Options on options
- Thread starter mutluit
- Start date
i think this guy believes that market makers are in the business of giving money away to option traders...
look, the more complex the exotic option is, the more margin the market maker has in it, as complexity implies additional trades to balance out its greek exposure, in order words, it is more expensive to trade exotics than say, calls or puts.
from a pure expectancy point of view, nothing beats trading calls and puts outright.
look, the more complex the exotic option is, the more margin the market maker has in it, as complexity implies additional trades to balance out its greek exposure, in order words, it is more expensive to trade exotics than say, calls or puts.
from a pure expectancy point of view, nothing beats trading calls and puts outright.
The amount is too small in relation to the possible price swing of the underlying.
Say, UL moves up $6 by expiration. 1st degree call would double from 3 to 6, 2nd degree would go from 0.8 to 3, and 3rd degree - from .002 to 2.2.
Who would risk 2.2 to gain .002 if they can risk 6 to gain 3?
Quote from sle:
What makes you think you can even use the same volatility (and apparently, the same model) for the compound options? Even if you disregard the modelling aspects (e.g. critical stock price), you should at least assume that realized volatility of an option is going to be a combination of volatility resulting from the stock price (approximately delta * underlying volatility / option price) and volatility resulting from the changes in implied volatility (which would approximately be vega * volatility of implied volatility / option price) plus some correlation factor that correlates these two. Obviously, that would make it very expensive and the lower the base option price, the higher the volatility would be.
My goal was to have a financial instrument for multiplying the leverage of a normal option if a specific event hits.
I thought maybe "options on options" (ie. "compound options") would do that, but a little research on the net shows that "barrier options" (yes, you had mentioned them) seem to be better suited for that:
http://en.wikipedia.org/wiki/Barrier_option
"
Barrier options are always cheaper than a similar option without barrier. Thus, barrier options were created to provide the insurance value of an option without charging as much premium. For example, if you believe that IBM will go up this year, but are willing to bet that it won't go above $200, then you can buy the barrier and pay less premium than the vanilla option.
[...]
Up-and-in: spot price starts below the barrier level and has to move up for the option to become activated.
"
So, I think "barrier options of type up-and-in" is the vehicle I was seeking... Have even found such products offered by banks here over in Europe, marketed as "Turbo Options" etc....
Hmm, yes, indeed an importantant question & criteria.
I must admit I have no clue yet how one could/should
do this decision for such barrier exotics, I would like to learn the trick
Obviously it must be cheaper than a normal option, the question is how much cheaper?...
I think there must be a formula specific for barrier options, isn't it?
On the wiki page there are some valuation methods mentioned for barrier options:
http://en.wikipedia.org/wiki/Barrier_option#Valuation
If you're a seller and you choose what option to sell: $3 on the UL or $.002 on the 2nd degree option, while your potential loss is about the same, which one would you choose?
My point is that no one would sell an option for $.002 if a similar option could be sold for $3.
Of course a buyer would rather buy .002 option but who would sell it to him?
Now, if you change IV in the BS formula you would arrive to the values of all tree degrees options to be very close to each other.