intraday time decay?

Discussion in 'Options' started by leorc, Sep 9, 2009.

  1. donnap

    donnap

    Perhaps you were comparing long 100s + 2 long puts vs. 2 calls + 2 puts both neutral.

    The 2 calls + 2 puts is twice the size of the synthetic straddle.

    Should be 100s + 2 long puts vs. 1 call + 1 put to see the equivalency.

    So all other factors being equal, with equivalent positions, one is not really better than the other.

    Often, though, all other factors such as liquidity are not equal.
     
    #31     Sep 20, 2009
  2. dmo

    dmo

    Walt, in your message you kept comparing a "long straddle" with a "synthetic straddle." You didn't say anything about comparing an option with stock.

    But if that's what you meant - if you want to compare the advantages of being long calls to being long stock - basically it goes like this.

    If you're long stock, your delta never changes. When the stock goes up x amount, you make x dollars. When it goes down x amount, you lose x dollars.

    Now, wouldn't it be lovely to have a stock with a delta that magically changed in the direction that was favorable to you? Where if the stock went up $10 you make $7, but if it goes down $10 you only lose $3?

    Well, that's what you get when you buy an option. The name of that property is gamma, and that's what you're paying for when you buy an option. Positive gamma is the magical property wherein you make more and more money as IBM goes in your direction, and lose less and less money as IBM goes against you.

    If you're long an ATM IBM call and IBM goes up a buck, you make about 50 cents. If it goes up another buck you make say 55 cents. If it goes up another buck you make say 60 cents.

    If IBM goes up far enough you'll make a dollar for every dollar IBM goes up.

    But if, instead, IBM goes down a buck you lose 50 cents. But if it goes down another buck you'll only lose say 45 cents. And if it goes down another buck you'll only lose say another 40 cents.

    And if IBM goes down far enough your option will become worthless, and then further drops in IBM will produce no additional losses at all.

    If you own options and start out with a delta of zero, then you'll make money when IBM goes up, and you'll make money when IBM goes down. All IBM movement is good. Which is to say, all volatility in IBM is good. Which is to say you own volatility in IBM. You have bought IBM volatility. Or you could say you own IBM gammas. Different ways of saying the same thing.

    That's a wonderful property, that gamma. But like all the finer things in life, it doesn't come free. That's why you have to pay for time premium. That's why you have to pay for gammas, for volatility.
     
    #32     Sep 20, 2009
  3. Excellent repsonse dmo, I appreciate you thorough response. It's right on target with my dilemma.

    Although the benefits of gamma and delta do cost (i.e. premiums), do you think it's worth paying the premium for two option legs in a long straddle, or is it better to have a long straddle comprised of one long option leg (such as a long put) with a long stock position (instead of a long call)...

    Walt
     
    #33     Sep 20, 2009
  4. dmo

    dmo

    Walt, I think you're still laboring under a few misconceptions.

    First, your statement that "the benefits of gamma and delta do cost (i.e. premiums)."

    Let's start with the fact there are four main greeks - delta, gamma, vega and theta.

    Now let's group them. Gamma, vega and theta are aspects of premium, and should be grouped together. They are unique to options. Stocks have none.

    Then there is delta, which belongs in a separate group. Delta is NOT an aspect of premium. Delta is not unique to options. It has nothing to do with premium. Stocks have delta too.

    Now your question "Do you think it's worth paying the premium for two option legs in a long straddle, or is it better to have a long straddle comprised of one long option leg (such as a long put) with a long stock position (instead of a long call)... "

    Walt, there are three ways to have a straddle. You can buy a put and buy a call. You can buy two puts and buy stock. Or you can buy two calls and sell stock. In each case you are buying the same amount of premium.
     
    #34     Sep 20, 2009
  5. You're right about delta being associated with stocks and options, as stocks have a delta of 1. True, gamma, vega, theta & rho are unique to options. However, one atm option leg is about .5 delta. Therefore, 1 long put option woud be offset with only 50 long shares of stock.

    In essence, is the 50 shares of stock better than 1 long call option for the specific purpose of gamma scalping??

    btw, thanks for getting me straight on the premium. It simply was an oversight on my part... typing without thinking:)

    Walt
     
    #35     Sep 20, 2009
  6. donnap

    donnap

    In essence, 50 shares/put creates a neutral postion 1/2 the size of the call/put combo.
     
    #36     Sep 21, 2009
  7. Blackscholes is one calculation... And while it is the daddy of them all using it as reference could start a debate...

    Whoops already there... ;)
     
    #37     Sep 21, 2009
  8. But wait if and I think IBM does give dividends. Then the price changes again because with a dividend the value of the call option decreases. At that point the calculation becomes an interest rate vs dividend yield question... No...
     
    #38     Sep 21, 2009
  9. spindr0

    spindr0

    Hey! Yep, that about sums it up. If I'm not making up the extra 12 cts by being treated like a MM then the puts are a better deal in an environment where rates are higher. And yeh, I fudged the hypothetical by using a rate of 1.5% :)

    Bottom line is that if I'm looking to be delta neutral, I'm probably better off placing a combo order on both sides that tries to nick the most I can off the option spread and whichever side gets filled first determines whether I'm long or short, assuming no issues like pending dividend, liquidity, margin, etc.
     
    #39     Sep 21, 2009
  10. dmo

    dmo

    Spin - if I understand correctly, you're inputting into your pricing model an interest rate of 1.5%, while the ACTUAL percent you're paid on your short sale is zero. Yet you are shocked, shocked that the model gives you results that do not correspond to your reality?

    If YOUR interest rate is zero percent, then that's the interest rate you should enter into your model. If you did, your model would use the current underlying price (rather than a forward price) to price your options, and you would find that your model values the put and the call at your strike identically when the underlying is at that strike as well.

    The whole issue that you have been puzzling about would disappear.

    Now do you see why I insist that the correct interest rate to input is YOUR interest rate?
     
    #40     Sep 21, 2009