Entries Tagged 'Greeks' ↓

Failing to Make the LEAP to Long Term Thinking

Is it possible to find an option strategy that delivers a swing at a home run, an 80% chance of 100% and a known limited risk? You bet it is.

While the old lore that 90% of options expire worthless does not give a true picture of the options market, it is true that buyers generally loose more than they win. Option buyers are speculators. There’s nothing wrong with being a speculator, the important point is to recognise that you are engaged in speculation and to make sure that fits with your personality and risk profile. As a general rule I need to win more than I loose so I don’t often buy options. If you buy options you can loose a lot of the time, but still make money. A few home runs can makeup for a lot of losses.

As predominately an option seller I didn’t get the opportunity for home runs. In fact my losses were sometimes other people’s home runs and those big losses sure ate up a lot of my winners. Just like an insurance company, I collected a lot of premium, but occasionally suffered a big loss. The small speculator in me, never got the reward of those cocktail party stories of option trading glory. It soon became ludicrous to have tor refer back to my SAP home run story of ‘95.

I was always searching for a strategy that could give me a shot at a home run and a high probability of profit.

Then one day I found it, the perfect strategy to add to my options armoury, a strategy that delivered a swing at a home run, an 80% chance of 100% profit and a known limited risk.

Are you mentally screaming tell me, tell me what that amazing strategy is? Maybe you’re screaming it OUT LOUD. Or maybe not, I know I wouldn’t have been. I’m sceptical of most things and the hyperbole surrounding options trading made me wary of such claims years ago. The thing is if you’re an experienced option trader or have any read a few books or followed online discussions then you probably know what this strategy is already. You probably knew it when you read the heading.

Read Part Two….

Do the Greeks accurately predict the future?

FDX closed up 1.61 (+1.79%) Wednesday. The 90 Puts bid/ask mean is 2.025 (1.95-2.10) and last trade was 2.00 down .70.
Using the Greeks let’s check to see if what was theoretically meant to happen did transpire.
The delta was -0.4889. Multiply 1.61*-0.4889 = 0.79. Another day has passed so time decay, theta, should have eaten another 7cents for a total of $0.87, yet the bid/ask mean only decreased $0.65 and the last trade $0.70. Where has my 20 cents gone?
First let’s look at the theoretical value which currently stands at 1.5702 and yesterday was 2.3335 for a change of $0.76. Which is closer to my calculation.

The difference between what yesterdays Greeks implied the price should be and the actual option price, is due to change. The Greeks are not static. As the underlying asset price changes so do the Greeks and the option price accordingly.

The Greek most responsible for dealing with change is Gamma.

As discussed yesterday Gamma shows how fast delta will change as the market price of the underlying asset changes. Gamma was 0.0602, multiply that by the price change of 1.16 and we get 0.0969. Subtract that from yesterday’s delta and we get a new delta of -0.3920. The reason that is not exactly the same as the closing delta of -0.3961 is that the Greeks are constantly changing throughout the day to reflect the changes in the underlying. In this case Gamma changed from 0.0602 to 0.0559.
If we take the closing delta and re-run our first calculation. Multiply 1.61*-0.3961 = 0.64. The result is closer to the theoretical change. Add in the 0.07 time decay and the result is close to the actual change of $0.70.

Theta has increased from -0.0703 to -0.0756. So as expected the closer we get to expiration the faster the time decay. Excellent! That’s what we want as option sellers. Volatility has also changed, but I think we have covered enough.

I haven’t included not understanding the Greeks in my 10 Biggest Mistakes in Option Trading series, but as in any endeavour you will do better if you know the tools available to you. I hope this quick overview has helped make the Greeks clearer.