The first step [for the pros only]

B

babutime

I've spent over 16 hours today on this forum. I'm new and I read everything from a guy's credit spread strategy backfire on him late 2007 to someone make a mockery of himself asking admins to remove his posts... Along the way I also read some great posts by a lot of knowledgeable members

...anyways....

What is it that the first thing pros here do before they make any risk management decisions, before any greek tweaking, etc. Before any of that stuff, what do you do?

How do you find the stocks that you are going to be likely to trade given condtion 1, condition 2, etc?

I've noticed a lot of guys here trade with Interactive Brokers and/ or Thinkorswim. Could you walk us through what scanners you use to first find the stocks you want to trade?

I have an IB account and I love the implied volatility and option volume screeners they have. Is that your first destination? Do you write your own code and have scanners based on that? Do you download vast volumes of data every night and do some crazy MATLAB manipulation? I'm working on an API implementation of my own for IB using java if that's also what's required. Ive read Natenberg, Taleb (Dynamic Hedging), Hull (as part of school curriculum), etc etc and feel like an idiot. Basically I'm the junior ferrari engineer who just passed his learner's license. I wanna make that transition from engineer to a rally driver!

Bottom Line is this:

What first steps do you take towards screening stocks/ ETFs/ futures/ etc that form the basis of your view on the direction the market in that specific instrument takes?

I understand that risk management and knowing what the greeks mean are essential- but I have that covered to a large extent. I wanna know what that all important first step is (besides overall market sentiment, and direction course along with global macroeconomic picture).

I have been only mildly successful as I have only done long calls and puts, verticals, IC on earnings to benefit from vol collapse [butterflies probably are better for that?]. I also do the occasional double diagonal as I did with recent apple earnings. But I cannot seem to capture big movers!

So what is it?? A humble request from an eager undergrad who will be handing out resumes soon.

Note*: This request is for those who have been trading successfully for more than two years. I'm sure all of us have certain set-ups and I don't mean any disrespect to anyone. Its just that guys like atticus, maveric and others seem to know what the heck is going on.

Note**: If its not something you'd like to discuss openly, could you maybe IM me? I'll respect your wishes and will likewise not share it publicly

Thank you!
 
I'm not a "pro" but I hope to give you some hints to talk about.

I use two "scanners" to search some opportunities of trading on about 40-50 of the most liquid ETFs and equity indexes:

1. the first one monitors the log-level of 30days IV. If I find an underlying whose 30d IV is above (below) 95% (5%) percentile I see a green or red spy. Then I calculate volatility cones with several different methods and choose maturities and strikes of the vertical figure according to my IV and HV confidence and Vomma/Zomma boundaries. If the IV is really next to cones, sometimes I make a linear model log(IV) ~ log(HV) to rescale IV in HV's measure;

2. the second one monitors the log-slope of the implied volatility term structure as log-difference of 30 vs. 90 days maturity ATM IV. This time series very often bounces from a floor to a cap and is statistically positively correlated to log-level of IV, so I see a green or red spy when it is below or above 95%/5% percentile. Then I start diagonal(s) choosing maturities (*) and strikes according to the theoretical weighted Vega and Vomma/Zomma boundaries. It is difficult to calculate properly the WVega, but the Vega acts like an upper or lower limit, so you can adapt to it.

Finally, Zakamouline Delta hedging.

Hope it helps, unfortunately I do not have the requirements you asked for because I have not at least two years of experience (previously I used differents methods) :)

(*) How can you estimate the term structure's slope speed to mean revert? For example you could use a simple ARMA model, 'cause that time series is really autocorrelated and mean reverting :) That's my choice...
 
I'm not a pro but I've had a couple of really good years here and there so maybe I'm a part time pro :)

There are a mulltitude of ways to make (and lose) money in the market so I don't think that there's a simple answer to your question because each of us has different objectives, talents, tolerances, etc.

I''ve had a number of phases in the market. In my early years, I was an investor. The 80's were good to me until the crash. Ughh, what a day! In the 90's I was an IPO whore :). In the early 2000's I traded an awful lot of EA's.

Along the way, year after year I read about and number crunched every imaginable strategy, looking to find those that I understood, perceived their implementation and usage and felt comfortable with their R/R spectrum.

Ultimately, I realized that in general, I have no clue what an individual stock or the market will do tomorrow so my approach became geared toward one/two sided hedged positions.

In '08/'09 I used an equity pairs strategy that performed splendidly. That past two years, it has provided only pin money so I've had to look elsewhere. IOW, markets change and so must I.

I don't use any scanners because I tend to trade only stocks in a few sectors. The two that that I favor the most are gold and oils because no one is going is likely to invent a replacement. For the most part, they're not going out of business and can be hedged individually, with others in the sector or with an ETF.

I guess my short answer is get to know a core group of stocks and find an approach that you feel comfortable with and run with it as long as it works. Then pray that you find another one that also works :)
 
IMO, there are two types of successful option traders. I would define successful as someone that is profitable 10 or months of the year, has smaller losses than gains, and is able to either make a living from trading or create above average returns for the risk applied. That would depend on your goals and asset levels.

