Using the option greeks to trade

Magdoran said:

Risk:
How much are you prepared to lose on each trade (what is the maximum loss you can tolerate?)? Are you prepared to lose?:
• 50%?
• 100%?
• 20%?
• Another amount?

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Hi folks,

I haven't got a lot of time today, but I just wanted to suggest an alternative view to risk.

The percentages Mag has used above, indicate the amount of risk of the actual capital used in the trade. E.g if you paid $1000 to go long some calls, how much of that $1000 are you prepared to lose?

I look at things in a completely different way. I don't give a toss how much premium I lose as a percentage of itself. I consider a 100% loss of premium as actual risk. There are many circumstances where you will not be able to avoid 100% loss of capital at risk, just check out the screenshot below.

This also illustrates quite satifactorily, option trading commandment #1 "Thought shalt cover thine @rse". Che Guevara stated it succinctly in his own field of endeavour. "The first duty of the guerilla fighter is survival"

Therefore, what I do care very much about is what % of my total capital that potential loss repesents. If that $1000 loss was from a bank of $2000, then that's catastrophic. You've just effectively blown yourself up. If it's from a bank of $2,000,000 then it's only lunch money. In the situation depicted below, I would ensure that this event is merely of passing interest, a mere war story where other folks blew themselves up. Maximum loss for me is a very small % of my capital.

Standard fixed fractional money management folks.

Just a quick comment:

Wayne makes a good point about the broader concept of potential loss to your overall trading/investing capital, and in the broader trading sense is a vital concept (good points Wayne, thanks).

What I was actually doing was something a little different however, and the question I raised about risk had a specific purpose: Under the new financial regime under the auspices of ASIC, determining the actual level of risk tolerance for the individual is critical (and a requirement for Financial advisors).

The question was designed to elicit a second response to the risk tolerance question in an effort to confirm or modify the response given (moderate to aggressive), which materially effects a whole range of approaches to derivative strategies, and will help me to set up a realistic scenario to best illustrate some points to benefit hissho, and anyone else in similar circumstances.

This method of verification is in part based on the approaches required to attain PS 146 certification (I have PS 146 certification in derivatives and securities), hence my interest was to tailor the scenario in a generic format, but in a way that would benefit hissho to the best of my ability, but also not to contravene ASIC requirements.

Hope this makes sense.


Regards


Magdoran

fantastic doran and wayne!

since this thread is about "how to use greeks to trade", i'd like to hear how you would approach it if you held the view that asx index has another 200-250 points to go down...i'm not saying i'll ask the question here and follow any advice to actually do the trade, just for education purposes.

so you got a view, how would you approach it? what would be your first step? find out historical and implied volatility about XJO? and then? what strategies would come up into your mind? buying puts would already be too expensive if IV is high... how would you compare those strategies coming to ur mind and finally decide to take one that you think is most appropriate?

again let me stress this: not seeking trade advice here and then simply "copy and paste", just to learn the way professional traders think and make decisions...

your comments would be greatly appreciated
hissho

Hello All,


I had intended to put up some real time examples to illustrate how to use the “Greeks: to trade, but in the current market conditions, I am reluctant to demonstrate short term bearish trades which are highly risky, and require both specialist knowledge in derivatives, as well as understanding how markets trend in order to forecast accurately enough in time and price to determine entry and exit points with precision.

I judge this dangerous for newer players to start with as it takes years to develop the requisite skills to do this, as well as it being inherently risky, and may give newbie’s the impression you can just cash in 1000% gains regularly, rather than recognise that these moves are the exceptions you look for if you are a directional position trader with the experience to achieve this kind of result in a bearish drive.

The problem with trying to day trade strong bearish moves is that the options market though opening at 10:00 AM doesn’t require the market maker to make a market for about 30 minutes, and if they do trade with you when there isn’t someone else to take the opposite side of the transaction (i.e. interest is low in the strike you’re looking at, at the time you want to trade, on the side of the bid and ask you want to enter). There are a host of hurdles like the width of the spread, and the artificial moving around of volatility.

You really need a major movement in the underlying to do well out of these moves for intra day players, and I’ve found position trading with specific time and price objectives to work the best combined with exiting partial positions to lock in profit (see the thread on trading partial positions). But this is of course up to the individual, and their preference and capability.

I also don’t want to tip my hand with what I’m up to while the market is trading like this by giving out key information that may be detrimental to my positions, so please understand, under normal conditions it wouldn’t matter so much. So, with these combined factors I haven’t published on this thread, and am waiting for a reasonable example. Please also understand that there are a myriad of viable approaches, and that the freedom to use derivatives comes at a cost of complexity and an over abundance of choices.


