The following video was passed on by a friend and mentor, Gino Poore. This video, while funny, is, for some, very real. Rather than blab a lot about emotional trading, let me just say that instead of trying to read a "crystal ball" we need to read the market. We need to trade what we see, not what we feel. It doesn't matter what we think of the politics of the day, or the fact that we may "love that stock," what matters is having a toolkit full of strategies that can be executed depending on the conditions of the market at that time.
Enjoy the market and have fun.
Saturday, September 11, 2010
Thursday, June 24, 2010
Gamma
So far we've discussed Delta and Theta. Gamma is next on the list. Gamma, simply stated, is the rate at which an option's Delta changes as the price of the underlying (stock, index, ETF) changes. Normally, the data provider on any given software package will express Gamma as the Delta's gained or lost for each one point/dollar change in the underlying.
The Delta will increase the amount of the Gamma when the underlying goes up and will fall the amount of the Gamma when the underlying goes down. If, for example, the $50 strike Call has a Gamma of .02 then for each point rise (fall) in the price of the underlying, the option will gain (lose) 0.02 Deltas. If the original Delta was 0.30 and the underlying moves up (down) one full point, then the new delta of the option will be 0.32 (0.28).
Gammas are always represented as positive numbers regardless of whether they are associated with a Call or Put. If we are working with either Calls or Puts we will always add the Gamma to the old Delta as the underlying rises, and subtact the Gamma from the old Delta as the underlying falls. When a trader is long in his option positions, whether Calls or Puts, he/she has a long Gamma position. When he/she is short options, he/she has a short Gamma position.
The Gamma has important risk characteristics that must be examined. If the Gamma is a large number, whether positive or negative, it indicates a high degree of risk. If the Gamma is a small number, whether positive or negative, it indicates a low degree of risk.
While there are volumes written on the subject of Gamma, we've discussed here enough to think about and establish a basic understanding of Gamma.
The Delta will increase the amount of the Gamma when the underlying goes up and will fall the amount of the Gamma when the underlying goes down. If, for example, the $50 strike Call has a Gamma of .02 then for each point rise (fall) in the price of the underlying, the option will gain (lose) 0.02 Deltas. If the original Delta was 0.30 and the underlying moves up (down) one full point, then the new delta of the option will be 0.32 (0.28).
Gammas are always represented as positive numbers regardless of whether they are associated with a Call or Put. If we are working with either Calls or Puts we will always add the Gamma to the old Delta as the underlying rises, and subtact the Gamma from the old Delta as the underlying falls. When a trader is long in his option positions, whether Calls or Puts, he/she has a long Gamma position. When he/she is short options, he/she has a short Gamma position.
The Gamma has important risk characteristics that must be examined. If the Gamma is a large number, whether positive or negative, it indicates a high degree of risk. If the Gamma is a small number, whether positive or negative, it indicates a low degree of risk.
While there are volumes written on the subject of Gamma, we've discussed here enough to think about and establish a basic understanding of Gamma.
Tuesday, June 8, 2010
Theta
Theta is a greek value that represents the decay factor in an option. All options lose value (extrinsic value) as they move to expiration. The extrinsic value of ALL options will be 0.00 (zero) at expiration.
Theta is normally listed as a negative number and is the dollar amount that is lost each day. If the Theta is listed as 0.10 on a particular option, then that option will lose $0.10 in value per contract share each day. If the option is priced at $5.65, then tomorrow that option will be worth $5.55. A long option will be listed as a negative number and a short option position will have a positive theta. If the trader notices a large negative Theta value, then this will represent a high degree of risk with respect to time decay.
With respect to Long Directional Calls and Puts, Theta can be viewed as a friend instead of an enemy if attention is paid to how much time is purchased up front and when the trader exits the trade on the back-end. Generally, if the trader if buying Calls or Puts, then they should buy 4-6 months of time and if they are still in their positions at approximately 60 days prior to expiration, then it is suggested that they exit. The curve of Theta decay becomes a very steep slope at 30 days and so to avoid an emotional decision, it is best to exit at around 60 days prior to expiration.
For the trader that shorts a position, Theta is a friend, not an enemy.
Next time, we will talk about Gamma. Remember that a large positive gamma correlates with a large negative theta, and a large negative gamma correlates with a large positive theta. We'll discuss this and other aspects of Gamma in the next post.
Theta is normally listed as a negative number and is the dollar amount that is lost each day. If the Theta is listed as 0.10 on a particular option, then that option will lose $0.10 in value per contract share each day. If the option is priced at $5.65, then tomorrow that option will be worth $5.55. A long option will be listed as a negative number and a short option position will have a positive theta. If the trader notices a large negative Theta value, then this will represent a high degree of risk with respect to time decay.
With respect to Long Directional Calls and Puts, Theta can be viewed as a friend instead of an enemy if attention is paid to how much time is purchased up front and when the trader exits the trade on the back-end. Generally, if the trader if buying Calls or Puts, then they should buy 4-6 months of time and if they are still in their positions at approximately 60 days prior to expiration, then it is suggested that they exit. The curve of Theta decay becomes a very steep slope at 30 days and so to avoid an emotional decision, it is best to exit at around 60 days prior to expiration.
For the trader that shorts a position, Theta is a friend, not an enemy.
Next time, we will talk about Gamma. Remember that a large positive gamma correlates with a large negative theta, and a large negative gamma correlates with a large positive theta. We'll discuss this and other aspects of Gamma in the next post.
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.
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