Stupid newbie question on options betting

[garfster]

Hi guys. First thanks to all the contributers on these boards. I'm learning about various investments at the mo and these boads are fantastic!

I was reading this on:

http://www.stockbrokers.barclays.co.uk/content/ads/documents/Barclays FST Brochure.pdf (page 24)

and try as i might I can't understand it and can only come to the conclusion it's wrong or I'm missing something fundamental! Can anyone explain why this is a loss and not a win?




Example – Betting on a put option price on the FTSE Stock Index future

Opening bet

In December the FTSE 100 is trading at 5250 and you think the market may fall. The quote for
the March FTSE 4725 put option is 72-77 and you place an order to buy £20 per point at 77.
Your maximum loss is limited to 77 x 20 = £1,540, yet your potential profits are unlimited.

Closing bet
Two weeks later the FTSE 100 is trading at 5000 and the quote for the March FTSE 4725
put is 124-129.

To close the position you sell £20 per point at 124.

Closing price: 124
Opening price: 77
Difference: 47
Loss on bet: 47 x £20 = £940

NB: If the price of the bet had moved in the opposite direction, you would have made a profit.


Thanks for any help and apologys if i missed something obvious... but it's wrong right????

 

[Directional]

hmm. if you buy a put option, and the market falls + the price of the put goes up (as it would) then in theory you should be in profit.

The wording of the example is poor.. but it clearly says you expect the market to fall and therefore buy on the puts at 77. you're basically betting on the value of the option going up, as opposed to buying an option, almost the same thing.

IF they mean that you expected the price of the PUTS to fall, rather than the market, then you'd be short the puts value, or in theory writing the option equivalent, so if the puts went up then you'd lose.

but the way its worded makes me think the example is a mistake.

 

[Splitlink]

Hi guys. First thanks to all the contributers on these boards. I'm learning about various investments at the mo and these boads are fantastic!

I was reading this on:

http://www.stockbrokers.barclays.co.uk/content/ads/documents/Barclays FST Brochure.pdf (page 24)

and try as i might I can't understand it and can only come to the conclusion it's wrong or I'm missing something fundamental! Can anyone explain why this is a loss and not a win?




Example – Betting on a put option price on the FTSE Stock Index future

Opening bet

In December the FTSE 100 is trading at 5250 and you think the market may fall. The quote for
the March FTSE 4725 put option is 72-77 and you place an order to buy £20 per point at 77.
Your maximum loss is limited to 77 x 20 = £1,540, yet your potential profits are unlimited.

Closing bet
Two weeks later the FTSE 100 is trading at 5000 and the quote for the March FTSE 4725
put is 124-129.

To close the position you sell £20 per point at 124.

Closing price: 124
Opening price: 77
Difference: 47
Loss on bet: 47 x £20 = £940

NB: If the price of the bet had moved in the opposite direction, you would have made a profit.


Thanks for any help and apologys if i missed something obvious... but it's wrong right????

Be very careful of betting on put (or calls) option prices. The time value is against a buyer of options.

I used to buy options about ten years ago, so am very rusty about them. If I remember correctly, the best time to buy them is much further out than March--probably those of September. That period lasts until they are, shall we say, six months old, as I said, I am rusty. Then, as the expiry gets closer the time starts to waste and the writers start making money and the buyer loses money. Then, during the last week, or so, they can be bought again, when the time value has, almost all gone.

Even if the price moves the time wastage can make the option stand still, so you end up with no profit. The slightest price move against you can mean that the price can drop to near zero in no time.

There are guys here who will know much more than me, but the time wastage is the point to watch.

Split

 

[fibonelli]

I traded in options very briefly in the early 90's. Suffice to say, the bid/offer spreads and time decay are a problem.

An alternative would be to do spread trades using traded options. This is a specialist subject and can either be incredibly risky or lower risk than an outright put/call. You must do your own research on this.

My own personal view is that warrants particularly covered warrants and investment trust warrants would be a better option particularly where the annualised premium to expiry is low.

 

[Splitlink]

You are betting that the index is going to fall , not to 4725, but to 4645- just to get your money back. As soon as the index rises 10-20 points, you'll see your option price fall to half.

So be careful to buy the right option at the right time.

These newspaper guys don't have a clue, they just put together a story to whet peoples appetites.

 

[garfster]

Thanks for the replys. So was the consesus that the example was wrong then?

 

[Splitlink]

Thanks for the replys. So was the consesus that the example was wrong then?

What I find confusing was that Barclays Stockbrokers was writing about placing £20 per point on an option that cost 77p. An option contract consists of 1000 shares, so the cost should be £770. Where does the £20 come in? Maybe buying options has changed from the time I was trading them

Split

Yes, I see. Barclays is working with Financialspreads, The arithmatic is correct but the advice is lousy. Like I said.most options waste.

 

[doktrade]

To buy options directly is not my choice to make real money. We have today a fortune to select from betting company where contracts counting is the simple game of choice and eliminate confusion.

Splitlink is most correct in saying the significance is time. Option exist to hedge against time. Thus, if you buy options it is a simple case when time is not on your side. It is better to write options, but only mega-rich companies can afford. Same as with insurance.

Most important that no-one mentions is to understand the *volatility* of underlying asset. Then option cost is easy math. I recommend to spend time in understand the volatility. Then effect of down market with put option become obvious.

doktrader

 

[TWI]

If you do not fully understand the risk you are taking with options you will do better to stick to the underlying product. Then you have a simple mark to market profit/loss.
You need to know about your deltas, gamas, thetas and vegas and how they change as function of underlying, time, interest rates etc before you start on this cr*p.

 

[garfster]

If I can drag people back to the original question.. Even the greeks would say its wrong...

 

[TWI]

Sorry to digress, yes, example is b/s. In scenario you should make profit basis the quotes you supply.
In reality the quotes may be different hence anything can happen.

 

[Splitlink]

Hi guys. First thanks to all the contributers on these boards. I'm learning about various investments at the mo and these boads are fantastic!

I was reading this on:

http://www.stockbrokers.barclays.co.uk/content/ads/documents/Barclays FST Brochure.pdf (page 24)

and try as i might I can't understand it and can only come to the conclusion it's wrong or I'm missing something fundamental! Can anyone explain why this is a loss and not a win?




Example – Betting on a put option price on the FTSE Stock Index future

Opening bet

In December the FTSE 100 is trading at 5250 and you think the market may fall. The quote for
the March FTSE 4725 put option is 72-77 and you place an order to buy £20 per point at 77.
Your maximum loss is limited to 77 x 20 = £1,540, yet your potential profits are unlimited.

Closing bet
Two weeks later the FTSE 100 is trading at 5000 and the quote for the March FTSE 4725
put is 124-129.

To close the position you sell £20 per point at 124.

Closing price: 124
Opening price: 77
Difference: 47
Loss on bet: 47 x £20 = £940

NB: If the price of the bet had moved in the opposite direction, you would have made a profit.


Thanks for any help and apologys if i missed something obvious... but it's wrong right????

Yes, to get back to that question I think that you have made a profit, not a loss. However, If the index goes to 4725 the option will close worthless and will be worth a penny per point that it goes lower.

You should ask them to clarify that. And paper trade their quotes for a bit. It's difficult to make money buying and selling the options, I really think that you are taking a lot on to spreadbet them.

Split