And all of this is really interesting except this is a terrible idea to open up to recreational traders. I say traders because when the average person thinks of options, they see it as a way to make leveraged bets and get rich quick. Likewise, institutions largely use derivatives (options, swaps, swaptions, etc.) to hedge their positions. The option, for an institution, is a hedging instrument, not a speculative instrument.
Here's the real reason this won't end well for most recreational traders - you're going to get scalped by the desk traders and algos at the prop shops for any illiquid options, and hit by the broader universe of trading algos out of the funds for any liquid options. You won't be able to see the order book and wouldn't know how to trade it even if you could see it. (@SIG @JaneStreet @DRW chime in)
But if you see this as a fun way to gamble knowing that the house (the Street) has a sizable built-in advantage, be my guest.
> The option, for an institution, is a hedging instrument, not a speculative instrument.
is not entirely correct. It's not at all uncommon for institutional capital to use options for directional leverage. Options are sophisticated derivatives for increasing upside, not just limiting downside.
I’ve never traded options. Have any non-traders here effectively used any of the above mentioned strategies? If so, how do you learn to use these techniques?
An option is a bet on the future price of a stock. If you think that Stock XYZ will go from $15 today to $20 next month, you can buy an option that will reflect your prediction.
A multi-leg option allows you to bet on the "magnitude" of a stock's price change, rather than the "direction".
For example: "Tesla reports earnings next month. They're either gonna be REALLY good, or REALLY bad. So let me buy a multi-leg option that predicts a 10% price jump either up or down". You'll make money whether Tesla goes up 10% or down 10%. You'll lose a ton of money if Tesla remains roughly the same price.
Or simply define risk/reward (spreads and the like). That's especially useful if you want to sell premium and not risk getting killed.
If a stock is volatile, as TSLA is, the out of money (OTM) options will take that into consideration and the premium for it will be very very high.
A OTM straddle options trade probably a very bad choice. Like you said, if TSLA don't make a big move, you will lose. Even if they do make a big move, you will still lose because you are opening a trade on both directions.
My personal opinion on options is this:
1. Find stocks that move
2. Buy in the motion options
3. Expiration at least 6 weeks away, prefer to be longer. If price move into your target, great, take profit early.
The premium on a 10% move option wouldn't be as high as you think. There's a lot of risk/reward here.
You'll pay a really high premium if your prediction is 'i think it will go up 2% in the next 9 months" :)
Stocks are manipulated, okay? It's very subtle, but it's a fleecing ceremony. For example, I once bought calls on DIS because my thesis was that the new Force Awakens film would make them a lot of money (which it did). However, ESPN totally shit the bed and cost DIS dearly and thank brought the stock down. Calls didn't do ITM, fucked that up big time.
It's all a big fucking game is all it is and the individual investor is the sheep to be sheared no matter what. It is the law of the universe--you are the sheep getting sheared always and forever. Don't fucking do this stuff. If you're not a securities trader with a real hunting license, don't go near this shit. They will front run on the buy and the sell side, fees and taxes will eat up any profits you make. You are picking up pennies in front of a steamroller.
You'll have to go through quite a bit of training and apprenticeship and suchlike first. That's a good thing. It will get you access to higher quality information than is available as an outsider (those in the know don't dilute the earning power of their best knowledge by just giving it away). Possibly even better yet, you'll be getting paid to learn it instead of expending your own resources and free time.
Once that's done and you're set loose as a full-fledged professional trader, you'll quickly have a pretty enormous amount of capital to work with. You'll only get to take home a small cut of what you're able to earn with that money, but the total size of that cut is still going to dwarf what you can make just playing with your own money.
...it's probably the guy trading on an app he downloaded 5 minutes ago, whose brokerage doesn't even let him use limit orders.
I do agree that there can be nooks and crannies with ample room for small players on the equity options market. I'm just not convinced that someone who thinks they have the skills (and guts) to reap a reliable reward in that space should be going straight to Robinhood without at least submitting an application to Citadel first.
One of the simplest example is to sell a call at $X and purchase one at $X+N. The purchased call is insurance against being on the hook for an unknown rise in the prices of security (which would then be exercised against your sold call). The "bet" in this case is that the rise in the price of the stock during the period of the spread is not going to rise above $X by more than the price difference of the two options.
All the rest of the fancy names are combinations of buying or selling these types of combinations. The names come a combination of the desired result (ex: "strangle") or the shape of the profit graph (ex: "condor").
Do a lot of reading before dipping your toes into options trading. On the one hand it's arguably less risky than regular equities as you "know" what you're risking. On the other hand it's very easy to get wiped out as well. Something as stupid as not closing your our spreads before expiration can destroy your account if they get exercised.
The people in the know (those who actually beat the market) don't teach other people how to trade, because giving away information is strictly less profitable than trading on it yourself (or on behalf of your firm). They also very rarely trade their own capital, and typically work within funds. This sets up a dynamic where it's extraordinarily difficult to learn the "proper" principles of derivatives trading in a sound framework of market microstructure unless you join a firm, because all public information on the subject is almost definitionally misleading. The next best thing is to learn from established textbooks, but surprise, very few people want to read three - five textbooks with advanced mathematics instead of watching a few webinars on "the greeks."
As the margin required for a spread is substantially less than the full price of the security (which is the whole point of the spread), you can end up in a situation where you're forced to buy more stock than the total liquidation value of your portfolio. Plus this happens at the close on a Friday (as that's when option expiration happens) so you can't liquidate the stock until Monday morning and you're at the mercy of the opening price. If the quantity of options sold is large enough and the price moves against you far enough, you can get completely wiped out.
