Options Trading Strategies
Options Trading Strategies
Options Trading Strategies
He never showed so I guess that he will have to download this lecture and figure it out like everyone else. He was a nice host, though. And he seems very interested in math. A lot of things going on in this large curved building behind me seemed to have a connection to math.
You can buy call option IBMJRX for 15 cents, which give you the right to buy IBM for 90 between g y now and Oct 20.
In the Money
Buy to Open to buy a call or put. Sell to Close to sell the call or put that you already own. Sell to Open to write a call or put. Buy to Close to offset (cancel) a call or put that you have written. Exercise to exercise an in-the-money option at any time.
Enter these
Before trading an option, always check open interest and volume for liquidity. O Once an option goes into the money, it can be difficult to ti i t th b diffi lt t decide when to sell it.
take profits now or hope that it goes higher and pray that it doesn't fall back out of the money.
Buy a call
gambling that the price will rise near or out of the money: high leverage, high risk deep in the money: lower leverage, lower risk
Buying a put
gambling price will fall excellent hedge for a long position in stock or related asset
Example
Suppose you owned 500 shares of IBM. When IBM was trading for $93.30, the following put options were available (6 week expiration): k i ti )
Strike Put 85 90
+IBMXQ +IBMXR
Chg 0 0
Vol 18 153
Buying 500 90 puts at ask would cost you $350, but you would lose no further money if IBM fell below $90. Buying 500 85 puts would cost you $100 and protect you at $85. Of course you can also protect yourself with stop-loss orders, although execution of those at the limit price are not guaranteed.
Premium Behavior
The premium on an option is determined by the three components listed on the last slide, (1) the volatility of the stock and the market in general, (2) spread from the strike price (whether in the money or out), and, (3) especially for out-of-themoney options, the time before the option expires. It is possible to segregate these three in theory and empirically and the ability to do so is essential for advanced options trades.
Spread
10/9/08 DIA at 91.55 DIA Nov Call Ask Strike Ask Premium 75 17.10 0.55 80 12.25 0.70 90 4.45 2.90
Closer is greater
Time
9-Oct-08 DIA at 91.55 DIA 94 Call Ask Oct 2.37 Nov 5.10 Dec 5.90 Mar 7.60
Note: Premiums were unusually high in Oct 08 because of volatility in the markets.
My approach
Name:Gary Evans Date:3/8/2011 Put Option Price Calculator Daily Volatility Stock symbol: Put option: Date Today: Expiration Date: DTM: Stock Price: Strike Price: Daily Volatility: Interest Rate: Time: d1 Numerator: Duration Volatility: N(-d1): N(-d2): Option Price: Option Premium: TLT Jun 91 5/12/2010 6/19/2010 38 92.72 91.00 0.0070 0.010 45 0.01996 0.04696 0.3354 0.3527 0.96 0.96
I generally have my own way of doing things, a little different from the book and the standard ways. Generally I dont use Greek-based models for reasons that I will explain when we get to the Greeks. Instead I use dynamic sensitivity models, which I will explain here in part and later in more detail. I always use daily volatility measures (because my trades are generally shortterm) and I use my own variation of the Black-Scholes model. We will learn both of course.
