Option Strategy

G

Giri

Hi guys,

I am new to Option trading and have been trying to learn as much as possible about trading for some time now.

I have been looking at one trade in particular for awhile now.

I was thinking of a Bear Call spread on BKE by selling the Sept 30 Call and buying the Sept 35 Call. However, I have a couple of questions regarding this trade.

Firstly, about volatility... Currently the implied volatility is greater than the historical volatility. So from what I understand, at times like these is it better to initiate a Credit spread?

If I am right about the direction in this trade and the stock price moves lower, will that increase volatility? If so, how will that affect my position? i.e will it cause the Call I bought to rise in value faster than the one I sold?

Also in this kind of spread, what kind of Greek numbers are optimal? I know this may be a vague question... if it is, I apologize and hope that someone may explain to me what I should be looking for in regards to the Greeks in this kind of spread.

Greeks for this spread are:
30 Call:
IV:52.03 Delta:0.58 Gamma 0.07
Theta: -.02 Vega: 0.04 Rho: 0.02

35 Call:
IV: 47.94 Delta: 0.25 Gamma: 0.06
Rho: 0.01 Theta: -.02 Vega: 0.04

I have an understanding of what the Greeks mean but I do not understand how they should be used when it actually comes to trading. In other words, I have a limited theoretical understanding of them but no real practical understanding of it.

I'm not too worried about my prediction for the direction of the share price for now... I just want to try and learn how the Greeks and volatility play a role in all this.

I know this is quite a large question... so any help would be GREATLY appreciated!!! :)
 
There is no rule that says if implied is above historical then options are overpriced, but yes, some people use it this way. If you expect the volatility to drop then a credit spread is an appropriate strategy. However, a credit spread has a limited vega so it's not terribly sensitive to volatility changes. This pretty much answers your second question. A rise in volatility will not cause your long option to rise faster than the short.

There are no optimal greeks. The greeks are a function of how far OTM you go, among other things. Some people prefer to trade closer to the money spreads, others trade deep OTM.

Greeks are a lot more useful when you have a complex position, or when you want to hedge it. In a simple spread like this what you should really be concentrating on is how likely the stock to go thru your short strike and what would you do if it happens. in other words, you should develop a plan in case the stock moves against you. This can be a simple stop loss - say, if the stock moves above 32 then I'm out...

There's a discussion going on right now in this forum about the usefulness of greeks in trading, check it out.
 
Quote from Giri:

Hi guys,

Firstly, about volatility... Currently the implied volatility is greater than the historical volatility. So from what I understand, at times like these is it better to initiate a Credit spread?

Giri, I admire you for trying to learn as much as possible about options trading before trading, but please remember that while in a theoretical world, it may be best to initiate a credit spread under such circumstances, price movement does make a huge impact on such a trade. I don't care what the IV/HV ratio or whatever is - if the stock gapped to $45 next week on someone buying them out, you would take a full loss - you probably understand that, but I wanted to point out that volatility is only a piece of the puzzle and price can be a large factor as well that can overwhelm volatility even.


If I am right about the direction in this trade and the stock price moves lower, will that increase volatility? If so, how will that affect my position? i.e will it cause the Call I bought to rise in value faster than the one I sold?


I think you might be overrating vol. again here - if the stock moves lower, volatility could increase, but the call value would probably still drop somewhat - not rise (other then a fairly extreme vol increase with minor price drop).


I'm not too worried about my prediction for the direction of the share price for now... I just want to try and learn how the Greeks and volatility play a role in all this.


If you are going to actually do the trade, you SHOULD be concerned about the direction of the share price. Not saying that it is everything, but it certainly is a factor and can be a huge factor. If you are just paper trading to see how it moves, then I understand.

JJacksET4
More...
 
Thanks JJacks!

I looked at the vegas for this particular trade and they basically cancel each other out.

So when is volatility an issue in a trade? I've heard of people trading non-directionally and focusing simply on volatility but I don't know much about that. I think I'll start reading into that.

I read the thread that MTE linked me to and it seems that while some people said the Greeks were useful, they were not specific in how it could be used practically. While others simply said they were unnecessary.

Could anyone give me an example of how the Greeks are used prior to entering a trade. I'm more interested in trades that were not done for hedging purposes.

Thanks guys!
 
Quote from Giri:

Thanks JJacks!

So when is volatility an issue in a trade? I've heard of people trading non-directionally and focusing simply on volatility but I don't know much about that. I think I'll start reading into that.


Of course, volatility can be a factor in any trade - I just wanted to point out not to forget price movement, etc. When people talk of non-directional trading focusing on vol, sometimes they might be referring to straddles, long or short. The idea is to buy before a large increase in vol or to sell before a large decrease. An example of the second case might be to sell a straddle just before an earnings report - if the earning come out and the stock doesn't move much, the straddle might lose alot of value even though only 1 day passed. Obviously however this risks a large loss if the stock gaps after earnings - a trader can buy protection before the earnings if they want with further out options (possibly making a long iron condor for example) or just try trading through it.


Could anyone give me an example of how the Greeks are used prior to entering a trade. I'm more interested in trades that were not done for hedging purposes.

This probably still isn't quite what you're looking for, but a few ideas are that some people might view their entire account and add up the deltas to see if they are bearish or bullish overall. If they get too much long deltas, they might do something bearish to even it out. Also, with more complex trades and maybe after some adjustments, etc., they might check the overall delta of the trade to see if they are even bearish or bullish on that trade at the moment. I'm sure other people can have more specific examples. I think the greeks are very helpful to know, but you still have to pick the correct trades and correct adjustments (or know not to adjust at times).

JJacksET4
More...
 
Quote from Giri:

So when is volatility an issue in a trade? I've heard of people trading non-directionally and focusing simply on volatility but I don't know much about that.
More...
Volatility is an issue when you're trading it :)
 
I have been monitoring the trade that I mentioned in my opening post and I noticed something that I hope someone may be able to explain to me.

The share price for BKE rose $0.42 but the 30 call lost $-0.05 in value while the 35 call rose $0.10.

I think this may have something to do with the IV of the 30 Call which fell from 52.03 to 47.93. However the 35 Call's IV rose from 47.94 to 48.13. Could someone please explain why this is the case?

Thanks!!
 
Quote from Giri:

Could someone please explain why this is the case?

Thanks!!
More...

The most likely explanation is that you are using the 'last' price. That is worse than worthless information.

You must look at the current bid and ask quotes for each option. That's the only way to know the current price. The last trade could have been hours ago, but even if it just traded, there is no reason to believe that you can trade at that same price.

Mark
 
Thanks Mark,

I decided to jot down the Bid/Ask prices and so I'll try follow them from now on.

I enjoy reading your blog :)
 
You must log in or register to reply here.
Back
Top