Question about the length of an option.

[HumpingFrog]

I was reading Options as a Strategic Investment and it said something along the lines of: Don't buy more time than you need, is that usually correct if you're going to be doing an outright purchase of a call or a put?

It seems to me that it'd be favorable to the buyer to buy options with a lot of time til expiration due to the time decay not taking so much of your option price (compared to if you bought a shorter term option).

For example if I thought that XYZ was going to go up by C pts in the next 6 months. Wouldn't it make more sense to buy a LEAP that had over 6 months of time, and just sell it once six months is up (so you don't lose as much money due to time decay), rather than buy a 6 month option and just wait til the 6 month option expires?

Does he say not to buy more time than you need due to the more vega exposure?

Thanks for your help.

 

[Splitlink]

I was reading Options as a Strategic Investment and it said something along the lines of: Don't buy more time than you need, is that usually correct if you're going to be doing an outright purchase of a call or a put?

It seems to me that it'd be favorable to the buyer to buy options with a lot of time til expiration due to the time decay not taking so much of your option price (compared to if you bought a shorter term option).

For example if I thought that XYZ was going to go up by C pts in the next 6 months. Wouldn't it make more sense to buy a LEAP that had over 6 months of time, and just sell it once six months is up (so you don't lose as much money due to time decay), rather than buy a 6 month option and just wait til the 6 month option expires?

Does he say not to buy more time than you need due to the more vega exposure?

Thanks for your help.

That was the last tactic that I used before I gave up options and reverted to straight trading. My experience with that was (this must be ten years ago) that it was ok but too slow for me. You might as well be in shares and more money with less risk was available by ordinary trading. A person like me needs fairly frequent trading. The options that I traded, using your system, involved quite a lot of capital and I found my self holding them for several weeks.

I don't hold myself up as being an expert in this, but that was my take on it.

 

[QuestOptions]

I was reading Options as a Strategic Investment and it said something along the lines of: Don't buy more time than you need, is that usually correct if you're going to be doing an outright purchase of a call or a put?

It seems to me that it'd be favorable to the buyer to buy options with a lot of time til expiration due to the time decay not taking so much of your option price (compared to if you bought a shorter term option).

For example if I thought that XYZ was going to go up by C pts in the next 6 months. Wouldn't it make more sense to buy a LEAP that had over 6 months of time, and just sell it once six months is up (so you don't lose as much money due to time decay), rather than buy a 6 month option and just wait til the 6 month option expires?

Does he say not to buy more time than you need due to the more vega exposure?

Thanks for your help.

Great book you are reading by the way. Options are priced on a probability model. More Time = More Chances of things happening = More expensive all things being equal.

So say you have four options same underlying asset different expirations.

XYZ is at 35 at around 55 % IV

1) 35 call with 30 days left until expiration: $3.60
2)35 call with 90 days left until expiration: $4.50
3)35 call with 120 days left until expiration: $5.80
4)35 call with 240 days left until expiration:$7.50

As you can see the more time you purchase the more expensive the option is.

Now let's assume the market starts moving in your favor right when you put on the trade.

Your near term options are going to show a greater percentage profit than your long dated contract.

You are trying to predict where the underlying price will be by expiration. Makes sense to be rewarded greater for being right on price and time.

So for the near term option you are rewarded for being right on time and price. The option with say 240 days will still be showing a profit but not nearly as great as say the option with 30 days on a percentage basis.

So I think what the book is trying to say is if you think the market is going to make a move within the next couple weeks then the 30 day option is a better play than the leap option.

More time does not always mean better. You purchase your option based on your expectations and time frame. If you think a move is going to happen within the next 2 days then a weekly option is a better play for you then a leap.

Because it's going to be cheaper and you will be rewarded for getting the timing right.

I hope this answers your question.....

 

[anley]

Frog, just make sure you understand the concept of volatility and the DOMINANT role it has on pricing options. If you don't then you have NO chance of making money, only losing, even if you're right on the overall direction of the market.

For example, on Monday and indeed for the next several weeks ALL options are going to be incredibly expensive so if you buy (puts or calls) you've actually got 2 seperate trades on, 1) the future direction of the underlying and b) the future direction of volatilty. Chances are you'll get 1 right but not the other which probably means breakeven at best. And how frustrating would that be to breakeven when your forecast about direction is 100% spot on.