Regards,


Magdoran

Magdoran said:

Hello All,


I had intended to put up some real time examples to illustrate how to use the “Greeks: to trade, but in the current market conditions, I am reluctant to demonstrate short term bearish trades which are highly risky, and require both specialist knowledge in derivatives, as well as understanding how markets trend in order to forecast accurately enough in time and price to determine entry and exit points with precision.

I judge this dangerous for newer players to start with as it takes years to develop the requisite skills to do this, as well as it being inherently risky, and may give newbie’s the impression you can just cash in 1000% gains regularly, rather than recognise that these moves are the exceptions you look for if you are a directional position trader with the experience to achieve this kind of result in a bearish drive.

Click to expand...

Great comments there. This something I have a monumental challenge with in regards to most seminar promoters... and why most noobs get crunched, combining unrealistic expectations with a (seemingly intentional) omission of crucial knowledge.

Magdoran said:

The problem with trying to day trade strong bearish moves is that the options market though opening at 10:00 AM doesn’t require the market maker to make a market for about 30 minutes, and if they do trade with you when there isn’t someone else to take the opposite side of the transaction (i.e. interest is low in the strike you’re looking at, at the time you want to trade, on the side of the bid and ask you want to enter). There are a host of hurdles like the width of the spread, and the artificial moving around of volatility.

You really need a major movement in the underlying to do well out of these moves for intra day players, and I’ve found position trading with specific time and price objectives to work the best combined with exiting partial positions to lock in profit (see the thread on trading partial positions). But this is of course up to the individual, and their preference and capability.

Click to expand...

Strongly agree. Day traders should avoid options in most cases.

Re 10:00AM opening: YO! Another advantage of the US market. It opens along with stocks and traded right through lunch as well.

Magdoran said:

Please also understand that there are a myriad of viable approaches, and that the freedom to use derivatives comes at a cost of complexity and an over abundance of choices.

Click to expand...

Yes. A book sized endeavour here.

Cheers

wayneL said:

Re 10:00AM opening: YO! Another advantage of the US market. It opens along with stocks and traded right through lunch as well.

Cheers

Click to expand...

Seems like there are some changes in the wind for us here as well. Lunchtime trading and only 10 mins for the MM's to get their markets up if I have understood right

NettAssets said:

Seems like there are some changes in the wind for us here as well. Lunchtime trading and only 10 mins for the MM's to get their markets up if I have understood right

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Not before time NA, the current situation is quite ridiculous IMO.

wayneL said:

Great comments there. This something I have a monumental challenge with in regards to most seminar promoters... and why most noobs get crunched, combining unrealistic expectations with a (seemingly intentional) omission of crucial knowledge.

Click to expand...

Is this also true for buying at the money? I've been trading for a year and haven't had an ATM option go against the underlying price.

I understand I should have a decent understanding of greeks, and it's next on my list of things to do, but so far ignorance hasn't affected me that I'm aware of. That is, just swing trading and buying at the money.

Had one recently on Santos that worked in my favour
Bought the may ATM call and sold 1.5 above and they both made money! whether this is just something that is actually not real I don't know.
I only gave a price I was prepared to pay and get for the spreads and the individual prices where quite different from what I expected

I've made about 100 trades at the money and none have gone against the security. Some may have not moved as much as I would have thought, but then I only have basic understanding of how they're valued. All of those were bought within 4-8 weeks out from expiry.

Here's an example of vega risk.

I haven't got the precise numbers but working off IV levels:

Earlier in the week ATM sept calls on S&P500 futures were worth around 46 points with IV having had crept up to around 19%. IV has subsequently collapsed to around 13% yesterday and (presuming there ws no movement in the underlying) those calls are now only worth about 32 points.

This means the index could have rallied 28 points over the last three days, yet the value of your call is the same.

I was on the other side. When I saw IV @ 19% I was able to write and get decent premium WTFOTM for expirty in July... 100 pts OTM in fact. In three days vega has handed me a tidy profit and it would take a particularly nasty black swan for me to even consider any defensive tactics necessary.

Now think of the numpties that bought those OTM options. They are way behind the eight ball and their chance of a profit is probably around 1%.

Bear in mind these tactics IMO are only applicable with a degree of safety on indexes (which I have explained elsewhere). I would NOT do the same thing in stocks without hedging myself.

Cheers

Hi, Waynel. Were you OTM index options deep OTM so that you do not have to worry about delta risk? How to do a gamma trading?
thanks

flyhigher said:

Hi, Waynel. Were you OTM index options deep OTM so that you do not have to worry about delta risk? How to do a gamma trading?
thanks

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Yes WTFOTM if I can get enough premium. Otherwise just WOTM and morph as necessary.

Also try to get delta neutral as conditions permit.

Gamma trading is a LOOOOOONG post...when I have time I'll go through it. But I don't believe it is a useable strategy in the Oz market.

Hi, waynel. Is it possible for a small investor to gamma and vega trading in the market. I think it takes a lot of money to hedge the delta risk.
cheers