Let's talk about options

[TinGull]

I've been asked to start a topic on options and trading them effectively and woould love to open things up for discussion. I've been trading options for a little over a year now and have gained some significant insight into that world as I am very active in a large options community, Investools, and also with ThinkorSwim and RedOption.

I'm not sure where to start, so hopefully some folks will ask questions and I can help and this can be a beneficial discussion.

For great info on options trading, check out redoption.com .

I'll start in the morning discussing basic option strategies, as its getting late and I'm super tired from travelling today.

Till then...

[torero]

Got a question for you: how does black-scholes model fit into trading options? Or is it useful anymore? Which type of options are you trading: index? stock?

Thanks.

[TinGull]

Hey Torero,

The Black Scholes model is used to figure out if your option is fairly priced. Say you have the strike you're looking at, the share price of the underlying, the time till expiry and the volatility of the option. Then, with the results, you can see if the option is overpriced, or fairly priced. It's very helpful, but I think a lof of softwares should have a "theoretical price" built in so you can see it without having to do the calculations yourself. So, yes, it's absolutely useful and essential to know if you're overpaying for an option. Now...if you're selling the option, which is what I usually do, then you want it to be overpriced.

For what I trade, index options only. They're treated like commodities by the tax man, which gives me some nice tax benefits, plus I don't have to worry about huge fluctuations because of earnings or scandal.

There are also volatility models that can help you figure out the probability percentage of an option expiring in the money or not. Those are somewhat useful, in that the market *usually* has a fairly normal pattern to things. October was a HUGE exception and I know a lot of options traders (myself included) who had their worst month ever selling options as we expected Oct to be a flat to down month, not the roaring month it was. So...probability analysis can work....most of the time.

[testaclese]

Hello all.

Just found this forum a couple days ago. I've been reading so much my eyes are "buggin". I have only recently ( 4 months) been demo trading e-minis so that is pretty new to me. But I have been in the option market for some time. Like all new endeavors there was a very steep learning curve for me with options. Timing wasn't right for me on so many things. However, persistence has paid off and I can say that I am fairly comfortable with the strategy that I finally locked onto.

I now usually only sell credit spreads on the indexes with an occasional spread on really strong trending stocks. My experience has been since most options expire worthless for the one who owns them, the logical side to be on is the opposite one. And with credit spreads I only have to monitor my positions. The reasoning for positions on indexes is primarily less risk. Most indexes spend most of their time in trading ranges which work perfectly for credit spreads. When they are in these ranges, many months I am able to open spread positions on both sides of the index and capture two premiums. With the right broker only one maintenance will have to be provided. For a conservative trader credit spreads offer a fairly decent return monthly. They aren't the most exciting plays in the book, but they are very consistent.

Anyway, I would be glad to engage in this conversation as I believe it would be as stimulating as the rest of this forum seems to be.

Testaclese

[torero]

Hi testa and welcome to the forum!

So does one approach making an option position? Starting with determining if there is an established range already and determine that this area has a probablity of not breaking out right?

[TinGull]

Welcome Testa! That was my main strategy as well for options...until october. Had a few iron condors and some bear call spreads and was rocked by that uptrend on SPX and RUT!! Took me for a good ride, and then decided to trade the eminis so I didn't have to have a bias that remained in place for a month or two at a time.

Credit spreads were good to me up until then, though, and I think that overall spreads are a good place to trade. Hopefully we'll be able to open up some discussions on this forum

Torero, as far as how one approaches putting on a position...this is how I look at it. First, see if we're trending...if so, sell a position to benefit you in that trend. Uptrend...sell a put spread. Downtrend...sell a call spread. If we're kind of in a range (which I would suspect we're starting to see happen now after that mega uptrend since July) Iron Condors are great in that kind of market. There, you're picking two areas to sell both a call and a put spread. For instance...look at a chart of the SPX... selling a 1350/1340 put spread and a 1420/1430 call spread would prove to be a nice way to go.

Why? You've got 3 areas of support and a 50Day MA to break through before you'd be taken out on the downside and start to lose money. Now, if we're at 1341 on expiry, you're getting the full credit. I will close my positions between 4-10 days prior cause the vega exposure is too great. That means that the delta is moving so fast as it comes on to expiry it can either really help your position, or really kill it. 4-10 days gives you good time.

For the call spread in the IC, that area is a bit above where we're at now...and it looks like a top is forming. We've been seeing some real rocky trading lately, and the trend is seemingly sideways for the time being, and then I'd love to see a nice correction down to the bottom of the IC. At that point, it's gonna take some time to get back up to around that 1400-1420 level, and by then you could have exited that call spread with profit and if we're around 1400 or higher by expiry (january)...then let that one expire worthless.

There are a few volatility models to show you expected percentages of probailities, and one that I use is in my ThinkorSwim platform. It'll basically say that based on past performance, this option has xx% chance of expiring worthless, which is what we want when selling spreads.

Hope that helps a little bit....
Chris

[isoroi]

New here as well.

I read that you do mostly buy-writes. When determining a stock to do a buy-write, what importance do you place on implied volatility?

[torero]

I read from another forum that there's a trader doing really well doing European style writing options for FTSE. I understand it's much safer than the American style option writing.

[TinGull]

I'm not aware of the differences in writing them...just aware of the differences between Euro style and american style as far as expirations and things go. isoroi, as far as implied volatility...thats the name of the game when you're selling options. If you sell something that has no volatility...then there's nothing to decay, really. You want something that has the premium pumped up SO much that there's little else for it to do other than dwindle away.

Say you sold a spread with very little IV, you could actually lose money on the options even if the underlying was to go in your favor. Thats because the IV is getting pumped into your options, making you lose money on the ones you sold, while you gain a minor amount in the ones you bought against the sold ones.

I hope that makes sense....let me know if you've got other questions.

[willd]

The attached article is one I wrote for a blog site about six months ago on TradingMarkets.com. This past week I took the time to update the data and the article to include all of 2006.

I was not sure as to where I should post this. However, it is about the effect option expiration week has on the SP500. Anyone trading intraday during this week may find this data to be useful.