Wednesday, May 26, 2010
Intermediate Trading Lab
Notes for the May 26, 2010 Intermediate Trading Lab are now posted on the Trading Lab Page.
Tuesday, May 25, 2010
Delta
Delta is a fascinating Greek value that is used several different ways in trading. In general the delta is a measure of how an option’s value changes as the price of the underlying goes up or down. However, the delta represents more than that as it includes probability of an ITM Strike Price and also serves as a comparison to stock ownership. One of the most important aspects of delta is that it is an estimation. It is NOT an exact.
Delta has a lower boundary of 0 and an upper boundary of 100. Most traders will write delta as a decimal and so we will do the same. A typical delta, for example 60, will be written as 0.60. For Calls, the Delta is positive, for Puts it is Negative. A Put with a delta of 72 would be written as -0.72. The negative sign indicates that the change of the Option will be in the opposite direction of the market.
The first aspect of Delta is using it as a measurement of the change in an Options value as compared to the movement of the stock. A Call Option with a Delta of 0.35 can be expected to change its value at 35% of the rate of the underlying. If the underlying were to rise $1.00, then the Option value can be expected to rise approximately $0.35. If the underlying were to fall $1.00, then the Option value can be expected to drop approximately $0.35. Call and Put Options that are close to being or are At-the-Money have Delta values that are very close to, if not at, 0.50.
Another aspect of the Delta is that it gives us the probability that the Strike Price will be In-the-Money (ITM) at expiration. If, for example, the $50 Call on XYZ Corporation has a 0.75 delta, then we have a 75% probability that the $50 Call will expire In-the-Money (ITM). What is nice about this is using this as we short or sell our Options. If we have constructed, for example, a Bull Put Spread completely Out-of-the-Money, and we want it to remain OTM to expiration, then we want to find a small Delta on our short Put. If we find a 0.18 Delta on our short Put, then we have a 82% probability that the Put will be OTM at expiration.
One important safety factor of the Delta is that it can help us hedge our positions. The Delta can help us determine the ratio of Stock to Option Contracts. Remember that the Delta of Stock is always 1.00. If we want to hedge our Option positions with underlying Stock we will divide 100 by the Option's Delta. If, for example, we have an Option that has a Delta of 0.50, then the proper hedge is 100/50, or 2/1. For every two Options that we purchase, we can sell one hundred shares of Stock. This will help us establish a neutral hedge.
Delta can aid the trader in establishing probabilities and also give an estimate as to growth in value as the underlying moves in the appropriate direction. It can also aid us in hedging our positions.
Delta has a lower boundary of 0 and an upper boundary of 100. Most traders will write delta as a decimal and so we will do the same. A typical delta, for example 60, will be written as 0.60. For Calls, the Delta is positive, for Puts it is Negative. A Put with a delta of 72 would be written as -0.72. The negative sign indicates that the change of the Option will be in the opposite direction of the market.
The first aspect of Delta is using it as a measurement of the change in an Options value as compared to the movement of the stock. A Call Option with a Delta of 0.35 can be expected to change its value at 35% of the rate of the underlying. If the underlying were to rise $1.00, then the Option value can be expected to rise approximately $0.35. If the underlying were to fall $1.00, then the Option value can be expected to drop approximately $0.35. Call and Put Options that are close to being or are At-the-Money have Delta values that are very close to, if not at, 0.50.
Another aspect of the Delta is that it gives us the probability that the Strike Price will be In-the-Money (ITM) at expiration. If, for example, the $50 Call on XYZ Corporation has a 0.75 delta, then we have a 75% probability that the $50 Call will expire In-the-Money (ITM). What is nice about this is using this as we short or sell our Options. If we have constructed, for example, a Bull Put Spread completely Out-of-the-Money, and we want it to remain OTM to expiration, then we want to find a small Delta on our short Put. If we find a 0.18 Delta on our short Put, then we have a 82% probability that the Put will be OTM at expiration.
One important safety factor of the Delta is that it can help us hedge our positions. The Delta can help us determine the ratio of Stock to Option Contracts. Remember that the Delta of Stock is always 1.00. If we want to hedge our Option positions with underlying Stock we will divide 100 by the Option's Delta. If, for example, we have an Option that has a Delta of 0.50, then the proper hedge is 100/50, or 2/1. For every two Options that we purchase, we can sell one hundred shares of Stock. This will help us establish a neutral hedge.
Delta can aid the trader in establishing probabilities and also give an estimate as to growth in value as the underlying moves in the appropriate direction. It can also aid us in hedging our positions.