It's your responsibility to close out your spreads prior to close. FYI, this situation can happen even if they're out of the money as the counter party to the worthless option could still choose to exercise it.
To me, it sounds like you are describing a naked short call, or a short put.
It is not a spread. By definition, spreads have limited risk, and limited rewards.
The four main types of spreads. Take a look at the PNL diagrams. It is limited risk.
The situation I’m describing is when the sold option expires in the money but the purchased cover does not. It won’t automatically execute and you’re left with essentially a naked short.
The basic idea of options is that you think the price is going to be somewhere within a certain period of time and you place a bet saying so. If you bet right, you make money, if you bet wrong, you lose it.
The different strategies give you different ways of targeting prices. For example a call debit spread is essentially "I think the price will be below $X in Y days", an Iron Condor is "I think the price will be between $X and $Y in Z days" and a straddle is "I think the price will move by $X in either direction in Y days".
The different strategies also have different profit/loss curves. For example selling a call option has unlimited loss potential (the stock could theoretically soar 1000x before the option expires) while selling a call spread has defined loss potential.
The process for me is basically find somewhere where the option is typically priced higher than it's worth and sell spreads. Sometimes this is year round, sometimes around earnings.
That said...yes, most profitable options trading (especially on intraday time resolutions) is focused on volatility and pricing inefficiency, not forecasting the directional movement of the underlying price.
Options can be used to increase leverage and they can also be used to decrease risk.
You can use options to change the risk / reward profile in non-linear ways. Meaning you can do things like, I'll sacrifice a little bit of my upside to reduce the risk on the downside (and vice versa).
You can also design positions such that if the stock goes up a little bit I make money much easier but if it goes up a lot I don't get as big of a win.
One of the best books on the subject I know of is "Option Investing as a Strategic Investment". It is sufficiently technical and yet approachable as well. It goes from introductory basic theory to complex multi-legged strategies.
Me personally I don't touch the market at all any more and choose to invest in real estate. I can't speak to the current option trading environment. I used to trade options in the past and didn't see anything significant from it. No catastrophic loses, no big wins. I don't know what the landscape looks like now with more algo type trading.
The biggest issue I had back when I played is commission. If this is commission free, that’s a whole new ballgame.
they don’t actually give you a real advantage, because that only comes from (insider) information. rather, they’re designed to increase your investment/involvement and prolong the gambling time (and enjoyment possibly).
What tangible value do options actually bring anyone besides gambling? Oh they allow shareholders to rent out their shares, or allow you to structure sales before/after the fiscal year? Big deal.
All it does is create a market for pseudo science middle men/rent seekers who sell "vehicles" that many use to try to get rich quick.
All this does is divert funds from markets that are actually tied to something useful like legitimate businesses that sell products or services
let's support creators (of all stripes) over rent seekers. there's no need to reward a person for simple ownership over some capital or good. rewards should go to those who wield them effectively by making something useful out of it. it's trickier to do than it sounds, but absolutely worth the effort.
Ok, but volatility isn't an asset. So this must be the original "synthetic asset", long before all the other exotics came on the scene.
On one hand, why should I care what other people do with their money. But what worries me is that with normal markets, assets have intrinsic value: corn, oil, securities. They're all things people want. The market can always assume this is true, but with synthetic "assets" like trading volatility, it's not true and that creates a market built on a false pretense.
* a paper trading account, where you can experiment with trading strategies without risking real money
* reading about the strategies and their payoff scheme, eg: http://www.theoptionsguide.com/long-straddle.aspx
Source: I was a TA for a graduate finance class for 3 years
I loved trading butterflies on Thursday-Friday. Butterflies are a form of debit spread.
Then please stay away from multi leg options stuff because it gets even more complicated.
Better yet, if you want to REALLY amplify your socioeconomic privilege, you can turn capital losses into Net Operating Losses and deduct the entire thing as an income expense. Do this by forming an LLC and sending a Section 475 election to the IRS before April. This is specific for traders doing short term strategies in the equity and equity options market.
You will then lose your money experimenting with options and the government will pay you back, from taxes you sent them in prior years, current and future years.
Well why do you think they aren't charging commissions?
The broker can send the order to the exchange with a field denoting their preferred market maker. In the absence of that field being populated, orders are allocated either by size (% of the best bid) or by time (who established the best bid first).
If that field is populated and the preferred market maker is on the best bid or best offer, he receives an outsized allocation of the order. The market maker keeps track of the number of contracts it has traded with that broker where the field was set and pays the broker whatever fee they've contractually agreed upon multiplied by the number of contracts.
The market maker can afford to do this because retail order flow is highly profitable to trade against (it's "dumb money"). In fact when a market maker runs a look back analysis on the profitability of his trading, he will see that his trading with other market makers and institutional orders results in almost no profit, whereas the retail flow is highly profitable.
This "payment for order flow" (PFOF) is not shared with the customer. So even if the customer pays no fee to trade, Robinhood can still earn a profit.
Source: Was an electronic options trader
So did you make your millions and retire to an island, or did the options trading not work out?
A good source of info is:
Good descriptions and visual tools for building and pricing strategies.
If you like that you can sign up for early access to more advanced tools at:
Happy to discuss other uses or applications of options, just drop me a message.
While I obviously think Robinhood is amazing for disrupting an industry with pretty high fees, I worry that it is basically becoming gambling for a certain part of the population.
Of course, it's hard to make money on dividend reinvestment.
Find options you like and get in on them.
TSLA over $347.50 buy short term options, targets are $400.
www.plainsitemanagement.com --> I hit winners. Better than anyone out there.
Also, I don't hold until expiration but I want maximum profits, not basic money.
Reminds me of the app’s namesake, Robinhood .