Stock Symbol: DIA Put Symbol: Feb 121.75 DTM: Days Time: Put Daily Volatility: 8 5 0.00600 PUT 121.75 0.00546 0.01342 0.34197 0.34691 0.37 0.37
2/19/2011 122.400 0.00470 0.010 CALL Strike Price: 122.75 -0.00272 0.01051 0.39795 0.39390 0.36 0.36 0.3980 0.74 1.03
My strangle calculator that I use all of the time (before and strangle or straddle trade). trade) I also calculate historical volatility many different ways:
Date: 1/28/2011 Symbol: DIA Abs DEL LN Plus 1 0.9997492 0.9989962 1.0005857 0.9907570 0.9959398 1.0003390 1.0005929 0.9954167 Average: Days: Volatility: Max: Min: StdDev:
Daily Volatility
Strike Price: d1 Numerator: Duration Volatility: N(-d1): N(-d2): Option Price: Option Premium: Delta: Profit/Loss: Profit/Loss %:
d1 Numerator: Duration Volatility: N(d1): N(d2): Option Price: Option Premium: Delta: Position Cost/Value: Original Cost:
0.02000
0.01500
0.01000
0.00500
0.00000
Time Decay
1.60 1.40 1.20 1 20 1.00 0.80 0.60 0.40 0.20 0.00
33 32 31 30 29 28 27 26 25 24 23 22 21 20 19 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1
This shows the actual projected time decay of a March 75 DIA call option, purchased for $1.51, when DIA was trading at $72.15 (implied daily volatility at 0.0156), calculated using an option calculator. calculator This assumes no change in DIA price and no change in volatility.
Time Decay
tp = d tpd
m = d 30 55 d .
TD = f
6
dtm
The standard deviation of the growth rate of any stock for a period measured in days is equal to the daily standard deviation times the square root of the days in the time p y period. For example, the monthly standard deviation is equal to about 5.5 times the daily standard deviation. This implies that the time decay of an option premium (especially otm) will be a function of the y p y y decay represented by daily taking the square root of the days remaining to maturity, as shown in the graph on the left.
0
30 29 28 27 26 25 24 23 22 21 20 19 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1
The VIX is a volatility measure of the S&P500 index based upon S&P500 stock index options prices. VIX futures contracts are offered by the CBOE. To see how the VIX is calculated, on Google find vixwhite.pdf
Graph source: finance.yahoo.com
VXX is the iPath short-term futures ETN which is invested in the first two near-term futures contracts of the CBOE VIX futures contract, which in turn is linked to the actual VIX index, which is calculated using put and call prices for the CBOE SPX benchmark index, which is a synthetic stock. The options are European style and futures are cash settlement.
Graph source: finance.yahoo.com
Scenario: 20 days have passed, leaving 32, no change in price, so the graph above shows the sensitivity to volatility alone.
On the other hand, if you make any kind of option trade, straddles, strangles, or just buying puts or calls, when the VIX is this high, you are paying a very large premium and might lose when the VIX falls. This might be a good time to write covered calls if the volatility is not due to market stress.
82
83
84
85
86
87
Stock Price
88
89
90
91
92
Option value
Profit
10
11
Maderas Golf Course, San Diego County, 9th hole. Your teacher brilliantly birdied this hole. He triple-bogied the one in the background. You should play golf to understand options because you learn how things can go from really good to really bad really quickly
2.
Although the stock may have a higher expected value (a positive alpha) and is therefore a positive-sum game, a call or put option on the stock is a zero-sum game and with transactions fees and B/A spreads is a negative-sum game ...
... although if the option is used heavily for hedging, which is possible for some heavily-held stocks and ETFs, in that case the spec position might actually be a positive-sum gain as it theoretically is for futures ... ... and this is a variation of an efficient markets hypothesis.
3.
Although this negative- or zero- sum feature is probably more or less true for the market as a whole, it is not true for every option in the option chain of every stock with options
bias is everywhere, so the secret is to discover the bias and act on it ... and this almost always requires the use of a model
Postulates 1 & 2
On March 9, 2011 at 11:52 AM PST, SPY Best Ask was 132.49, and this (above) was the May 21 Call option chain at that moment, with 73 days to expiration. Consider the 135 Call and the 137 Call (highlighted). What does postulates 1 & 2 say about them? Both represent a zero-sum game, as do all of the other options on this page, and as do all other put and call options in other months for this stock!! What exactly does that imply?
Interpretation of P1 and P2: Strong EM hypothesis: The expected value of the bet (area under line) is equal to the cost of the bet. Weak EM hypothesis: The expected value of all bets, whatever they are, are equal. , q Important note: if we can demonstrate that the weak is false, then the strong is false.
