How Do Options Make Predictions?

MAESTRO · Feb 3, 2009

This is a Prop-Trading part of our business.

http://www.marketguidance.com/index.html

It is a separate operation from our Money Management division. The "multi-monitor" setups are used for all of our 3 divisions. We currently have operations in 4 different cities. The trading floors are different for all of them. I just want to make something very clear:

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stock777 · Feb 5, 2009

Quote from kjb1891:

I've seen it numerous times where someone will something along the lines of "options are predicting an X% move for XYZ stock".

How would you go about determining that? Do you look at specific signs from volume, open interest, IV, B-A spread?

Lots of something on this thread, but not an answer to a simple question.

Sad.

I know jack shit about options compared to some, but this is not hard question.

Let's see if these guys with 150 monitors can actually give a straight answer.

MTE · Feb 5, 2009

Quote from stock777:

Lots of something on this thread, but not an answer to a simple question.

Sad.

I know jack shit about options compared to some, but this is not hard question.

Let's see if these guys with 150 monitors can actually give a straight answer.

OK, OK, here's the answer:

Look at the price of the ATM front month straddle (assuming the move is expected before the front month expiration), which is the approximate size of the move that the market expects.

cvds16 · Feb 5, 2009

Quote from stock777:

Lots of something on this thread, but not an answer to a simple question.

Sad.

I know jack shit about options compared to some, but this is not hard question.

Let's see if these guys with 150 monitors can actually give a straight answer.

if you think the answer is simple it only proves you know jack shit about options ...

nitro · Feb 5, 2009

Quote from MTE:

OK, OK, here's the answer:

Look at the price of the ATM front month straddle (assuming the move is expected before the front month expiration), which is the approximate size of the move that the market expects.

Well, this is not incorrect, but it is incomplete.

The theta of the straddle can also be covered if the realized volatility is such that the underlying moves back and forth enough to cover theta. So if a stock is $5 say, and the ATM straddle is $1, that does not mean the market expects the stock to be $4 or $6 within the given time to expiration of the straddle. However, that would be one way that the the straddle theta would break even.

MAESTRO · Feb 5, 2009

Quote from stock777:

...

Let's see if these guys with 150 monitors can actually give a straight answer.

The answer is "YES". The "how" question however is up to you to answer.

MAESTRO · Feb 5, 2009

Watch this:

http://www.ted.com:80/index.php/talks/steven_strogatz_on_sync.html

ElCubano · Feb 5, 2009

Quote from MAESTRO:

A very good question. The answer is this. Why birds and fish tend to swarm? Why such unintelligent creatures form such stable formations that last for long time?

swarn theory..dumb individually smart in colonies....

iloveoptions · Feb 5, 2009

Quote from nitro:

Well, this is not incorrect, but it is incomplete.

The theta of the straddle can also be covered if the realized volatility is such that the underlying moves back and forth enough to cover theta. So if a stock is $5 say, and the ATM straddle is $1, that does not mean the market expects the stock to be $4 or $6 within the given time to expiration of the straddle. However, that would be one way that the the straddle theta would break even.

One of the best responses so far in this thread.

"Ask not what your straddle can do for you, but what you can do with your straddle."

Author, unknown

stock777 · Feb 6, 2009

mte's answer is close enough. The added genius is debatable.

I don't get where you think the vibration (path) of the stock could be embedded in the vol.

You mean to tell me they have an opinion that XYZ will vibrate 10 times between X & Y before landing at some price? This is highly unlikely .

Of course if the stock goes 5 -4- 5- 6- 5- 4- 5- 6- 4- 5- 6- 5, you can make a killing on a straddle.

I can make a killing on the lottery if I know the numbers too.

Essentially , the atm straddle tells you what the market thinks the breakeven move will be , so that neither buyers or sellers have an apparent 'edge'. If you think they are mistaken then you can play happily. If not, you can't. They get it wrong often enough.