Also, realise that options are incredibly complicated so you better know your enemy, ie the people on the otherside of your trade. Assume they're hot, assume they REALLY know what they're doing, and assume they've been in the game a long time. Then consider how you shape up in regards to them. Do that and you might find you're bringing a flick knife to a fight but they bring a machine gun And even if you're the world's greatest with a knife it won't help you too much......

Just trying to be of help

 

[tripleogstar]

anley stop talking BS you fool

 

[Splitlink]

No bull**** being spoken there. Once the time starts wasting away the inexperienced option holder will need the stock to go up a lot, just to stay in the same place, then he may be lucky, and lucky is the word, if he can make a penny on his price. If the share price does not go up, if it stays in the same place or goes down, it hardly matters to the holder. He'll lose his money.

If he starts with spreads so that he can contain his risk, he is containing his profits, too. That will cost him the brokers spread on a another option.

You need thorough training with options and you won't get it from a book.

IMO, buying distant expiries, before the time starts to waste ties up time and capital.

The salesman's trick is to tell you that you cannot lose more than the option price. What he does not say is that you always lose that!

If I can persuade any inexperienced newcomer to leave options alone, then I have not wasted my time.

The reason for options is so that big investors, who have large portfolios, probably with good profits could sell calls on them when they thought that the price might fall back, much like this last week. If they get exercised then they sell the shares at that price, which is more than they paid for them

These are called covered options and make good sense because he, also, pockets the option money. If he does not get exercised he keeps his shares, which he probably does not want to sell, anyway, and keeps his option money.

The trouble is that the clever guys discovered a way for them to make more money on commisions by trading them to the suckers.

 

[tripleogstar]

I meant BS in the sense that he says the following garbage:

Also, realise that options are incredibly complicated so you better know your enemy, ie the people on the otherside of your trade. Assume they're hot, assume they REALLY know what they're doing, and assume they've been in the game a long time. Then consider how you shape up in regards to them. Do that and you might find you're bringing a flick knife to a fight but they bring a machine gun And even if you're the world's greatest with a knife it won't help you too much......

Just trying to be of help

 

[tripleogstar]

options are a great way of making money, unlike most financial products. You can make a fortune from the market moving a lot or the market not moving at all.

 

[QuestOptions]

No bull**** being spoken there. Once the time starts wasting away the inexperienced option holder will need the stock to go up a lot, just to stay in the same place, then he may be lucky, and lucky is the word, if he can make a penny on his price. If the share price does not go up, if it stays in the same place or goes down, it hardly matters to the holder. He'll lose his money.

If he starts with spreads so that he can contain his risk, he is containing his profits, too. That will cost him the brokers spread on a another option.

You need thorough training with options and you won't get it from a book.

IMO, buying distant expiries, before the time starts to waste ties up time and capital.

The salesman's trick is to tell you that you cannot lose more than the option price. What he does not say is that you always lose that!

If I can persuade any inexperienced newcomer to leave options alone, then I have not wasted my time.

The reason for options is so that big investors, who have large portfolios, probably with good profits could sell calls on them when they thought that the price might fall back, much like this last week. If they get exercised then they sell the shares at that price, which is more than they paid for them

These are called covered options and make good sense because he, also, pockets the option money. If he does not get exercised he keeps his shares, which he probably does not want to sell, anyway, and keeps his option money.

The trouble is that the clever guys discovered a way for them to make more money on commisions by trading them to the suckers.

if you are long stock say @ 100 synthetically that is long the 100 call and short the 100 put. If you sell a put against your long stock you now have synthetically (+1)100c and two naked short puts. This position is extremely vulnerable against a downward move.

The covered write you are referring to is long the stock and short a further out of the money call. This again does not hedge against a large downward move since you still have a synthetic naked short put.

I disagree with your comment that you can't learn options through books. Experience is the greatest teacher but books can definitely help you get through the learning curve. Options pricing are heavily based on math so how can you learn math without the use of books? Why do PhD's get hired to work on trading desks?

I agree with you that you are not going to learn everything right away but that is like everything else that is worthwhile. You have to put the work in.

 

[Splitlink]

The covered write you are referring to is long the stock and short a further out of the money call. This again does not hedge against a large downward move since you still have a synthetic naked short put.

