Sentimental Options

Benton D Struckcheon said:
Options on individual stocks are not usually efficient. As noted above, I stick with ETFs because their options trade in dollar increments with very tight bid/ask spreads. Can't say the same for options on stocks.
There are a few exceptions, such as NYX, for instance (which I'm actually thinking I might add). Mostly not a good idea though.
I'm comfortable with doing sectors rather than stocks. A matter of taste I suppose.
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Leaving aside actually trading stock options, do you think there is merit in using them in some way as any sort of predictor of the underlying stock? I guess abnormal option volume may be an obvious one but you might get the same benefit from simply eyeballing the chart itself.

Incidentally, IB has a daily options intelligence report here: http://www.interactivebrokers.com/en/p.php?f=daily_analysis

IB definitely maintain there is merit in using options data as some sort of gauge of the underlying. I guess they should know, as TimberHill is a big options MM.

I have IQFeed data feed, which supposedly gives 30 days historical tick data for US equity options, so I might have a go at building up some history. Will take a bit of time though, starting with designing a reasonable DB schema to hold the stuff. It might be quite interesting to incorporate options data into the screener/real time scanner that I have already written. Actually it might be very interesting.
 
DionysusToast said:
As I understand it, if I buy a call option I am betting that future prices will rise.
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Not exactly... your betting that the markets VIEW on that rise is underestimated...

The option pricing has incorporated the markets view on the probability and size of a move higher; your bet is that they have priced in wrongly.

For example: Say a call is $1.50
The market percieves that if you were to buy this call option 100 times, you would breakeven on their view of the current probability regarding the size of an up move or the probability of an upmove.

Therefore your bet is saying either
1) I think that the move is on average (over the 100 trades sample) going to be bigger than your implied volatility
2) I think that a move higher is more probable than the options market view.

Furthermore; you think that it'll move that much and in that direction in a certain amount of time.

The way i think of options is;
You get dealt your hand ( = The price of the option) and your analysis tells you how mispriced the option is, then you are only looking for those with a big enough edge...

This isn't the only way to use options; in fact i think Benton uses them very differently to the above.
 
Interesting Gladiator. If I buy a call and the underlying stays where it is, won't my call actually go down in value because of time decay ?

So - even if the market underestimates the probability - how do I make $$$ if the price doesn't actually rise ?

Like I say - I've never traded an option in my life - so I expect to be asking dumb questions.
 
DionysusToast said:
Interesting Gladiator. If I buy a call and the underlying stays where it is, won't my call actually go down in value because of time decay ?

So - even if the market underestimates the probability - how do I make $$$ if the price doesn't actually rise ?

Like I say - I've never traded an option in my life - so I expect to be asking dumb questions.
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If doing this directionally, vertical spreads will cancel a lot of the theta. The challenge then is to define the time in which you think the option will be worth more.
But a vertical won't protect you if the stock doesn't move. What it does do is minimize loss if it moves against you. You can do two short vertical spreads on either side of the price if you think it won't move; this is an iron condor.
My idea is to have a signal system with >50% probability, wherein the options I trade expire at a time greater than the median holding time defined by the system. Actually, to really work, the time to expiration would have to be well above the median holding time, as with options theta is parabolic: the closer to expiration, the steeper that curve.
Which means you try to stay away from the front month, which is the first way to minimize theta. Secondly, you do a vertical. When the whole thing is finished, your net theta should be low.
The challenge with doing a spread is what I was trying to show earlier with that graph of the Pareto distribution of movement over the median holding time. You want the spread to be wide enough to allow for profits most of the time if the signal is correct, but narrow enough to do a good job minimizing theta.

BTW, just to clear something up here, my suspicion all along has been that gold is a much easier market to read than most of the rest of the market because of the speculative fever that grips it when it's in a bull market. As far as I can tell so far, that suspicion is proving to be correct, which is why I came up with that exchange stock based system idea in the first place. After seeing how IWM options are so obviously used mostly for hedging, in sharp contrast to the GLD options, I began to try to come up with some idea that would just as accurately show where sentiment is headed in the broad market. Once I was finally done constructing the sentiment index for the market via options, it was time to try the exchange stock idea.
It looks like it's a better idea on the surface, but it has this huge flaw: the publicly traded exchanges are subject to competition from privately-held exchanges like BATS. Their stock prices are already reflecting the effects of this kind of competition. So, how long any edge you might derive from looking at their prices would last is definitely an open question. While the options-based sentiment contraption is in fact crazily complex, it's also not nearly as subject to decaying because of changes in the market. VIX will always be VIX, and I doubt that punters trying their hand at VIX options will change how they approach trading them any time soon.
 
