Credit Spreads

Quote from ArchAngel:

Don should stick to talking about stocks - options are clearly not his forte.

When you pull that "estimate" out of thin air (or a body part as the case may be) of 5 in 20 (that's 1 in 4 to the rest of us) blowing up - what's that mean? A spread can't "blow up" because it has a fixed risk going into it. You could get a move that leaves the spread fully in the money costing you your already known fixed risk - but that's hardly a "blow up". Selling a naked put might "blow up", but not a spread.

As far as pricing on conversions usually netting to within a small variance of what he's calling "fair value" - duh. If option prices skewed too far out of whack with respect to comparable calls/puts pricing, they're immediately arbed back into consistency (i.e., if prices allowed for a large enough positive net on long/short conversion, a thousand automated systems would hammer it immediately to take the easy profit and force the prices to close the gap).

But internal pricing consistency has nothing to do with "fair value" - the calls and puts can still be over/under priced relative to the underlying depending on the expectation for volatility. And the probability of success on any given credit spread involves where, when, and how you put it on and also whether you leave them on until expiration.
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I am referring to Equity Options, and of course, everyting "depends on where, when, and how you put it on..." I expect that to be a "given" since this is the "options" thread. I think my 14 years on the options floor, and the million or so contracts that I've traded make me somewhat knowledgeable about pricing models.

(Not being defensive, just defining). Many of the same old strategies tha we did a hundred years ago keep resurfacing to those that are new to the business. I just like to explain the only "true" valuation scenerio, that allows for all possible outcomes (except for keeping the conversion/reversal until expiration, and having the stock close at the striking price. Everything else depends on "guessing" volatility from historical and implied, and defining interest based on "long or short" (whether your paying or collecting).
Just don't start doing "covered writes" (ala Wade Cook) vs. selling naked puts, and I won't question your tactics. Most everything else can work if you keep an eye on all your deltas, gammas, thetas, betas, and all the rest of the Greek alphabet.

All the best...

Don
 
Quote: Sorry, but if anything's "simplistic", it's Mr. Bright's last post. No discussion of the Greeks or volatility make me question his understanding of options, particularly from a retail trader's perspective.

Response (friendly as always).::

Sorry to dive in on the options page, but you might read my response.... My brother and I made millions trading options on the floor of the CBOE, PSe, and futures on the CME (we still have a seat).

Since I do so much "education" on the subject of trading, including options and futures, I stay up to date, and have a good understanding of the pricing models.

I normally have to "dumb down" my comments to most (newer) option guys... which may have been my mistake on the thread here.

If you guys are doing well, making some good money, then you must be pretty knowledgeable already...so I guess I can speak more directly.

Sorry for any confusion...

Don
 
Don,

No problem and I appreciate the reply. Though it seems I haven't been at the game as long as you and, though I've made enough to pay the bills, haven't yet made millions with options as you have, I think I've learned a thing or two about options since I started trading them several years ago. One thing of which I'm convinced is that certain approaches which work well on the floor simply are not viable for off-floor traders. At the same time, and as I've said on the boards, trading options without the proper knowledge is the fastest path a trader can take to ending his nacent career.

Nonetheless, despite the myriad risks, I am of the opinion, which I base on personal experience, that traders can make money consistently with options assuming they know what they're doing and apply careful risk management. But the same prerequisites apply to stock trading, do they not? After all, stock traders are required to "guess" correctly regarding direction to be profitable and to also control their risks. Indeed, on this point, I would posit that options traders have a distinct advantage over stock traders in that, with certain strategies (i.e OTM credit spreads), one can "guess" wrong on direction and still profit.

In any event, I appreciate the dialogue and look forward to future exchanges on this always facinating subject.

Regards,

HD

P.S. I must admit that I haven't been keeping a close eye as you advised on my options' "beta", but I will be sure to start doing so now.
 
OK, I think we're on the same page Mr. Dollars....and if there is anything I can do to help, please let me know.

One of the main reasons that people get involved (off-floor) with the trading of options, is of course, the leverage involved. When we (BT) allow our traders enough capital to trade the same Delta's with the underlying, then we can slip in and out without too much concern about time decay, extra slippage, etc.

Stay in touch!!

Good Luck!

Don
 
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