Trading options vs underlying

traider said:
Let me rephrase the question in another way, for those familar with options, is it wrong to use real world probabilities in option valuation assuming all the black scholes assumptions hold?
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What do you mean by this exactly? What are real world probabilities according to you?

Options are priced according to how the market interprets 'real world' probabilities by using expected volatility, based on the past, present and future events and applying skew to OTM options...

So, no... it's not wrong, it's being done all the time. The only problem is, which expected volatility should you use. When the market in options is in equilibrium, then everyone agrees on a certain volatility/probability... but they change all the time... therefore shifting implied vols/skew/prices up and down.
 
" Trading options vs underlying "

Trading underlying is to trade only one single thing - the movement of the underlying.

Trading options is to trade several inter-related moving parts for the combination of the separate movements of both the underlying and the options.

Just 2 cents!
 
JackRab said:
What do you mean by this exactly? What are real world probabilities according to you?

Options are priced according to how the market interprets 'real world' probabilities by using expected volatility, based on the past, present and future events and applying skew to OTM options...

So, no... it's not wrong, it's being done all the time. The only problem is, which expected volatility should you use. When the market in options is in equilibrium, then everyone agrees on a certain volatility/probability... but they change all the time... therefore shifting implied vols/skew/prices up and down.
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https://www.quora.com/We-all-know-t...-rate-of-return-while-pricing-the-derivatives
 
traider said:
https://www.quora.com/We-all-know-t...-rate-of-return-while-pricing-the-derivatives
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That has nothing to do with volatility and options pricing. But merely the financing.
The risk free return is used as an input for the interest component. To be fair, 'we' shouldn't really use the risk free rate, since not everyone can use that for financing.

This quora stuff has to do with arbitrage and put/call-parity... where prices of a put and a call with the same DTE and strike need to align with each other according to (roughly) C-P=Spot+interest-Strike.

So, say Spot = 100... interest = 1... Strike = 100... will mean when the call = 6, the put = 5
If the call is 6.50 instead... the arb would be to do a conversion, Sell the call, buy the put (which is a synthetic short stock) and buy the stock. You hold until expiration... and make 50 cents.

If you would use an expected rate of return in stead of the risk free rate... say 5%...
Than your pricing would be call = 10 and put = 5.
Which is fine by me... but I (and everyone else) would most certainly arb that by doing a conversion and make 4 bucks.
Remember, at expiration, the short call and long put are cancelled out by the long stock. I would have paid 1 in interest... and end up making 4.

Expiry at 100 means call = 0 and put = 0
Expiry at 105 (your rate of return!) means call = 5, put = 0... but I was long the stock that went from 100 to 105...

If you're still not seeing the light, and think that you wouldn't have lost money since the call is worth 5 vs put of 0 (exactly what it was when you trade)...
If you think the stock is going up to 105 by applying a rate of return of 5%, wouldn't you rather buy the stock than the calls?
 
Assume makes an ASS out of U and ME- if you trade on assumptions you will be wrong most of the time. Options trades can be structured, the dumb money cannot comprehend this, and only sees things in binary-buy or sell. Derivatives give us a huge range of possibilities in direction, timing, and even neutrality
 
Another strategy worth mentioning is selling naked puts.

It basically allows you to buy stock at discount, or keep the premium if the stock is above the strike at expiration.

The tradeoff of course is missing potential gains if the stock makes a big moves.

However, in many cases selling naked puts can provide better returns than buying stocks with less volatility.
 
Kim Klaiman said:
Another strategy worth mentioning is selling naked puts.

It basically allows you to buy stock at discount, or keep the premium if the stock is above the strike at expiration.

The tradeoff of course is missing potential gains if the stock makes a big moves.

However, in many cases selling naked puts can provide better returns than buying stocks with less volatility.
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You can buy the stock at a discount but if it moves beyond the strike that is your loss, right? Interested to know what all the dynamics are in selling puts to buy stock at a discount.
 
If you sell a naked put, you are obligated to purchase 100 shares of the underlying at the option's strike price if the option is exercised before its expiration or expires in the money.

For example:
Stock is at 100, you sell 95 put at $5.

You keep the $5 in any case (unless you decide to buy the put back). So this is your gain if the stock stays above $95 at expiration. If the stock goes below 95, you are obligated to buy it at 95. So if it is at 90, you have to buy it at 95. Your loss is $5 less the premium you got, so your real loss is $3. It is equivalent to buying the stock at 93.

Compare it to just buying the stock at 100. If it goes down to 90, you lose $10, compared to losing only $3 if you sell 95 put. You effectively purchased the stock at 93 instead of 100. So yes, if it goes below the strike price by the amount of the premium, you start losing money - but you lose much less than just buying the stock.

More: Selling naked put options
 
Lets say I have a short bias on a stock over the next couple weeks. No price target, nothing more than a bearish directional bias. I'm thinking of the pros and cons of trading an initially delta neutral strategy of long slightly OTM puts with long stock. My reasoning is that if I am correct, I should see profit through an increase in IV, and if the price tends to be more directional vs rangebound I can make money via gamma as price moves towards my strike. If I rebalance daily (or intraday if I think I can read charts) via stock then essentially I limit my loss to theta minus gamma profits, with the potential for a windfall profit if IV spikes. I'm not too experienced with options, mostly have studied them vs traded them. Does this sound reasonable or worth the effort and transaction cost vs a straight short?
 
Sorry, OT, but geez Baron, Stocks and Options are now listed BELOW Classified and Hookup?

I know, subjects have been grouped into categories, but still...
 
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