Wednesday, May 19, 2010
Intermediate Trading Lab
Notes for the May 19, 2010 Intermediate Trading Lab are now posted on the Trading Lab Page.
Wednesday, May 12, 2010
Intermediate Trading Lab
Notes for the May 12, 2010 Intermediate Trading Lab are now posted on the Trading Lab Page.
Wednesday, May 5, 2010
Medicine, Faith and the Greeks
Sometimes you just need Dramamine. The world has its hot spots and the market goes through its peaks and valleys. We ride the roller coaster and we take our motion sickness medicine. It’s a time of upheaval and uncertainty. We hear over and over that the sky is falling, but I continue to be the eternal optimist. How can we be optimistic in world conditions that bring fear to so many? Well, first I have faith. I don’t want to sound like a arrogant practitioner of religion, but I believe that above everything else, there is a plan, an eternal plan, that if followed, brings peace. I’m not ashamed of my faith or of my optimism. That optimism is not rooted in naivety, but has solid footing. Frankly, I don’t think the world is going to become more peaceful, but does that sway me from living? No! Too many people tend to duck and run for cover the minute even a small sign of trouble looms on the horizon. I love life too much to always stand under cover. There will always be those that want to hide under a rock, but I am not going to live in fear. Fear brings negativity and frankly the principle of self-fulfilling prophecy comes into play. If we believe bad things will happen - they will.
What we need now, more than ever is resolve. We need to continue to financially shore up what we have and, in the vernacular of today, we just need to “Man Up.” Instead of expecting a hand out, we can collectively and individually give a hand up to ourselves and those around us. It comes from work and from implementing solid trading principles. It comes from continual education and having the foresight, vision and frankly “guts,” to step out of the proverbial box.
As an Options trader and instructor I often hear that “Options are too risky.” While Options have risk, it surprises many that Options, if managed correctly, are usually more safe than owning stock. One of the flaws in trading today is believing in the old, antiquated and outdated philosophy that we should buy stock and hold it for 20-30 years and then sell it and retire wealthy. If 2008 wasn’t a wake up call to re-tool that kind of strategy, then the current instability and rising volatility should be.
There has never been a greater need to have a trading plan. That plan has to adapt to changes in the market. As traders we MUST learn to react to current market conditions and apply solid strategies instead of hoping that the market will change because of our superior mind power.
Over the next few posts I want to talk about using the Greeks as part of a Master Trading Plan. Learning about the Greeks is an essential part of the trader’s toolkit. Some view the Greeks as forbidden territory, however they are absolutely necessary in having a solid plan. The basic Greeks are Delta, Theta, Vega, Gamma and Rho. There are other Greeks, but for now we are going to concentrate on the fundamental Greeks that can have a huge impact in the way we trade.
We hear from some, “Those were the days.” For them, their life is in the past. I think “These are the days!” We have much to be thankful for and many opportunities to embrace. Now is our time! We will take the market and ride it. Hang on - it’s going to be a lot of fun!
What we need now, more than ever is resolve. We need to continue to financially shore up what we have and, in the vernacular of today, we just need to “Man Up.” Instead of expecting a hand out, we can collectively and individually give a hand up to ourselves and those around us. It comes from work and from implementing solid trading principles. It comes from continual education and having the foresight, vision and frankly “guts,” to step out of the proverbial box.
As an Options trader and instructor I often hear that “Options are too risky.” While Options have risk, it surprises many that Options, if managed correctly, are usually more safe than owning stock. One of the flaws in trading today is believing in the old, antiquated and outdated philosophy that we should buy stock and hold it for 20-30 years and then sell it and retire wealthy. If 2008 wasn’t a wake up call to re-tool that kind of strategy, then the current instability and rising volatility should be.
There has never been a greater need to have a trading plan. That plan has to adapt to changes in the market. As traders we MUST learn to react to current market conditions and apply solid strategies instead of hoping that the market will change because of our superior mind power.
Over the next few posts I want to talk about using the Greeks as part of a Master Trading Plan. Learning about the Greeks is an essential part of the trader’s toolkit. Some view the Greeks as forbidden territory, however they are absolutely necessary in having a solid plan. The basic Greeks are Delta, Theta, Vega, Gamma and Rho. There are other Greeks, but for now we are going to concentrate on the fundamental Greeks that can have a huge impact in the way we trade.
We hear from some, “Those were the days.” For them, their life is in the past. I think “These are the days!” We have much to be thankful for and many opportunities to embrace. Now is our time! We will take the market and ride it. Hang on - it’s going to be a lot of fun!
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