noob questions, help a brotha out

J

jonbig04

How does shorting a stock make it go down? (ie bear raid) is it simply bc other traders notice the rising short interest?

What does the VIX index tell you and how do you use that information?

How did bear stearns lose so much cash so quickly?

I've been doing a lot of option research, and for some reason it seems like the overall consensus is that you (for example) buy a call option and hope you hit your strike, if you dont, you lose money. yet, depending on how far out of the money you bought, the option price will sometimes double or triple or more if the stock rises even if the strike price isnt met. i understand of course that the option is worth nothing on the expiration date if the strike hasnt been met, but if you buy say a $0.05 option (say 3 weeks before exp) if the stock goes up substantially that same option may be worth $0.10 or even $0.40...4 times your initial investment. at which point you could simply sell it. i know that is risky, but ive watched it happen quite a few times. why do no books mention this kind of speculation? am i missing something?

don't flame me too much.
 
Options decay in value every day. You can buy an OTM call, have the stock go all the way to the strike price, and still lose everything you paid for it.

Before trading options for real money, learn how conversions and reverse conversions work, and how they are priced. You will find out how most options are priced almost exactly at fair value based on current interest rates and time until expiration. The Floor traders have all the numbers, all the programs, and the ability to hedge off immediately. Just be careful.

Good luck,

Don
 
1) A "bear raid" can succeed if the selling is aggressive enough to overwhelm the buyers.
2) The VIX is a "lagging indicator".
3) I believe a big part of BSC's undoing was they finally had to mark-to-market assets that were worthless. They couldn't put it off anymore.
4) Try not to get caught up in buying option "teenies". Seldom do they become worth more. The bid-ask spreads are bad too. It would be irresponsible for an author to encourage that type of trading.
 
thanks guys for the intelligent responses! some things are more clear now. however im still confused as to why for SPECULATIVE purposes, more people dont buy out of the money options. assuming all due diligence is done. for example:

a LEH 35 april call went up 85% today. thats awesome, but the april 45 call rose 160% along with the 50 and 55's which went up 150%. in one day.

as far as speculation is concerned, if you really think the stock is going to go up substantially based on a certain catalyst on a certain day, wouldnt it make sense to buy these options? thanks for all the advice,
 
Quote from jonbig04:

thanks guys for the intelligent responses! some things are more clear now. however im still confused as to why for SPECULATIVE purposes, more people dont buy out of the money options. assuming all due diligence is done. for example:

a LEH 35 april call went up 85% today. thats awesome, but the april 45 call rose 160% along with the 50 and 55's which went up 150%. in one day.

as far as speculation is concerned, if you really think the stock is going to go up substantially based on a certain catalyst on a certain day, wouldnt it make sense to buy these options? thanks for all the advice,
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I forget the exact percentage, but something like 75% of all options expire worthless, calls and puts together.

And the delta of an option OTM option is usually pretty small. Stock has to go up $5,00 for the option to rise 50 cents in many cases.

Don

Don
 
Quote from Don Bright:

I forget the exact percentage, but something like 75% of all options expire worthless, calls and puts together.

And the delta of an option OTM option is usually pretty small. Stock has to go up $5,00 for the option to rise 50 cents in many cases.

Don

Don
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right! i read that too. I'm sure the chances for the LEH 55 calls actually being "in the money" is next to 0%. but having said that if you thought for whatever reason LEH was going to go up yesterday and bought these calls, to me, it looks like these out of the money ones would have been much more profitable than the in the money ones.

what does OTM mean? or rather, how does that have an affect?
 
There's many things that affect an option's value. The delta is the hedge ratio which basically means the percentage the option will move compared to the underlying price. Example if delta is .5 and stock goes up a dollar, the option will go up 50 cents. Also Implied Volatility. Typically if a big event is about to happen, ie earnings, or some news event just happened, IV increases, which will increase the value of the option. But if you buy the option when Implied volatility is already elevated way above the yearly mean, you will get killed in the option as the price goes up and IV drops. Implied volatility is especially important in out of the money options. Most of the time right after earnings out of the money options get crushed by the drop in implied volatility. Time decay is self explanatory, and interest rates also.