See this post: We'll title it the Eleven Steps.

The idea of trading without a limit (see the post to see what's meant) is the principle reason why I do options. Back there somewhere I said something like that trading options with the feature of knowing the exact risk on each trade meant you were managing risk for the entire trade rather than for some random point the price might hit during the trade's life. Ironically, in many cases you're using the randomness of the market to make money, but at the same time you're preventing it from taking that money away from you.
Of course, there's many ways to skin that cat, so if options seem too complex, this guy might have a way of doing it differently. The point is to not let the randomness of the market get to you.
 
My apologies for being absent for a while. This is already a busy time of the year because right about now you have to gather up all your records for purposes of reporting taxes, and then came a nice big fat snowstorm smack in the middle of the week. And of course Sunday is Valentine's Day, and there's no way you can get away with forgetting that. The tender mercies of the IRS are indeed tender in comparison.
Thanks DT for stepping in to answer that ETF question.
Below, 2nd trade on NYX done with the assistance of my newly minted system. I confess to giving into temptation and buying it on Monday in anticipation of Tuesday earnings, and then collaring it, just to get myself back in practice to what I used to do back in the day. That worked out OK, as it did in fact go up, which meant I sold the put at the open, and closed out the rest of it on Wednesday, when the underlying went over the strike price of the call, which was 24.
Trades are tiny, of course, as we are merely putting our foot in the water, first of all to see if going forward on this exchange index idea is anywhere near as good as the backtest, and secondly, in this case, to get myself used to trading equity rather than ETF options again.
Trade is a backratio, or backspread, not exactly according to Hoyle, as both the sold and bought side are now OTM, and were when I did the trade. Reason for this is that implied vol has come down nicely since earnings on Tuesday, and I expect, this being a stock, first of all, and it being a stock that has nicely outperformed since reporting earnings on Tuesday, that if a downdraft does occur, it will hit this stock harder than the other exchange stocks, since it has outperformed so well over the last four trading sessions.
White nos across the top are delta/gamma/theta/vega/P&L Day/P&L overall. Most interesting of these is vega: if vol goes up at some point during this trade, I should make a decent bit of change. If that happens AND it goes strongly in my direction (down) it'll be very nice indeed.
System actually goes bearish with the open on Tuesday (Monday is a holiday here in the US) but backtesting showed a slight advantage to getting the closing price on the day of the change, rather than buying at the open on the next day (not surprisingly, it being generally better to get tomorrow's newspaper today, as they say), so once I saw the system was easily going to generate a signal at EOD today, I planned on doing a trade late in the day at as close to the closing as I could manage, which I did, as you can see by the fact I managed to get this spread at a mere 1 buck diff to what it closed the day at, because the underlying was all of four cents higher than when I put the spread on (25.29 vs 25.33).

ou5udj.jpg


With IWM, things are of course murkier. Sentiment-based system went bearish a while ago, and so has me underwater, while the one based on the exchange stocks went bearish today. It's been kinda 50/50 between the two, with a noticeable advantage to the exchange stocks system over the options one on the backtest, but not enough to really and definitively make the case. Interestingly, this signal might just definitively make the case for the exchange one, as after this the overall P/L for the testing period will be, if this trade works out, fairly strongly tilted to the exchange stock idea. Between that and the shorter holding period and the much simpler design, you have a pretty much slam dunk case for using the exchange stock idea. The risk as noted is that the exchange stocks wind up trading more on the fact of increased competition rather than the direction of the markets that they support.
BTW, I tried to add Knight Capital (symbol NITE) to the system, but it not only didn't add any new info, it took away accuracy both from NYX and from IWM. My supposition is that this is because this company does other things besides compete with the other four exchanges. Either that, or I haven't quite figured out what the correct weighting for it should be. Something to work on.
I've toyed with the idea of adding LAB (LaBranche), the only NYSE market maker I can find that's publicly traded and a pure play on a market maker. If I get bored, I might fiddle around with it over the weekend. But it's kind of like a buggy-whip maker after the invention of the car, with a definite negative bias to its stock price.
 
