Timing the markets is one of the most difficult things a person can try to do. A few claim they are skilled at this, but I have my doubts. Your goal is to learn to use options; to understand the strategies; to be able to quantify the risk and reward potential of any trade and decide if that potential is suitable for you and your investment objectives. It's great to have the math background, but trading options is about <i>trading</i>. Please do not make the mistake of believe your background gives you such a huge edge that you don't have to pay close attention to what you are doing. Learning when to apply a specific strategy is part of the learning process. It takes some time and some practice. Consider paper trading. It's not for sissies who are afraid to use real money. It's for people who are too smart to use real money b4 they are ready to trade. Here's my feeling: Enter a trade when the risk/reward profile makes a position that is comfortable to own. Exit a position when it is no longer comfortable. that means either a) you've made so much that there is little profit potential remaining and holding is not worth the risk; or b) the current risk is too great and you are no longer residing within your comfort zone. You can forget about arbitrage. These situations do not last very long and you will never find them quickly enough to make the trade. Mark http://blog.mdwoptions.com/options_for_rookies/
Thanks Mark for your insightful pointers. But still I don't see how would BS and greeks help me in retail trading... Any thoughts?
The greeks are essential tools for <i>managing</i> risk. By being aware of what can go wrong and how much it may cost, you will not be caught by surprise. IMHO, the path to success with options is avoiding large losses. You have some gains, some losses, but no large losses. BS is another matter. Some people (mistakenly, in my opinion) assume options are always fair priced and that there is no need to estimate the value of an option. Others, believing they can make a very good estimate of future volatility, use BS as if it were gospel. That's also not a good idea. What BS can do for you is to give you a reasonable measure of the IV you are paying or collecting when trading options. Comparing that IV to something - whether it's long-term (or short-term) historical stock volatility, or recent IV - gives you some feel for whether the option price gives you some sort of edge. No one likes to sell undervalued options nor pay for overvalued options. IF you can form an opinion on the fair price of an option you can minimize doing that. On the other hand, if you are planning to trade over an extended period of time, and if you trade spreads (which minimizes the effect of IV), and if you keep the greeks in line (at a level of risk that suits your comfort zone), you can get by by ignorong BS. Part of the time you'll get a good deal and part of the time you won't. What's most important is being able to manage risk. That's of greater value to you than a few extra nickels on the price of a spread. Mark
To me a better question is how would you trade options without a pricing model and greeks? First, you want to know whether the options you are considering are cheap or expensive historically speaking. Are they as cheap as they've ever been? Are they as expensive as they've ever been? Are they near the middle of their historic range? Now, the only way to evaluate the cheapness or expensiveness of an option is by looking at its implied volatility. And for that you need a pricing model. You'll want to look at the cheapness or expensiveness of different months to see how those correspond to historic norms and ranges. Is the spread between the front month and second month closer than usual? Wider apart than usual? As wide apart as it's ever been? You'll want to look at the cheapness or expensiveness of the different strikes in relation to one another - the skew. Let's say the OTM calls are trading at a higher IV - which is to say they are more expensive - than the OTM puts. Is that the way they normally trade? Or is that an anomaly since the OTM puts usually are more expensive than the OTM calls? How do those relate to the ATMs? How does that compare to their historically normal relationship? If you find an anomaly - some IV relationship that differs from historical norms - you may want to make a play based on the assumption that historical norms will reassert themselves. But in order to do that intelligently, you have to understand how options behave. You have to know that as IV rises, the options with more time remaining will rise in price faster than options with less time remaining (vega). You have to know that options with less time remaining will decay faster than options with more time remaining (theta). If you are long and/or short options at different strikes, you may not know at a glance whether you make money or lose money as the underlying rises, so you need to calculate the delta. As the option moves, you'll want to know whether the delta changes in the direction you want it to change (positive gamma) or in the direction you DON'T want it to change (negative gamma) - and how much it changes. If all you want to do is play the direction of a stock or futures contract, then I would not bother with options. Options add a few dimensions to the game, and without a pricing model and a thorough understanding of greeks, you are flying blind.
Once you're ready to tradeâI mean trade profitablyâyou'll have a pretty good understanding of the greeks. There's no way around it. Download TOS's software and study their paper money account. You start with $100K, but don't trade it yet. There are lots of good books on options and there are lots of crappy books on options. Keep reading all of them until you can recognize which ones are good and which ones are useless. Now, watch the free videos out there (CBOE, youtube, etc.). Try to find a good teacher that uses TOS (or whatever platform you settled on). It is so helpful watching someone trade options using the same broker you use. Now, trade your 100K paper money account. Turn that 100K into 500K and you're ready to trade real money. I guarantee you'll have a damn good understanding of the greeks by then.
My 2 cents, if you are going to trade options directionally,that is buy a vanilla call or put you must at least understand delta and theta. If you were the world's greatest stock picker you could probably daytrade options just having a good understanding of delta. What the other intelligent posters are trying to tell you is you will get drawn and quartered if you don't understand the basics. I remember my first option trade ages ago. Walked 2 miles to dump some money to a broker, after calling them five times a day I made my first trade, and waited for the the $$$ to rain from heaven, two months go by and I am slowly losing money, why? I had no idea what theta (time decay) was. Lost the whole thing because I was an uninformed idiot, not because market makers were out to get me. This is kind of a misnomer, the market does what it does cause it can. You can be the smartest guy who ever walked the earth, and still be a shitty trader. The latter is a skillset you must learn and earn. I would tell you to have patience and trade small, but so far you don't sound like you are ready to trade real $$$. Get a practice account and burn yourself with a candle every time you lose a grand or more.
Everything by Mark Wolfinger. Practical, plain language, conservative introductory texts. If it turns out you are a brilliant mathematician, there are tons of more technical tomes, but these will get you started.
Thanks, but just in case anyone want to take your advice literally, please don't buy all three books. The Rookie's Guide is the best and most complete. Mark
if you would like to get your feet wet with webinars, Bill Johnson has a free webinar randomly and he is very informative without a lot of sales hype. he has an archive of webinars on his site @ http://optionsatoz.com/Classes/NiteOwls.aspx