Hi,

No, I mean the guy who owns the shares. If he bought them for 300p and they double but he thinks the market is due for a setback, such as this last week, could he not sell the call option for an exercise price 500p, depositing those shares as cover?

If the shares fall below 500p, he does not get exercised but keeps the option money. If they stay over 500p he may get exercised but he has made a profit, anyway, and gets to keep the option money, too.

Any other way of trading options is, IMO, (I admit to being a bit naive on this) synthetic or whatever, is simply a way of re-selling, time and time again, those same options.

The same has been the cause of the mortgage debt in the US. The same mortgage being bought and sold over and over again by hedge funds or whoever. The result has been calamitous.

 

[HumpingFrog]

Okay just to make sure I understand what you are saying, your reasons for not buying LEAPS is

1: You have a bigger percentage gain with shorter calls because of:
a. Less initial costs
b. Higher Delta (assuming the Call is ITM)

2. When you take a bet that is longer than you intend to hold you are not only taking a directional bet but also a volatility one, and you (under most circumstances) have to be right about both to make a decent profit.

So what about buying option with 1 more month than you need? You're taking on a little more volatility risk and a little less percentage gain for a chance to prevent losing money due to extremely steep time decay.

And what's better about options (when you just outright buy or sell as a directional bet) vs underlying instruments anyways? You can always limit risk of underlying with a stop loss.

 

[Splitlink]

Okay just to make sure I understand what you are saying, your reasons for not buying LEAPS is

1: You have a bigger percentage gain with shorter calls because of:
a. Less initial costs
b. Higher Delta (assuming the Call is ITM)

2. When you take a bet that is longer than you intend to hold you are not only taking a directional bet but also a volatility one, and you (under most circumstances) have to be right about both to make a decent profit.

So what about buying option with 1 more month than you need? You're taking on a little more volatility risk and a little less percentage gain for a chance to prevent losing money due to extremely steep time decay.

And what's better about options (when you just outright buy or sell as a directional bet) vs underlying instruments anyways? You can always limit risk of underlying with a stop loss.

You are losing me---I pass!

As I see it, the more complicated a potential trade gets, the more risky it becomes, too.

Can you put stop losses on options? It's a long time since I traded them. I thought that one had to buy or sell two exercise prices.

You are, obviously, more knowledgeable about this, than I and I admit to being outof my depth.

 

[QuestOptions]

let me take this out of context. If you and I were to place two different bets.

You are betting me that I can't make a basket from the half-court line.

Now wouldn't it make sense that the payout would be greater if I make the shot if you gave me only one attempt vs. you giving me 10 chances to make it.

If I make it with the first bet my returns will be greater than if you gave me 10 chances. What if you gave me 100 chances? then my payout would be smaller if I make the shot.

Another thing you want to take into account is volatility various amongst contract months. Usually volatility is higher in the later dated months but when we have periods of great uncertainty and panic we will see volatility rise sharply in the front month contract and not as greatly as the later dated contracts.

the idea is that panic will eventually normalize so no reason to jack up the volatility levels for the later dated months. Unless there is some kind of structural change to the market.

Your second to last question about buying one more month. This is a common practice, to give yourself a little bit more time. There are strategies out there that can reduce the role of time. Spread positions as well as time spreads can all reduce the role of time.

To answer the last question. This is a personal decision you have to make. One thing options do is give you staying power. The increase in volatility might make it hard for you to stay within your risk management parameters. Getting whipsawed or stopped out only to see the market reverse back to where you thought it would go. This could be frustrating for some. Options also allow you to do things that are non directional. You can make volatility bets, you can make bets the market reaches certain levels or doesn't reach certain levels, you can make bets that the market stays within a specific range etc...so you can do a lot more things with options.

 

[HumpingFrog]

Alright, I get it. Thanks for your help guys!

 

[anley]

I meant BS in the sense that he says the following garbage:

Also, realise that options are incredibly complicated so you better know your enemy, ie the people on the otherside of your trade. Assume they're hot, assume they REALLY know what they're doing, and assume they've been in the game a long time. Then consider how you shape up in regards to them. Do that and you might find you're bringing a flick knife to a fight but they bring a machine gun And even if you're the world's greatest with a knife it won't help you too much......

Just trying to be of help

Hardly foolish to realise who's on the other side of the trade and build counter strategies to theirs. Far too many people get involved in options but never realise just how complicated it is and who they're really up against. For example, if you don't how how to play bid-offer games the market markers play then most of your money will become theirs as they skillfully and expertly take ticks off you all day long.