COST: $2.64 Expected Value of the bet: $2.64 $2 64
135
132.49
137
Postulate 3 It tends toward efficiency (weak or strong) for all, but not for the components.
Basically, weak EMH is going to fail because there is no way that even arbitrage will force every component of an option chain to produce an expected ROI. But if Postulate 3 is true, then the bias that is found in each individual option is as likely to be harmful (negative sum) as helpful (positive sum). Postulate 3 is essentially untestable, but we have to assume that it is true. Therefore we have to use some kind of model to find the bias!
132.49
All calls and puts in all of the option chains for SPY, when considered, must fit this distribution for even the weak EMH to be true for individual stocks.
Where are we going with this?? Hint: P1 and P2 imply that (a) given that core standard deviation must be the same (b) then implied and all actual volatilities must therefore be the same.
82.00
80.00
78.00
76.00
74.00
72.00
0.0300
0.0200
0.0100
0.0000 0 0000
Two volatility estimators for IWM, 60 day, graph shown with 5 DMA. DMA.
-0.0100
-0.0200
-0.0300
IWMDailyABSCGRVolatility y y
0.03000
0.02500
0.02000
0.01500
0.01000
0.00500
0.00000
5-day VIX
Above is the Apr 16 option chain at the moment when IWM was 80 26 This was on 80.26. a bad day when the Dow was down about 200 points and the Russell 2000 was down 1.68% at this moment.
Stock Symbol: IWM Put Symbol: Apr 80 DTM: Days Time: Put Daily Volatility: 37 37 0.01580 PUT 80.00 0.00427 0.09611 0.48228 0.52060 2.90 2 90 2.90 -0.5177 0.00 -0.07
4/16/2011 80.260 0.01310 0.010 CALL Strike Price: 80.00 0.00427 0.07968 0.52135 0.48958 2.72 2 72 2.46 0.5214 5.62 5.62
Strike Price: d1 Numerator: Duration Volatility: N(-d1): N(-d2): Option P i O ti Price: Option Premium: Delta: Profit/Loss: Profit/Loss %:
d1 Numerator: Duration Volatility: N(d1): N(d2): Option P i O ti Price: Option Premium: Delta: Position Cost/Value: Original Cost:
Note: IDV for Call does not match IDV for Put and neither matches historical IDV. Why not, and what opportunity does this imply?
Stock Symbol: IWM Put Symbol: Apr 78 DTM: Days Time: Put Daily Volatility: 37 37 0.01648 PUT 78.00 0.02959 0.10024 0.38393 0.42272 2.12 2.12 -0.6161 -1.78 -46.28
4/16/2011 80.260 0.01250 0.010 CALL Strike Price: 82.00 -0.02043 0.07603 0.39410 0.36517 1.72 1.72 0.3941 3.84 5.62
Strike Price: d1 Numerator: Duration Volatility: N(-d1): N(-d2): Option Price: p Option Premium: Delta: Profit/Loss: Profit/Loss %:
d1 Numerator: Duration Volatility: N(d1): N(d2): Option Price: p Option Premium: Delta: Position Cost/Value: Original Cost:
Note: IDV 82 Call = 0.01250 80 Call = 0.01310 78 Put = 0.01648 80 Put = 0.01580. ????
Original straddle was on a Thursday March 10. How will the 82 call look on Monday at these various volatilities? We paid $1.72 for this call. p $ 4-day time decay $1.72 - $1.58 = $0.14 If the call goes to estimated volatility, the call will be worth 1.58 $1.32, a loss of $ 0.40.
1.14 0.72 0 2 0.32 0.04 2.03 2.48
3.39 2.94
$0.00 0.0025 0.0050 0.0075 0.0100 0.0125 0.0150 0.0175 0.0200 0.0225
On the other hand, if you make any kind of option trade, straddles, strangles, or just buying puts or calls, when the VIX is this high, you are paying a very large premium and might lose when the VIX falls. This might be a good time to write covered calls if the volatility is not due to market stress.