Simple option trading question...

[blueplayer]

amma is an upside U curve peaking ATM.

Using Sept options also has non-linear PnL according to your criteria. You keep saying over and over that you non-linear PnL but you have not disproved that 3, 4 and 5 month options have similar gearing.

I have to respectively disagree with your assertion that only the front month options have non-linear PnL. I have showed you with a few examples this is untrue already so I think we can go no further.

Man, I see you want to pick a fight where none is present. My point is very clear, short dated options (when compared with other ones, no matter the expiration) have higher gamma than longer dated ones. I have also said that LEAPS and very long dated options have very little to no gamma and those assertions are true to the best of my knowledge (unless of course you have a way to contradict that).

So far I don't think we disagree on any of this. My point is more toward very short term moves and yours towards longer time frames. You don't care about gamma and I don't care that you don't care.

I'm attaching a graph that shows the PnL for a move up in SPX options for tomorrow of about 20 points. Notice the strikes with better returns and Risk Reward. Please also note how longer date options perform and draw your own conclusions.

So as you can see gamma makes a huge difference when playing such a short moves which has been my whole point all along.

 

[ironchef]

In general playing long term moves with options is always a losing proposition. There is very little optionality in far dated expirations and more vega risk.

For short term plays ( days), OTM options almost always beat ATM ones both in percentage return and risk reward.

Are you saying this based on actual trading experiences or from analyzing options outcome or back testing or reading others' studies?

Also is the optimizer based on BSM or actual data or something else?

Thanks.

 

[ironchef]

Far date options such as LEAPS can present much lower risk than owning a stock outright if you use ITM options with delta in the .8 to .9 range. Options using 3 to 6 month expirations can gain on vega if you find relatively low IVs when you get in.

Same question to you sir:

Are you saying this because you had actual experiences, analyzed this theoretically, studies with simulation/back test, read studies on this. etc.?

I am not debating, just want to get a better understand.

Thanks.

 

[blueplayer]

Are you saying this based on actual trading experiences or from analyzing options outcome or back testing or reading others' studies?

Also is the optimizer based on BSM or actual data or something else?

Thanks.

The optimizer uses real data from OPRA and the version on the web uses the Quantlib pricing engine (BSM for SPX and Barone,Adesi,Whaley for the american style ones).

My comment about playing long term moves with options is mostly directed towards index options where the presence of a variance risk premium really reduces the opportunities for profit for those that buy them. This is from experience and also numerous research papers have confirmed that a VRP is ever present in SPX options.

For options in equities the situation is a bit different, some names might have a very high VRP while others are more fairly priced. Also in single names you have acquisition risk that might play in your favor (if using calls).

As other people has mentioned the best thing to do is check your thesis against hard data, and pick the best strike/expiration for the trade you want to place.

 

[OddTrader]

For options in equities the situation is a bit different, some names might have a very high VRP while others are more fairly priced. Also in single names you have acquisition risk that might play in your favor (if using calls).

Mainly for single-stock options, right?

My comment about playing long term moves with options is mostly directed towards index options where the presence of a variance risk premium really reduces the opportunities for profit for those that buy them. This is from experience and also numerous research papers have confirmed that a VRP is ever present in SPX options.

How bout the options for ES futures? Any idea? TIA

 

[El OchoCinco]

Same question to you sir:

Are you saying this because you had actual experiences, analyzed this theoretically, studies with simulation/back test, read studies on this. etc.?

I am not debating, just want to get a better understand.

Thanks.

It has long been known that you can use DITM LEAPS as a surrogate for stock ownership for less risk than owning the stock outright. If you need an example then here is one:

COST @ $153
JAN 17 $100 Call @ $54 (.9 delta) - effective stock price is $154 due to small time value premium that remains.

Assuming no margin you can buy 100 shares of COSTCO for $15,300
OR buy 1 DITM Leap Call for $5,400 and get almost 1:1 movement in the underlying if the stock price moves higher and less if stock moves lower.
Your capital committed is reduced by 2/3 to still be able to participate in capital growth of the stock for almost one year. Less money in the trade means less risk but also allows you to do more with your portfolio.

You could take the remaining $10k available and invest in other stocks, options or LEAPS. The amount of money contributed to the position is much less, thus less risk for the same profit potential for the next 305 days.

It is due to the nature of delta.

 

[El OchoCinco]

Man, I see you want to pick a fight where none is present. My point is very clear, short dated options (when compared with other ones, no matter the expiration) have higher gamma than longer dated ones. I have also said that LEAPS and very long dated options have very little to no gamma and those assertions are true to the best of my knowledge (unless of course you have a way to contradict that).

So far I don't think we disagree on any of this. My point is more toward very short term moves and yours towards longer time frames. You don't care about gamma and I don't care that you don't care.

I'm attaching a graph that shows the PnL for a move up in SPX options for tomorrow of about 20 points. Notice the strikes with better returns and Risk Reward. Please also note how longer date options perform and draw your own conclusions.
View attachment 163103
View attachment 163104

So as you can see gamma makes a huge difference when playing such a short moves which has been my whole point all along.

