The Official Options Questions Thread

[DcifrThs]

ok guys,

the APPL put discussion made me realize i am very weak when it comes to options. i've spent some time going through option theory & pricing again from first principles and some time in excel building 2 way tables to see how theoretical B-S prices of options respond to changes in spot & time 'til maturity.

i'm still not as comfortable as i need to be though and have some questions. so while i can provide some insight about options, i need some stuff answered.

so i'll try to help where i can but mainly i'd like to hear from technical analysts & other people with a deep understanding of the practicalities of options trading.

questions:

1) taking the APPL example, you go long the put at 105 maturing in october and short the put at same strike that matures a few months earlier. so now how does the sensitivity to changes in the underlying price (delta) respond with respect to time to maturity (i.e. what is: dDelta/dt?) i ask because if the price of the option is more sensitive to changes in the underlying when there is more time until maturity, then the long exposure is even more valuable and this makes more sense to me.

2) is there a good site for reviewing all the option strategies mentioned (condor, calander etc.) b/c i haven't heard of some of those. i am familiar w/ the more basic butterfly, straddle, strangle and the like but would like to get more familiar w/ other possible methodologies for taking various positions & when it is a good idea to think about using one vs. the other.

basically i really appreciated the contributions in the APPL thread and i think this specific area of technical analysis is very promising. you set yourself up to make profits off of mispricings in the market and can completely eliminate tail risk in portfolios if you choose. i much prefer the payoff profile of lose, lose, lose, lose, WIN BIG to the reverse.

so thanks in advance for your help and i'll try to answer whatever theoretical questions i can w/ my limited knowledge.

thanks,
Barron

[pig4bill]

See Larry McMillan's site: http://www.optionstrategist.com/

It has some options calculators, but for fancier things you need dedicated software. The options station stuff from Tradestation is supposed to be good.

BTW, Larry's books and courses are good for for an in-depth introduction to options.

[DcifrThs]

[ QUOTE ]
See Larry McMillan's site: http://www.optionstrategist.com/

It has some options calculators, but for fancier things you need dedicated software. The options station stuff from Tradestation is supposed to be good.

BTW, Larry's books and courses are good for for an in-depth introduction to options.

[/ QUOTE ]

my immediate gut reaction to that site is slightly negative:

1) he is selling his own hedge fund, individually managed accts, and products.

2) he promises EV calcs of any positions even complex ones.

well the whole point of options in my mind isn't to KNOW what you will get, but to KNOW what you will lose! thats the beauty of it imo. you can know your max loss and try to set yourself up to make big gains when something move sin your favor. you thus shouldnt' be able to know what your expectation is.

and while i have "limited" knowledge of options, i do have a very strong foundation. i took mathematical finance series where we started off mathematically deriving the B-S world, then going to asset pricing, then portfolio construction and option & derivative pricing.

the next courses involved using gauss and matlab to price those securities we learned about in theory.

finally, we did interest rate modeling for swap/swaption and other IR derivative pricing.

i say my knowledge is limited in the sense that i haven't experienced options trading and don't feel comfortable as i'd like.

so do you happen to know about the second derivative of the options price with respect to the underlying and then with respect to time? how does this play out in practice?

thanks,
Barron

[mal_noles]

I will try to contribute to this thread further when I get out of work.

Quick answer, the option closet to expiration is going to be most greatly effected by a movement in the underlying. The easiest way to think of delta is the liklehood the option will expire in or out of the money.

[mal_noles]

Lack of sleep plus the debacle that is the DME is making me retarded. I will offer something that actually makes sense later.

[mrbaseball]

I don't have much time right now but I'll try to answer what I can.

[ QUOTE ]
1) taking the APPL example, you go long the put at 105 maturing in october and short the put at same strike that matures a few months earlier. so now how does the sensitivity to changes in the underlying price (delta) respond with respect to time to maturity (i.e. what is: dDelta/dt?) i ask because if the price of the option is more sensitive to changes in the underlying when there is more time until maturity, then the long exposure is even more valuable and this makes more sense to me.


[/ QUOTE ]

For an out of the money spread like this it starts with a slightly negative delta meaning it is slightly bearish. Over time the delta gets more negative as the front month (earlier to expire) option decays.

It's easier to understand though if you look at an at the money spread. On the money options all have a delta of .5 whether they expire tommorrow or next year. The gamma (sensitivity of delta to price changes) is dratically different though. If an on the put money option expiring tommorrow has it's underlying drop a few points the delta will rocket to probably -1 and start trading at parity with the underlying because it has no time left. A year out option will have a very muted change in delta.

