Options 101: newbie Qs

[trendie]

1: There are two types of options; American style and European style.
(US style allow you to exercise the option any time before expiry date; European style allows the option-owner to exercise only at expiry)
Q: Does this mean, that if you have a strategy where you WRITE options, ie take premium, and you don't own the underlying, you should take European style options, so you don't get exercised "out of the blue"?

Q: can you specify US or Euro style?

Q: does the price of these options differ cos of the exercising rights?

Q: any decent websites about learning robust strategies?
(yeah, I know about Howard Cohondas thread; am a reader)

Optiongenesis: any good?

thanks

 

[oiltanker]

there is a free course here. haven't tried it

http://www.21stcenturyinvestoreduca.../course-201/outline.html?sid=1096453437.15063

there are demo eg

http://www.optionsxpress.com/free_e....aspx?said=MBox_VirtualTrading_Bottom#utility

 

[Martinghoul]

First of all, you normally can't choose the sort of option you sell/buy, as it's normally determined by mkt convention. Secondly, the last thing to worry about is the exercise type.

 

[meanreversion]

Depending on the yields of the underlying instruments, the American style option is occasionally more expensive than the European style. For the American style to be exercised early, it needs to be a call option on an asset with a higher interest rate than the asset on which it is also a put, and the delta needs to be sufficiently high such that the cost of carry of the delta hedge outweighs the vega benefit of the option itself, roughly speaking.

However, this is of little or no consequence, it's very rare for American style options to be exercised early and won't affect your P/L anyway.

 

[trendie]

The "80% of all options expire worthless" meme.

The assumption behind the above statistic is that money is being "lost", or is used to suggest writing options is the only way to make money.

However, the expiry of an option may well be anticipated, or even desired.
This is when an option is just one part of a larger strategy, whereby the option was a form of insurance policy by the owners of the underlying asset.

Is it worth digging deeper, and finding out: (or even possible to find out)
1: what proportion of options are part of a broader strat, where the expiry of an option in one part of the strategy is seen as an acceptable cost of ensuring profit in another part of the strat? (in the same way in a game of chess, tactical sacrifices are valid in a strategic game)

2: what proportion of options are actually part of a bigger strat.
For example, in an iron condor eek, one option expiring worthless is a desired outcome in order to secure the premium from another written option. Here, 2 options are in play. 50% of the option expires worthless, the other 50% generates the return.

3: should there be a statistic of what proportion of written options expire worthless?

4: should there be a statistic, or can it be found, of how many options (of the total amount of options) are purely speculative, ie, perhaps those trades which are entirely driven to make profits in themselves, as opposed to being insurances?

The saying "80% expire worthless" changes when seen in above contexts.



5: Does the put/call ratio have any bearing on the price of futures near expiry?

6: (rumour): by knowing the most popular options strike prices nearing expiry, can you use this information to trade futures, or anticipate prices that need to be hit to ensure most options expire worthless? (ages ago, I read/heard that speculators attempt to manipulate futures prices near expiry to ensure popular option strike prices get hit/dont get hit)

 

[meanreversion]

I think you're barking up the wrong tree a little.

Most bets placed on horses don't pay out, but that doesn't stop people from betting, nor does it lead people to conclude that perpetually laying horses on Betfair will make you money in the long run.

End users of options buy them to speculate or to insure.. they typically look to buy sub-50 delta options (the lower the delta, the cheaper the premium). Most options start off life as sub-50 delta, so by definition most options expire worthless.. but it doesn't mean a whole lot (refer back to horse racing analogy).

You can deduce the market's vol position from the skew, but you certainly can't extrapolate this information to somehow predict where spot is going. In the same way, just because AUD/USD futures trade below spot, this doesn't mean that spot is more likely to go down.

 

[jontyxxxx]

Martinghoul is right - there is lots more to worry about on Index options!

 

[Martinghoul]

The "80% of all options expire worthless" meme.
4: should there be a statistic, or can it be found, of how many options (of the total amount of options) are purely speculative, ie, perhaps those trades which are entirely driven to make profits in themselves, as opposed to being insurances?

Well, there's something like that for some assets, such as Eurodollar options, published in the CoT report. However, it's really neither here nor there and isn't likely to be of much help

5: Does the put/call ratio have any bearing on the price of futures near expiry?

Not in any sort of a consistent, generalizable fashion.

6: (rumour): by knowing the most popular options strike prices nearing expiry, can you use this information to trade futures, or anticipate prices that need to be hit to ensure most options expire worthless? (ages ago, I read/heard that speculators attempt to manipulate futures prices near expiry to ensure popular option strike prices get hit/dont get hit)

Well, this is an old wives' tale that has been disproved more recently. It may have been the case before, when option mkt liquidity wasn't what it is today. These days you can occasionally observe the underlying gravitate towards the strike with the highest open interest, but it's a very sporadic and inconsistent effect. It's not something you can base a trading strategy on, that's for sure. Also, note that this is not speculators normally who manipulate, but mkt makers.

In general, I would agree with meanie. All these are meaningful and sorta interesting questions, but they should hardly be your starting point in understanding options.

 

[dmeista]

Ok..80% of all options will expire worthless..check.

Lets assume you earned 80$ premium with these options.

The question is: How much money do you think you earn with the other 20%, for instance far out of the money options which cost nothing and will make a lot of money with profit warnings, disaster, takeovers etc.

 

[DashRiprock]

...

Well, this is an old wives' tale that has been disproved more recently. It may have been the case before, when option mkt liquidity wasn't what it is today. These days you can occasionally observe the underlying gravitate towards the strike with the highest open interest, but it's a very sporadic and inconsistent effect. It's not something you can base a trading strategy on, that's for sure. Also, note that this is not speculators normally who manipulate, but mkt makers.

hi martingoul

(interesting with axl and dragby and mersch eh?)

anyway about the last thing you said before and I have copied above...

.. OK so I get what you said... but.. do you thinks its nice to know wether banks (mm's) are generally long or short gamma close to expiry?

i mean that can be nice to know if you are local cos you can front run banks hedge or whatever?

 

[Martinghoul]

hi martingoul

(interesting with axl and dragby and mersch eh?)

anyway about the last thing you said before and I have copied above...

.. OK so I get what you said... but.. do you thinks its nice to know wether banks (mm's) are generally long or short gamma close to expiry?

i mean that can be nice to know if you are local cos you can front run banks hedge or whatever?

Well, in the stuff that I do, banks aren't the mkt-makers normally, but yeah, it's sorta nice to know. However, these people aren't stupid. Just knowing their aggregate exposure doesn't necessarily imply knowing their behaviour. You can sometimes guess correctly, but that's about it.