An extremely interesting day in NYX. Below, the chart (30 min bars on all charts. Less than that makes no sense if you're doing swing, IMO):

1269rtu.jpg


The thing to notice here is the volatility. I use an unusual setting: 18 X 6, which means, six periods, "annualized" out to 18. This is the bottom part, labelled "HV (6, 18)".
If you use this in conjunction with 30 minute bars, you immediately notice the day is divided into morning and afternoon sessions, in which the morning session is far more volatile, in a typical day, than is the afternoon one.
Today was an exaggerated version of this. Peaked at around noon, which is pretty normal, but then at 2:30, it collapsed. Looking at the price action, you can see how, starting at the 12:30 bar, it just flattened out.
I confessed to GladiatorX in an exchange of messages that volatility was the very first indicator I ever looked at, long before I'd even thought about options. So it's kind of built into everything I do. A gradually increasing volatility, like you see in this chart, indicates a trending market. Decreasing volatility over this setting I've chosen indicates a sideways market, if you're looking at it intraday. Once I saw the volatility collapse in the late afternoon today, I knew the trend higher was over. Then I looked at the price action, and saw that price had hit a solid brick wall.
Odd place for resistance; I went back 20 days on the chart, and couldn't find anything except around 25.50, which I suppose is close enough for government work:

dfi06w.jpg


More revealing is that, if you're using the Linear Regression Channel (100), you can see that at 25.60 or so, where it stalled out, that price makes the whole range wider on a 20 day chart. So it stalled once it got past the point where the range over the past 20 trading days, roughly equivalent to a month, was surpassed from a price action/volatility basis.
I thought about this for a bit, and especially after zooming out and seeing the 20 day action, decided tomorrow was going to be some sort of breakout day. Or if not tomorrow, the day after. Point being, volatility can't stay this low for long. It's usually an indicator that the price is about to zoom to a new range.
The system says to go short, so I'm trading with a short bias. But I wanted to trade with that bias intact but for the possibility of a breakout in either direction.
So, I bought back the 25 put. If you remember, I had a backratio: bought two 24 puts, sold a 25 put. By buying it back, I radically increased my deltas to the downside. These were all dated March.
So, since I'm looking for down, that meant anything I did with an up bias would be a hedging, short-term transaction, as in probably overnight, two days on the outside. I wanted the front month, which would have very high gamma and a very cheap price to compensate for the high theta. So, I bought a 26 Feb call with the proceeds from buying back the 25 put, which had made a profit of 16 simoleons since the price had gone against me. The 26 call cost me 15 of 'em.
My Greeks right now are as follows:

Delta: -17.39
Gamma: 75.74 (!!!)
Theta: -5.54
Vega: 5.75

Basically, I have a strangle, but across expirations. I've maximized my gamma bigtime, and my exposure to vega, but of course that means a high theta. If my breakout theory is correct, I should be good for tomorrow.
P&L on this mess so far: -9 simoleons overall, but because of the bought back put, +16 realized.

We'll get around to IWM, but starting with the next signal, which will come from the exchange stock system, unless something really really weird happens.
 
25.50 was it. Today was like watching paint peel.
Hopefully, tomorrow will be just a bit more exciting, regardless of profitability. I mean, sheesh.
 
Lots o nuthin again. But Bernanke pulled a seriously clever move, so tomorrow oughtta be fun. Good thing, I was getting seriously bored.
 
nice thread, i cant stand options lol..way to much math involved for me! and i have been mega stung before lol. i trade purely commodities + the es. all my trading is seasonal based position trading including alot of sentiment based stuff.
 
N Rothschild said:
nice thread, i cant stand options lol..way to much math involved for me! and i have been mega stung before lol. i trade purely commodities + the es. all my trading is seasonal based position trading including alot of sentiment based stuff.
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What kind of sentiment based stuff? At this point, I'm a sponge for anything I can get in this regard.
 
its all comodoity based stuff, dont think it would be that usefull in stocks. do you trade comods?
 