You are also making my point that your statement is completely biased by your assumptions going in. You assumptions are that the stock is going to make a large move in a relatively short period of time. If that is your fixed assumption than ANYONE in the option world will tell you to play the short term options. NO ONE would tell you to buy 6 months options if your expectation was a big move in 30 days. My problem is you are making a GENERAL statement based on your limited assumption.

If you are the one trader than can pick out 1 sigma moves in short time periods consistently (which no one here believes) then you should be trading short-term OTM options. But I bet that if you made such trades on a consistent basis, you would lose money over time.

Showing the charts just confirms the theory of gamma that its peak is bigger for shorter term options which I already stated is true. However you have said long-term options have no gearing or serve no purpose. AGAIN your statements are all fitting into your assumption of 1 sigma move in a short time period. Also you never account for the fact that long term options have HIGHER delta and therefore the gearing is similar with smaller gammas.

.01 gamma on .57 delta (short-term) or .005 gamma on .61 delta (long-term). You are saying only the former has gearing but for a $1 move the further out in time option will move by a greater amount despite smaller gamma.

AGAIN we are not disagreeing, your UNIVERSE though is only 1 sigma move in 30 days so naturally you discount anything beyond front month options. That is not rocket science.

 

[blueplayer]

You are also making my point that your statement is completely biased by your assumptions going in. You assumptions are that the stock is going to make a large move in a relatively short period of time. If that is your fixed assumption than ANYONE in the option world will tell you to play the short term options. NO ONE would tell you to buy 6 months options if your expectation was a big move in 30 days. My problem is you are making a GENERAL statement based on your limited assumption.

Ok so we mostly agree fair enough.

I just want to point out that what you call bias is what I call a thesis. Also I want to clarify that the said thesis is opportunistic. That is, the thesis doesn't hold all the time for all underlyings. My whole point is that playing long gamma requires you to have a thesis that have a positive expectancy of return, and what that translates into is that the expected move should be at least as big as the implied move in the price of the option for a given time frame (being 1 day or the lifetime of the option). If that doesn't hold, I don't play the move with options, perhaps I look for shares or other linear instruments.

I however still have some disagreement with the following statements:

Showing the charts just confirms the theory of gamma that its peak is bigger for shorter term options which I already stated is true. However you have said long-term options have no gearing or serve no purpose. AGAIN your statements are all fitting into your assumption of 1 sigma move in a short time period. Also you never account for the fact that long term options have HIGHER delta and therefore the gearing is similar with smaller gammas.

In terms of LEAPS I repeat my position, LEAPS and in general long term options are inefficient ways to play an arbitrary move. I didn't want to imply they were useless just that other instruments could be used for that kind trade with better PnL and Risk Reward (like shares, CFD's or futures). When you are trading like that you only want leverage and for that there are many ways to get it other than options. Sacrificing optionality just for the sake of getting leverage is not a good trade-off at least in my book. However of course you are free to trade as you feel more comfortable.

.01 gamma on .57 delta (short-term) or .005 gamma on .61 delta (long-term). You are saying only the former has gearing but for a $1 move the further out in time option will move by a greater amount despite smaller gamma.

I think I can see where your mistake is, you are only thinking about the linear part (which is delta), but you are not seeing the non-linear component to this. Of course a 0.9 delta option will have a better *dollar* profit than a 0.5 delta option for a 1 point move. But you left out two very important things that are obvious from the charts that I posted:

1. The return must always be reported with respect to cost. It makes no sense of talking of $1 dollar profit if the position cost you $100 versus $0.5 profit if the position cost you $10

2. Take gamma into account, a 0.57 delta option will accelerate really quickly in price, eventually reaching 0.9 deltas if the move is big enough, whereas a 0.9 delta option only has 0.1 more delta to go up.

That is why in the charts I posted, options with higher gamma *always* beat options with lower gamma for the same kind of move ( that should be self evident).

AGAIN we are not disagreeing, your UNIVERSE though is only 1 sigma move in 30 days so naturally you discount anything beyond front month options. That is not rocket science.

My universe is very general, however I agree that if I play long gamma with options is because I think the expected move in the underlying will be higher than what is priced in the options for a given time-frame. It doesn't matter if my view is for 1 day or 120 days, if the expected move is lower than what options are pricing then why give my money away to the option dealers?

This just boils down to the basic concept that an options play should only be done if they are mispriced (that is where the edge is). And mispriced for long gamma should be understood as options pricing a move that is smaller than the one I think we'll get (for a given timeframe). If there is no misprice I don't play the move with options. Of course I'm not saying that that is the only way to play trade options but I think that is the most efficient way.

 

[El OchoCinco]

Agree

 

[ironchef]

Blueplayer,

Thanks. Can you explain variance risk premium to someone who does not have a finance background? Or point me to some books that can explain it in simple layman's ?