For example the Apple 105 Jul/Aug put calander has a delta of -.27 which is basically all in the August (july -.01 August -.28). This spread will work real well on the downside as the July delta won't really do much until it gets closer to the money and the August will react better due to the amount of time it has. If it blows through 105 then the table turns and the Julys start performing better (from a delta perspective. But the August has much more vega (sensitivity to volatility changes). A big down move will almost certainly increase volatily which means the spread works well in that envirnment as well.

[ QUOTE ]
2) is there a good site for reviewing all the option strategies mentioned (condor, calander etc.) b/c i haven't heard of some of those. i am familiar w/ the more basic butterfly, straddle, strangle and the like but would like to get more familiar w/ other possible methodologies for taking various positions & when it is a good idea to think about using one vs. the other

[/ QUOTE ]

Not sure about websights? But any basic options book should be able to explain the various strategies. The stragies can get complex but it's usually easier just to keep it simple with a simple 1 to 1 spread.

A good book that explains the "greeks" I think is what you are looking for. The 4 basic components are delta (% of underlying), gamma (delta sensitivity to price changes), vega (sensitvity to volatility changes), and theta (time decay). Most professioinal options market makers stay delta neutral and trade changes in volatility. Spec traders will usually trade a delta looking for a specific move.

With so many options and months available the strategies are practically unlimited. But once you understand the greeks and how they effect prices you will feel more comfortable.

[DcifrThs]

[ QUOTE ]
It's easier to understand though if you look at an at the money spread. On the money options all have a delta of .5 whether they expire tommorrow or next year. The gamma (sensitivity of delta to price changes) is dratically different though. If an on the put money option expiring tommorrow has it's underlying drop a few points the delta will rocket to probably -1 and start trading at parity with the underlying because it has no time left. A year out option will have a very muted change in delta.

[/ QUOTE ]

thanks, this is what i was looking for.

the sensitivity of the sensitivity of price changes to the underlying increases as time value decays. now why should this logically be the case? i think the way i'd put it is that a small change in price w/ a year left means less to the sensitivity to price changes than it would with only a few days left since at that point, the option is almost entirely priced off of intrinsic value. so the more the intrinsic value dominates the payout, the more sensitive the delta would be to changes in the underlying.

but this paragraph isn't so clear as it relates to price movements.

holding time value constant, should an OTM, ATM, or ITM put (or call) option have the highest gamma? it seems to be that if i were to guess i'd say the OTM should have the highest gamma. the price sensitivity to the underlying should get bigger as the price moves away from the strike, right? and, it should become more sensitive to price changes in the underlying. i'm not comfy enough here to sum this up in a sentance like above so that means i would need some clarification.

now at the strike price, it should have the lowest possible detla, but should it also have the lowest sensitivity of delta to price moves? why or why not?

finally, if an option is already in the money, does its delta become more or less sensitive to the changes in the price of the underlying? again, why or why not.

thanks,
Barron

[mal_noles]

All else constant an ATM option has the most gamma. Since the delta is close to .50 its going to move more drastically with a move in the underlying proportionally than a ITM or OTM option.

An ATM options delta is going to have the greatest sensitivity to the underlying. A deep in ITM or OTM option is likely to expire that way with a $1 in price, but for something right at strike a $1 maybe a significant move.

A ITM option moves closer to a 100 or -100 delta as expiration nears. When trading deep ITM options you arent trading volatility anymore it becomes a purely directional trade.

Sorry if thats not very clear, its a lot easier to explain in person in front of an actual option chain. Optionmonster .com is a good site for research.

[KDuff]

Barron,

Last month I read a pretty good primer of the Greeks in Futures Magazine,which I strangely get for free. The article clearly broke down 5 of the Greeks. It's available in their online archives, but you'd have to pay a subscription fee, which I don't recommend.

I was just putzing around and found Derivatives Strategy, which is now defunct, but the archives are accessible. You'd enjoy some of the articles including an in depth interview with Taleb in which they skewer VAR.

Also, Interactive Brokers should have some educational resources. If you use an options trading calculator for straddles, etc you'll be able to see how delta, gamma, etc figure into the strategies.

Derivatives Strategy

[mrbaseball]

[ QUOTE ]
An ATM options delta is going to have the greatest sensitivity to the underlying

[/ QUOTE ]

This is it. ATM options will have the greatest gamma. Also closer to expiration months will have greater gamma than further out months. The further out months will have greater sensitivity to volatility increases or decreases.

It easier to see the effect by playing around with an options analyzer. The previously mentioned optionmonster.com has one you can use and optionstar has one you can download free (for use in excel) if you want to look at spreads and with it you can plug in a few different options and see how their deltas and gammas etc vary from month to month and strike to strike.

optionstar free analyzer