The only long side option players that I know of, that are successful over time, are directional. They have done some type of analysis and believe the security will do something over a short term. If find this is a difficult but not impossible strategy. Traders feel that buying premium reducing their risk, so I find they get lazy with bad position. "I can only lose $XXXX on that trade, so I going to see what happens." What happens is they lose money,

Most success options trader lean toward positive theta or short Vega. Option prices over time tend to be too high. Option sellers that combine selling what they feel is over valued or a direction they feel is unlikely, are more profitable. If you not comfortable with this strategy because of your risk profile, size of your account, etc, I would trade something else.

A good option seller, monitors the different months skew, strike skew and know what they are for the securities they follow. When if jumps, and you feeling that is a selling opportunity, you jump in. Buy dips to close, sell increases in increments. Never get over extended. You'll tend to panic when you should be selling more if you use too much leverage in one trade.

That's the way I traded for many years. Stick with a small sample of stocks or indexes. Know them well. If there are no selling opportunities because vol is too low in your analysis, wait and do nothing. Keep trading simple. Run it like a business.

Good luck.
 
What Spin said. There are a lot of different ways to use options, so no two of us are exactly the same. I don’t use scanners either, I like to know as much as I can about the underlying.

If you are going to be looking for a job, where you work is a lot more important than any questions asked here. I learned a lot by choosing jobs that would teach me the options business.
 
Quote from rmorse:

IMO, there are two types of successful option traders. I would define successful as someone that is profitable 10 or months of the year, has smaller losses than gains, and is able to either make a living from trading or create above average returns for the risk applied. That would depend on your goals and asset levels.

The only long side option players that I know of, that are successful over time, are directional. They have done some type of analysis and believe the security will do something over a short term. If find this is a difficult but not impossible strategy. Traders feel that buying premium reducing their risk, so I find they get lazy with bad position. "I can only lose $XXXX on that trade, so I going to see what happens." What happens is they lose money,

Most success options trader lean toward positive theta or short Vega. Option prices over time tend to be too high. Option sellers that combine selling what they feel is over valued or a direction they feel is unlikely, are more profitable. If you not comfortable with this strategy because of your risk profile, size of your account, etc, I would trade something else.

A good option seller, monitors the different months skew, strike skew and know what they are for the securities they follow. When if jumps, and you feeling that is a selling opportunity, you jump in. Buy dips to close, sell increases in increments. Never get over extended. You'll tend to panic when you should be selling more if you use too much leverage in one trade.

That's the way I traded for many years. Stick with a small sample of stocks or indexes. Know them well. If there are no selling opportunities because vol is too low in your analysis, wait and do nothing. Keep trading simple. Run it like a business.

Good luck.
More...

I like the lazy comment. But it seems to me the most successful options guys are the relative value guys and the market makers (basically relative value guys as well).
 
Quote from newwurldmn:

I like the lazy comment. But it seems to me the most successful options guys are the relative value guys and the market makers (basically relative value guys as well).
More...

I would say that 9 out of 10 option market makers that don't trade a global dispersion strategy like Timberhill, GS, Barclay's, etc, are net short options most of the time. When vols get "cheap", they get flat Vega or long a small position.
 
Quote from rmorse:

I would say that 9 out of 10 option market makers that don't trade a global dispersion strategy like Timberhill, GS, Barclay's, etc, are net short options most of the time. When vols get "cheap", they get flat Vega or long a small position.
More...

Interesting. I would have figured that the floor guys would be net long vol as they are less likely to blow up and can run larger books on less capital. My bank had a very STRONG preference to being long vol/gamma.
 
I guess the first thing I need to learn is the definition of a pro.

How about this, everyone with successful option money making strategies please respond!

Haha!

A few questions to you Monsieur Cren1:

Quote from Cren1:

Then I calculate volatility cones with several different methods and choose maturities and strikes of the vertical figure according to my IV and HV confidence and Vomma/Zomma boundaries. If the IV is really next to cones, sometimes I make a linear model log(IV) ~ log(HV) to rescale IV in HV's measure;
More...

So you're basically looking to capture rise in volatility going forward by looking at the rates of change of lower order greeks (mainly vega and gamma) wrt volatility. What does verticle figure mean? And when you say if IV is next to cones, do you mean if the IV curve (or current level ?) is next to one of the HV levels?


Quote from Cren1:

Then I start diagonal(s) choosing maturities (*) and strikes according to the theoretical weighted Vega and Vomma/Zomma boundaries. It is difficult to calculate properly the WVega, but the Vega acts like an upper or lower limit, so you can adapt to it.
More...

What does a Vomma and Zomma boundary mean ?

As for the slope of the term structure- estimating parameters of Ornstein-Uhlenbeck process could also help. But I guess ARMA and O-U are pretty damn close as both serve the same purpose to this end...

As for mean reversion itself, what if the regime changes and now it takes much longer to mean revert? Is that inherently your biggest risk?

I guess I need to brush up on my higher order greeks more.

Thanks!!!
 
Quote from rmorse:

Stick with a small sample of stocks or indexes. Know them well. If there are no selling opportunities because vol is too low in your analysis, wait and do nothing. Keep trading simple. Run it like a business.
More...

Is this how you typically trade Robert? Have you worked at one of the large firms too and is this how option traders sort of specialize loosely speaking?
 
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