Dennis Chen (in a book he co-authored with Mark Sebastian) used language referring to inexpensive OTM options with unpredictable greeks as "units". The author claims this is language used by MM but after checking with one that has been on the floor of the CBOE, he's never heard of that concept. Anyone familiar with this lingo and who can elaborate what Chen is trying to get at.
While I do not know what the author really intended, the term "unpredictable" is typically silent, but implied when referring to option Greeks. (with Rho, often being the exception)
Here's the section from the book, quoted verbatim (I only omitted a couple of examples). So what exactly is a unit in this context? Units Can Save Your Portfolio The following is an example of how to protect your portfolio against a black swan event. Look back to the flash crash of May 2010. A fund had entered a May OEX butterfly that had been doing reasonably well, until the first week of May. The market began to fall away from the short strikes. At one point the trade was down almost 10% on the butterfly, even after all the hedging and adjusting had been done. Then on May 6, the flash crash happened, and the position made a killing. Why? Because the fund was long what most market makers call "units". These units enabled the butterfly position, which by itself got killed by the crash, to be protected by the options. A unit is an inexpensive option with unpredictable Greeks. You can break them down relative to product, so that the more expensive the underlying, the more expensive the unit. For instance, in SPY an option becomes around 20 cents; in the SPX an option is a unit closer to 2.00. All units have deltas below 5 and little to no gamma or vega. So how do these units work? One of the major issues with most models, especially those used by the retail world, is that they predict uniform increases in volatility. This simply is not the case. When the market makes a violent move downward, two things happen: 1. Front month options increase in value far more than any other month, in relative terms. 2. Downside puts gain far more value than the model predicts. ... This is the way cheap puts act in a major down move. In the panic, the world is buying ATM puts. Every trader selling or shorting these puts races to buy something to protect the position in case the market tanks. These shorts buy "units" and all of this buying causes the unit to gain a little price, which increases vega, which increases delta, which increases the value of the unit as the market tanks. This in turn causes the unit to gain more value as traders race to buy these to protect sales, which raises the vega... you get the point -- there is a snowball effect. .... So how can the ordinary trader use units to increase the returns of his portfolio? Buy units, not a huge amount, but about 5% to 10% of allocated trading money (not the total account value), should go into puts, against a standard set of spread trades (condors, butterflies, and time spreads). This amount should be enough so that, adjusted for any increase in volatility if the market drops 10%, your position no longer loses money and possibly gains. If the market drops 20%, you should be making money. The math is not that simple. Understanding how units work comes with understanding volatility. By properly implementing units, you are willing to bet that you will never have to sell your house because the market dropped 25%.
Mark does a bi-weekly podcast on the Options Insider and you can submit questions. If you want him to clarify.
Maybe he means stuff that's trading at the min increment? I've been a market maker across multiple asset classes and have never heard anything referred to as "unit" except for 1 million dollars.
Well in translation: buy deep OTM options for protection. Only problem: 95% of the times you're throwing those money off the window because those options expire worthless so you never get back something for them. I've done enough backtests to confirm that. And $2 for an OTM option may not look much when you sell an ATM option with $20, but only a tiny bit of that $20 is profit on average. In fact you know how much? About $2 So if you buy protection, on average you make nothing anyways.
This is one of the better books on options out there. But there are various parts of the book where I get confused, and I've read much denser optionality books before.
I recall that "units" (aka, teenies) are DOTM options purchased (long) to reduce margin requirements for short option positions. That is their primary purpose - margin reduction. A secondary benefit would be protection, but they are so far out of the money that you would consider it a "catastrophe stop" and not a typical hedge.