Basically if you want to play out of the money options, you will lose all or most of the premium on big moves because of IV and Delta. You could get a 40 dollar move on a stock and still lose money on the otm option if IV was too elevated when you bought it. Most out of the money options have very low deltas such as .2, or .1 even. So, my question to you is, if you know a stock is going to move in the future, why only take .1 percent of that move.?

Even for speculative purposes, you will think you bought a lottery ticket, and the next day some huge move happens and you get chicken scratch. There are a few times when it can work out, but it's usually an unpredictable event, that is not easily repeated.

As far as a bear raid, it's just a huge seller coming in and selling into all the buyers until the longs start puking their positions.

I forgot about your vix question. Basically the $vix, $vxo, $vxn are contrary indicators. When they are elevated to their highest levels you will typically see a huge rally within a week. It's just crowd psychology saying the mass is too fearful and bearish, no more money to pile on to the one sided trade. These also reflect the intraday fluctuations in the markets. When volatility indices are elevated you want to trade smaller size intraday. Lastly they affect the value of options overall causing premiums to be higher. You want to be more of an option seller than buyer when they are elevated.
 
Quote from RiceRocket:

There's many things that affect an option's value. The delta is the hedge ratio which basically means the percentage the option will move compared to the underlying price. Example if delta is .5 and stock goes up a dollar, the option will go up 50 cents. Also Implied Volatility. Typically if a big event is about to happen, ie earnings, or some news event just happened, IV increases, which will increase the value of the option. But if you buy the option when Implied volatility is already elevated way above the yearly mean, you will get killed in the option as the price goes up and IV drops. Implied volatility is especially important in out of the money options. Most of the time right after earnings out of the money options get crushed by the drop in implied volatility. Time decay is self explanatory, and interest rates also.

Basically if you want to play out of the money options, you will lose all or most of the premium on big moves because of IV and Delta. You could get a 40 dollar move on a stock and still lose money on the otm option if IV was too elevated when you bought it. Most out of the money options have very low deltas such as .2, or .1 even. So, my question to you is, if you know a stock is going to move in the future, why only take .1 percent of that move.?

Even for speculative purposes, you will think you bought a lottery ticket, and the next day some huge move happens and you get chicken scratch. There are a few times when it can work out, but it's usually an unpredictable event, that is not easily repeated.

As far as a bear raid, it's just a huge seller coming in and selling into all the buyers until the longs start puking their positions.

I forgot about your vix question. Basically the $vix, $vxo, $vxn are contrary indicators. When they are elevated to their highest levels you will typically see a huge rally within a week. It's just crowd psychology saying the mass is too fearful and bearish, no more money to pile on to the one sided trade. These also reflect the intraday fluctuations in the markets. When volatility indices are elevated you want to trade smaller size intraday. Lastly they affect the value of options overall causing premiums to be higher. You want to be more of an option seller than buyer when they are elevated.
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wow that cleared a lot up for me. is there a way to find out the delta of an option? i appreciate everyone taking the time to explain.
 
Selling short has the same immediate effect on the market as regular selling. That is to say it increases the supply so price goes down.

Don't buy out of the money options, even though they are cheap. That's a suckers game, unless you have inside information of course.

Another factor that hurt Bear Stearns is that they were heavily leveraged, meaning they bought using borrowed money. Leveraging magnifies both profits and losses. Still another problem is that some of their assets became illiquid after they had acquired them. That means that there is a not a ready market for them without price being very adversely affected. Normally they would not worry about this too much, though they should have. When the market for their assets, which included illiquid mortgage bonds known as CDO's or collateralized debt obligations, started to dry up they found that they could not readily convert these assets into cash because no one wanted to buy them except perhaps at a huge discount. If you can't sell your assets because they are illiquid, but you need to raise cash in a hurry, you are in big trouble. The result was that they had to devalue the assets they carried on their books because their was no market for them, consequently the value of the Company sank to the point where their liabilities exceeded their assets and they would have to declare bankruptcy. That is where JP Morgan and the Fed came to their rescue using you as one of the guarantors, so that in the event that the Fed's agreeing to protect JP Morgan against loss in the deal resulted ultimately in higher interest rates, or US currency devaluation, or inflation, or some combination of these, you and your fellow US taxpayers would be there to back up the Fed and JP Morgan. We are all grateful for your part in saving Bear Stearns from Bankruptcy.
 
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