ANOTHER set of newbie question

Discussion in 'Options' started by brokershopping, Oct 12, 2001.

  1. Like others here, I find myself looking for new ways to trade in my IRA. With IB offering options now, I thought I should learn a little about them and see it they were something I could put to good use. Another advantage would be the ability to play the down side of the market. Not having the ability to short, my account has been pretty dormant lately.

    The extent of my knowledge consists of reading this board, browsing the books that have been recommended here, and making a few small trades just to get a feel for them. My first impression is that if trading stocks is like a game of checkers, trading options is like a game of chess. There are just a lot more factors to take into account with options. It actually sounds like a fun challenge to learn the game. I am sure learning what questions I even need to ask will take some work, but here are a couple general ones.

    -Given the wide spreads, transaction costs, and time decay, is the technique of betting on a stock's direction by buying 'calls' and 'puts' a suckers game or does it work? Does the leverage you get from this technique make your winners powerful enough overcome these costs? (I am sure part of this is how good you are at predicting the price of the underlying :) ) Should I look into more advaced strategies?

    -Do options prices tend to follow the standard models fairly closely? (Black-Scholes, etc) You have the wildcard of 'implied volatility', but in general will they tend to follow their mathematical destiny or do you find that some options are occasionally "mispriced"? (I imagine there are arb players who look very closely for these discrepencies.)

    -I have not spent much time studying volatility. I am interested in visually seeing how it will vary with price movement. Are there any web sites which allow you to plot volatility along with stock price?

    -I believe 'implied volatility' is the term used for what traders expect the volatility to do. (based on what they expect the price to do). If a stock breaks through a major support or resistance area, will 'implied volatility' make the price of the option go up more as it goes through these price levels? In other words, will the change in the price of the option be greater for a $0.50 drop below support than a $0.50 drop above support? The belief being that a break through these levels can signal a larger move. (Did I make any sense with that one?)

    Thanks in advance for any advice. (If you have any suggestion as to what I should ask next, that would be great too!)
  2. One more question...

    How do you find out which options are the most liquid? Will they tend to follow the most actively traded stocks or are there 'cult' options that draw a lot of traders?

    You have a lot of 'lists' for stocks (most active, biggest gainers, etc) but is seems kind of tough to find out what options are doing without pulling up the chain in each stock.

  3. My advice to you is run, don't walk away. To quote Mark Ritchie:
    "For novices to come in and generate profit in this incredibly complex industry is like me trying to do brain surgery on the weekends to pick up a little extra cash." :(
  4. brokershopping,

    Do yourself a favor. Read a couple of books on options before you start trading them. Two good ones are McMillans book, the title I don't recall, and my favorite, Natenberg's Option Volatility and Pricing.

    The options markets are highly efficient and it is unlikely you, as an off-floor retail trader, will be able to find and exploit pricing inefficiencies. Most are so tiny they would be dwarfed by the spread which you will pay both ways. It is very hard to buy at the bid or sellat the offer, as the options floors operate like Nasdaq did before it was cleaned up.

    Your best chance to make money will be by predicting the movement, or lack of movement of the underlying stock. There are dozens of strategies, and each is appropriate for a particular market environment. Simple long call or put positions are extremely risky, highly leveraged bets. You can make a lot of money doing that in a strongly trending market, but the people who are selling you the options are not fools and are not out to lose money.

    Options are more like three dimensional chess, and indeed there are 3D charting applications. My advice is don't even think about trading them until you totally understand the concepts of delta, gamma, theta, implied volatility and the pro's and con's of the major strategies.
  5. def

    def Sponsor

    options do follow the models otherwise there would be arbitrage opportunities. Off floor you'll probably have a tough time taking advantage of them w/o a great deal of experience.

    the implied vol may at times move/jump after a stock breaks a certain level. more often than not it is just a factor of supply and demand. i.e. if the flow is moving to buying out of the money calls, the market makers will keep raising their offers to offset their risk.

    for a newbie, i think you may want to look at swing type trade opportunities. If a stock hits your level and you expect it to move by X or Y, you can get increased leverage with less risk if using options wisely.

    As a user of IB, you may want to play around with and familiarize yourself with the Interactive Analtics Options package. read the manual on the web site to see how it works. you'll be able to track vols and risk.