct pure profit? Unlikely..

Rather than play mental games with how you perceive the option and its premium, just calculate its delta and add/subtract it to your underlying position. You'll achieve far more consistent results that way.

Also, remember that call - put = outright position, so whether your option sale is "covered" or otherwise, you still have risk until the option rolls off.. convincing yourself otherwise is just financial delusion, along the lines of taking out a 10 year loan because monthly repayments on a 5 year loan are too high.. see my point?

 

[gooseman]

mean-you're pretty anti-options aren't you?

futures weren't originally created for speculation, neither were swaps etc. it's just how it is. if someone is there to make a price and provide liquidity then i see no problem with it. as long as they can honour their prices/debts.

mark to market makes sure you don't get carried away with the money in the bag theory.

agree your point for retail traders.

 

[meanreversion]

Hi Gooseman, I'm not anti-options at all. What I'm against is non-professionals putting their money on the line with a product they don't understand. I'm not suggesting drilling down to third order differentials.. it's more on a basic level. For example, if you're long the underlying and sell a call with a strike higher up, try plotting the payout of each on a chart, then plotting the sum of the two. Let's say you're long 10,000 shares in RBS and sell 5,000 of an ATM call - this has the exact same profile as being short 5,000 of a call and 5,000 of a put.. the payout profile is an upside-down smile. This position is short gamma, thus the delta always changes unfavourably whenever spot moves (but of course you earn the time decay).

Selling low delta options, whether "covered" or not, always entails risks. Simply owning the underlying does NOT leave you with a "risk free" position.

 

[meanreversion]

Sorry there's an error in that. It should read 'if you're long 10,000 RBS and sell 10,000 of an ATM call, this is identical to being long 5,000 of the stock and short 5,000 each of a call and a put'