Once Upon A Time in Mexico

Just sitting here watching this movie, and my wife, who's American but who lived in Mexico from the time she was 7 until I met her, in her mid-twenties, yelled out "That's San Miguel"!
Being as how we're talking a Mexican town, the main feature of this town is, of course, the church, and when the action in this movie started revolving around it, both of us recognized both the church and the plaza in front of it. Definitely San Miguel.
It's not unusual for Americans to be in this town and from this town; it was discovered, as the Wiki article notes, by GIs after WWII, and in the Sixties was a favorite destination of counterculture type folks, of which my wife's mom was definitely one.
But the most fascinating thing, to me, about this place is that it may, just may, have furnished the inspiration for Zorro. (This is all me talking; to the best of my knowledge, no one else has made the connection I lay out here.)
In the book and the movie, Zorro is a Spanish aristocrat named Don Diego who fights for the oppressed of California when it was under the Spanish.
The de Allende part of San Miguel's name comes from a hero of Mexico's War of Independence and native son of San Miguel, General Ignacio de Allende, a Spanish aristocrat who befriended a certain Miguel Hidalgo y Costilla, a priest who is also a hero of Mexican independence, being known, merely, as the father of Mexico.
One of his other names was "El Zorro".
So, did Johnson Mcculley, in his pulp fiction classic, The Curse of Capistrano, weave Hidalgo into his story? Well, Hidalgo was known for promoting economic independence among the mestizos and Indians of Mexico, one of which was working with leather. In the story, Don Diego befriends one Fray Felipe. In an important incident in the story....

Fray Felipe is arrested and brought to the pueblo to stand trial for cheating a dealer in hides. The Fray is sentenced to a lashing, much to Don Diego's horror. Don Diego tries to intervene for his friend, but is warned that it would not be wise. Later, Zorro accosts the dealer in hides and his assistant and lashes both of them as punishment for their testimony against Fray Felipe. Afterwards, Zorro returns to the pueblo and whips the magistrado who had ordered the lashing.
Click to expand...

Hmmm.
So, did Mcculley switch roles, turning the aristocrat into El Zorro, assisted by a priest who is treated unjustly by the Spanish? Could be...

Back to business: today was a major disappointment. Again, nothing happened. It's as if the market knew I'd gone and done a strangle, and proceeded to slowly strangle my strangle to death, or something.
It's been a very peculiar market lately anyway. Chaos theory posits that chaos results from too much energy being thrown into a system, and lately that's been how the market feels, going this way because of the Greek situation, then that way because it looks like it's been solved, and then last night Bernanke throws another factor into the mix, while China raises reserve requirements and the UK, the largest European economy outside the euro, reports high inflation and lousy retail sales.
I admit to being completely flummoxed and fooled by it all in my main bread and butter, GDX. I have what amounts to a kinda sorta short iron condor on this, with a slight bias to the downside, despite having received a long signal in this yesterday. I trust that signal the way Vince Lombardi trusted rookies: like a grenade with the pin pulled. IMO, gold has no right to be going up right now, and I feel like there's a huge air pocket just underneath the current price. Since I've been trading this forever, and am usually profitable in it, I tend to trust my gut a little more than I would in something like NYX, where I will fully admit to being a bit rusty on how to trade straight out equities, as part of what happened this week looks like it was just the normal letup in volatility you see after an earnings report. I should have been prepared for that. Something to note for the future.
The other factor here, as far as GDX goes, is that options volume in GLD, after peaking in early December, has been slowly descending, with that descent continuing right through the recent rise in price after that beautiful Thursday last week.
Which wouldn't really be so odd, since coming off a bubblicious explosion in volume like the one that occurred in early Dec, you'd expect a bit of distortion on the downslope. That makes me think, as well, that this alleged upturn the options may be signaling may not have a lot of validity.
We'll see if my gut is right. The way I'm positioned, either way it breaks I'll do OK. But if it goes sideways like NYX did this week, I'll be murdered.

All in all, a lousy week. Next week we hope will be better.
 
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