How Do Options Make Predictions?

dmo · Jan 30, 2009

Quote from pinthestrike:

I assume some of you have read or are otherwise familiar with Gisin's Geneva experiment.

Never heard of it.

MAESTRO · Jan 30, 2009

Quote from dmo:

Never heard of it.

I assume that the reference is made to the information propagation that is faster than speed of light. Two particles spread by a significant distance had virtually simultaneous change in spin when one of them is modulated.

jficquette · Jan 30, 2009

Quote from dmo:

This sounds very logical but - and this is just my experience - this kind of linear logic will get you nowhere in the markets. It just doesn't work that way.

Maestro's "poetic" approach - where money and human herds move in ways similar to a school of startled minnows - is a more fruitful and accurate way of looking at it IMHO. I don't know what his strategy is but in general the way he talks about market behavior rings true.

Consider the swarming around the perceived less risky strike as being equivalent to the swarm of fish balled up when a threat is perceived.

John

MAESTRO · Jan 30, 2009

Quote from jficquette:

Consider the swarming around the perceived less risky strike as being equivalent to the swarm of fish balled up when a threat is perceived.

John

Any swarm can be described by just three simple rules:

1. Each member of the swarm is only aware of its nearest neighbors (usually 2- 6 of them)
2. Each member keeps the constant distance between its close neighbors
3. Each member moves in the direction of its neighbors with relatively equal speed.

stevegee58 · Jan 30, 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?

That's simple. Option premium is set according to IV. IV is the market's *belief* of how volatile a stock is gonna be within some time period. Stocks frequently *do* move this much, as "predicted".

The ability to find over and under priced options is key to making money in that game. If the IV is too high, sell premium. If the IV is too low, buy premium.

MAESTRO · Jan 30, 2009

Quote from stevegee58:

That's simple. Option premium is set according to IV. IV is the market's *belief* of how volatile a stock is gonna be within some time period. Stocks frequently *do* move this much, as "predicted".

The ability to find over and under priced options is key to making money in that game. If the IV is too high, sell premium. If the IV is too low, buy premium.

If that would be as simple as you described everybody on ET would be a millionaire by now. Unfortunately, it is infinitely more complex.

kjb1891 · Jan 30, 2009

I was just wondering if someone makes a statement such as "options are predicting an X% move for XYZ stock" how did they come to that conclusion? Why not Y% or -X%?

What option parameters did they look at to come to the conclusion that the X% move was what the options were predicting to be the "most likely" move for the underlying?

It can't be some secret or overly complex calculation because they'll make statements like the above on CNBC for heaven's sake. I just can't find much info about the topic.

dmo · Jan 30, 2009

Quote from stevegee58:

That's simple. Option premium is set according to IV. IV is the market's *belief* of how volatile a stock is gonna be within some time period. Stocks frequently *do* move this much, as "predicted".

Looking at the SPY options, I see that the 95 strike is trading at 31% IV, while the 60 strike is trading at 70% IV.

So if IV is the market's predicted volatility of SPY, then what does the market believe? That SPY's actual volatility will be 31%, or that it will be 70%?

MAESTRO · Jan 30, 2009

Quote from kjb1891:

I was just wondering if someone makes a statement such as "options are predicting an X% move for XYZ stock" how did they come to that conclusion? Why not Y% or -X%?

What option parameters did they look at to come to the conclusion that the X% move was what the options were predicting to be the "most likely" move for the underlying?

It can't be some secret or overly complex calculation because they'll make statements like the above on CNBC for heaven's sake. I just can't find much info about the topic.

I consider CNBC people being as dumb as they come. Their statements are so moronic sometimes they make me sick! No one can say for certain that the price will move X points up or down. I wonder sometimes did anybody actually measure their IQ? I wouldn't be surprised to find it lower than 80.

Edit:

I should not deviate from the topic of this thread though! My apologies.

jem · Jan 30, 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? Did you know that if you put two metronomes that have different frequency onto a moving surface they quickly will synchronize by them selves? In Taiwan there are billion fireflies who blink simultaneously in huge numbers all along the river banks. Why does it happen? Why atoms in a laser became synchronized and produce coherent and monochromatic light? There is no reason for that to happen. This is a fundamental property of closed loop feed back systems. Option chains and the distribution of their premiums vs their respective strike prices behave the same way without any individual option traders âknowingâ better where to put their bets. It just works this way. Collective behavioral patterns of spontaneous decision makers tend to synchronize revealing stable distribution patterns that have enormous predictive values. If the predator attacks the school of fish they move in much synchronized manner precisely reflecting the level of danger they are under.

This is a very interesting quote.
In the past maestro doubted technical analysis.

Is this not just like the argument for fibonacci points.

As you study what quants do - most of them are really just renaming different types of technical analysis.

I see so many statements from quants that sound just like someone putting bollinger bands on a chart or scanning for them in Tradestation.

Now we have quants and physicists sounding like fibonacci enthusiasts.

I am not doubting you maestro, because when I was younger I made great money trading off the same belief system. I traded million of shares and thousands of trades. It was not just luck as other traders in my office made money doing the same thing.

I just used a technical setup - which worked for years. (does not work well anymore.)