Ultimately, successful trading and investing is SO much more than buying/selling at the right prices.

But you Tripple are obviously one of the people that no doubt looks for the fool around the table but can never spot him/her. In which case..........

 

[HumpingFrog]

Hardly foolish to realise who's on the other side of the trade and build counter strategies to theirs. Far too many people get involved in options but never realise just how complicated it is and who they're really up against. For example, if you don't how how to play bid-offer games the market markers play then most of your money will become theirs as they skillfully and expertly take ticks off you all day long.

Ultimately, successful trading and investing is SO much more than buying/selling at the right prices.

But you Tripple are obviously one of the people that no doubt looks for the fool around the table but can never spot him/her. In which case..........

Where can one learn about these "bid-offer games" that the market makers play?

 

[QuestOptions]

Where can one learn about these "bid-offer games" that the market makers play?

To avoid not getting "played" you need to trade liquid products/markets and within those products/markets you need to trade liquid strikes.

Open Interest and Volume is a good indicator. Sometimes looking at the bid offer and ask offer size is a good indicator.

Simple rule: The more liquid an option is the more competitive its going to be. The more competitive it is the tighter the bid/ask spread is. You want markets that offer tight bid/ask spreads. (the difference between the bid and ask are similar)

There are some markets in which are thinly traded. You get wide bid/ask spreads in those markets and you are at the mercy of the market maker.

You can get butchered on the way in and if you are lucky to be right you will get butchered on the way out.

This is easily avoidable and many option products can be traded on the computer so transparency is improving.

Another thing to note is that you can be trading the same product but liquidity may vary amongst contract months. Some products may only see liquidity in the near term months and no action in the later dated months(just an example not a fact). Liquidity varies amongst products and contract months.

If you trade liquid markets, you will be fine. The improvements in technology and transparency is making this less of an issue.

In many cases liquidity is greatest for the ATM and OTM strikes and less liquid for the ITM and Deep ITM options. Again this may vary amongst products.

Liquidity out of context: It's cheaper to buy beer at the grocery store than it is at Yankee stadium. You have the option of shopping around for the best prices when you are home but when you are at Yankee stadium if you want to drink beer you have to pay their prices. So they can overcharge you because they don't have competition.

Thin markets will offer wide bid ask spreads and competitive markets will offer tight bid ask spreads.

Liquidity data is readily available for free for most products nowadays.

 

[anley]

Re the bid-offer, just realise this - A) market makers would normally sell them mother before they sell on the bid (or pay the offer) and B) They quote wide as an indication of where they're like to trade so you must get inside the big-offer.

For example if they quote you 45-50, never pay 50 and never believe anyone that says you should pay 50 (you might5 be using for example a stockbroker who doesn't understand the options market). But at the same time don't expect to be filled on at 45. So go 46 bid for a min or so, then 47 for another min then up to 48 but no more and there's a 90% chance you'd get a fill. But it does depend on what the underlying stock is doing at that time. if the market is fast then you've got to be fast, if slow, you go slow etc.

So fight for every tick because they're worth their weight in gold in the options market. A tick here and a tick there might never seem that much but look at it in percentage terms and the difference can be massive.

Good luck anyway.

 

[QuestOptions]

a point i missed earlier in which I think anley picked up is during periods of uncertainty, high volatility and panic you may see the bid/ask spread widen so the market maker can give themselves a larger margin for error.

 

[DailyTA]

Once you understand how gamma works and you know the average length of each winning trade... then you can determine which time frame to buy.

Tweet me for more info: @DailyTA_com

I was reading Options as a Strategic Investment and it said something along the lines of: Don't buy more time than you need, is that usually correct if you're going to be doing an outright purchase of a call or a put?

It seems to me that it'd be favorable to the buyer to buy options with a lot of time til expiration due to the time decay not taking so much of your option price (compared to if you bought a shorter term option).

For example if I thought that XYZ was going to go up by C pts in the next 6 months. Wouldn't it make more sense to buy a LEAP that had over 6 months of time, and just sell it once six months is up (so you don't lose as much money due to time decay), rather than buy a 6 month option and just wait til the 6 month option expires?

Does he say not to buy more time than you need due to the more vega exposure?

Thanks for your help.