Implied Volatility vs. Real Volatility

[cdcaveman]

I thought models served the purpose of burying risk and justifying tons of leverage... haha

I just can't let things go.... I'll keep picking at it till it makes sense...
Check out Greeks on wiki .. zeta and the such...

Options are awesome because you can create so many different expressions on the market.. get leverage with limited risk..

How else are you gonna make money in a consolidated choppy to dead market

 

[newwurldmn]

Quote from justrading:

I cannot answer as an expert on options, which I very obviously am not, but let me offer a pragmatic view.

It is not necessary to understand the physics of the internal combustion engine in order to benefit from having and driving a car. Energy conversion, torque, drive-train efficiency are nice to know if you are a mechanical engineer, but for a driver knowing that the car needs a particular grade of fuel etc is sufficient.

It would be wonderful if authors like Gatheral would write the book from the perspective of 'this is what we found, these are the implications, this is how you could use it', and stick all the mathematical models in the appendices.

Unless of course the story is in the models, ie. more like a research paper.

Using your car analogy: a driver doesn't need to know the details but a race car driver does. And the reason: he's looking for any advantages his competitors haven't understood. Ferrari uses a special gas to fill the tires of their formula 1 cars. Given that a trader is using options to compete against others it is a good idea to view them as a race car where understanding the internals on your own will likely fond you opportunities.

Re your post about short gamma: the jargon is used for precision. Being short gamma implies you aren't just short any options. You are short options that have a lot of gamma risk (vs options with a lot of skew risk or vega risk).

 

[quatron]

Quote from newwurldmn:

Re your post about short gamma: the jargon is used for precision. Being short gamma implies you aren't just short any options. You are short options that have a lot of gamma risk (vs options with a lot of skew risk or vega risk).

You can be net long options but still short gamma. E.g. ratio/back spread. So it's not just for precision, it's to remove confusion.

 

[newwurldmn]

Quote from quatron:

You can be net long options but still short gamma. E.g. ratio/back spread. So it's not just for precision, it's to remove confusion.

That's true as well.

 

[justrading]

Quote from newwurldmn:

Using your car analogy: a driver doesn't need to know the details but a race car driver does. And the reason: he's looking for any advantages his competitors haven't understood. Ferrari uses a special gas to fill the tires of their formula 1 cars. Given that a trader is using options to compete against others it is a good idea to view them as a race car where understanding the internals on your own will likely fond you opportunities.

Re your post about short gamma: the jargon is used for precision. Being short gamma implies you aren't just short any options. You are short options that have a lot of gamma risk (vs options with a lot of skew risk or vega risk).

The Ferrari driver does not need to know the physics of how the gas in his tires helps him. If it affects the way he has to manage tire wear, or specifically how the tires performance varies through the race, then all he needs to know is what he has to do as a driver given those factors. R&D chaps figure out the technical details.

As for jargon being used for precision, that is perhaps an oxymoron. Try 'large negative gamma position' for precision - everyone and his dog can understand that. Is there a lexicon somewhere that specifies short gamma implies large gamma risk? All my searches for 'define short gamma' have not turned one up, so at precisely what point does a negative gamma position become short gamma? Where is the boundary?

 

[justrading]

Quote from quatron:

You can be net long options but still short gamma. E.g. ratio/back spread. So it's not just for precision, it's to remove confusion.

That is a negative gamma position.

If there is a lot of short gamma, then it is a large negative gamma position.

Edit: To clarify, I don't think anyone would quibble about saying short gamma to mean having a negative gamma position. It gets boring when people say 'I trade short gamma'. Why not just say 'I sell options' or 'I trade ratio/back spreads'. Isn't that a lot more precise?

 

[justrading]

Quote from cdcaveman:

I thought models served the purpose of burying risk and justifying tons of leverage... haha

I just can't let things go.... I'll keep picking at it till it makes sense...
Check out Greeks on wiki .. zeta and the such...

Options are awesome because you can create so many different expressions on the market.. get leverage with limited risk..

How else are you gonna make money in a consolidated choppy to dead market

That too. I wonder if Taleb is still buying puts, or has the market proven that it can outlast his beliefs?

Yes, options are awesome for the variety of ways they can be used to make money. Far more interesting (exciting?) than directional trading.

 

[filthy]

Quote from justrading:

I cannot answer as an expert on options, which I very obviously am not, but let me offer a pragmatic view.

It is not necessary to understand the physics of the internal combustion engine in order to benefit from having and driving a car. Energy conversion, torque, drive-train efficiency are nice to know if you are a mechanical engineer, but for a driver knowing that the car needs a particular grade of fuel etc is sufficient.

It would be wonderful if authors like Gatheral would write the book from the perspective of 'this is what we found, these are the implications, this is how you could use it', and stick all the mathematical models in the appendices.

Unless of course the story is in the models, ie. more like a research paper.

i like gatheral's book but i don't see any reason at all that a vanilla option trader would need to read it. the models he discusses are really only necessary when spreading and hedging exotics. a possible exception would be someone who is trying to trade vix options against sp options, but even then the model driven approach is not what i would go with.

BS (and binomial) models are good not because there assumptions are realistic. they are good for reasons unrelated to their assumptions. they turn fast moving things (option prices) into slow moving things (implied vols) that are easier to keep track of and compare. BS isn't a model that (anyone other than taleb's strawmen) thinks represents reality. it is just a translation device.

 

[newwurldmn]

Quote from justrading:

That too. I wonder if Taleb is still buying puts, or has the market proven that it can outlast his beliefs?

Yes, options are awesome for the variety of ways they can be used to make money. Far more interesting (exciting?) than directional trading.

He is. He is the figurehead of a hedgefund that is consistently long vol and making good returns since 2008. Who knows how long it will continue.

 

[newwurldmn]

Quote from justrading:

That is a negative gamma position.

If there is a lot of short gamma, then it is a large negative gamma position.

Edit: To clarify, I don't think anyone would quibble about saying short gamma to mean having a negative gamma position. It gets boring when people say 'I trade short gamma'. Why not just say 'I sell options' or 'I trade ratio/back spreads'. Isn't that a lot more precise?

No. Because an options trader doesn't care what your actual options position is. They view the world as a vector of risks.