April 29, 2007
For Dummies Considering Trading Options
Reader “Born2Code” left this comment in a recent post that intrigued me:
“If you are looking for a day trade and you have a dummy entry you can use the exact setup to enter ATM (or ITM) front month calls.”
Is this a good idea? I tried to get the data off the Bloomberg to draw an overlay chart (option on top of stock), but I couldn’t. I’m an old fart like Sandy Weill so if anyone can tell me how to export intraday options data from the Bloomberg I’d be much obliged. Anyway, I just grabbed some screenshots instead.
So here we have the call summary page which has Delta, Gamma, Vega, but no (Catherine) Zeta (-Jones), alas.
OK, enough fooling around, let’s look at the 1-minute chart of the AMZN May 55 Calls. That, my friends, is a chart which makes me break into a cold sweat just squinting at it because there’s nothing happening there. Sure I screwed up and didn’t grab the whole day’s chart, but you get the idea.
Now to be fair we can look at it from a volume at price perspective for a better view of the action, seeing exactly where those 2,964 contracts traded.
Still I’m not comfortable with the idea of using options to trade dummy spots. I’ll keep thinking about it, and I’ll try not to be such a fuddy-duddy — I’m trying to keep an open mind. Comments about the (de)merits of Dummies trading options are most welcome!
UPDATE:
Here’s the 15-minute chart for the May 55 calls over Thursday and Friday. You can see that the action on the 26th (Thursday) was pretty good, but the 27th (Friday) looks just awful. They would get you coming and going if you tried to be an options Dummy that day.
April 29th, 2007 at 4:42 pm
Hey,
To export bloomberg intraday data, you can use the BLPIT function in Excel (or the Intraday history wizard).
Alternatively use the GIT function in your terminal, copy and paste into excel and then do Data->Text to Columns -> Fixed Width
Hope this helps….
April 29th, 2007 at 5:20 pm
Tamas: I tried the intraday history wizard in Excel but it wouldn’t give me any options data (ZQN+EK Equity?).
I’ll try GIT next time but I doubt I’ll be able to GIT it. ;-)
April 29th, 2007 at 5:46 pm
I don’t think dummy trading with options is a good idea.
The return/cap employed looks great but if you are trading based on return/defined risk it makes no sense.
Slippage in trading options will definitely be greater than trading the underlying.
Even for an underlying that normally has tight spreads in atm options, on days where it is a dummy candidate, mm’s will only offer wider spreads due to the increase in volatility.
Suppose you were lucky enough to get a midpoint fill on your entry, you would still have to assume a hit on the bid/ask that is not in your favor on your exit.
Commissions also tend to be higher for options in trading the same number of the underlying.
If I play with options I would only sell time premium and volatility.
April 29th, 2007 at 6:09 pm
brian: I agree and you’re saying things I love to hear, but I’m trying to keep an open mind and take in all perspectives.
April 29th, 2007 at 7:48 pm
I generally agree with brian, but consider the following approach (for very liquid options only. If not liquid - stay away):
Once you get a buy signal, buy a call (or a spread) if the volatility is relatively low, or write a put (or a spread) if the volatility is high. In other words, either buy cheap calls or sell expensive puts. Cheap / expensive may be determined by comparing the implied standard deviation of the option with the recent standard deviation of the underlying.
Certainly not bulletproof, and there can still be cases where you earn on the underlying and lose on the options.
April 29th, 2007 at 8:10 pm
By the way, didn’t you use options for the 10-Year Treasury Yield trade described in the one of the Dummy lessions?
April 29th, 2007 at 9:10 pm
Carlton: That was the last trading lesson and I featured the ten-year bond (yield) chart just to show that the principles apply to anything actively traded. I mentioned that one could have used options (or futures for that matter) to make the trade, but I certainly didn’t.
April 29th, 2007 at 11:56 pm
just to be clear i am not advocating anybody go out and start trading options. I do little day trading and almost never day trade an option.
My comments were in the context of finding an “optimal” price for an option to trade. My point is that if you were going to trade the option then you can do so without knowing the optimal price.
i have made and lost a ton of money trading options and i exclusively trade them based on the stock chart and not the option chart. I use them for leverage on swing trades and find that ATM or shallow ITM front-month options suit my style best. I only trade liquid strikes with reasonable spreads and i always use a limit order, mostly at the mid-point of the bid/ask.
April 30th, 2007 at 6:31 am
I should have read the original post and responses before my first response here.
Anyway, these are what the 15 min charts of AMZN and .ZQNEK look like on thinkorswim on 4/26/07. The time axis looks funny as I’m 12 hours ahead.
AMZN
.ZQNEK
It is interesting to see a surge in volume at 11:30 am for .ZQNEK that does not occur for AMZN.
I don’t have access to historic bid/ask info so can’t really quantify the impact of slippage from the spread. But based on the thinkorswim chart slippage doesn’t look too bad.
Assuming that slippage is not much of a problem, I think that there is some merit for Dummies trading options instead of the underlying in certain situations.
Suppose you only have $6,000 of buying power left on 4/26/07, and you are able to find several more Dummies candidates in addition to AMZN. If you trade AMZN with the underlying, you use up at least $5,700 of your buying power and most likely would not be able to trade the other candidates. But if you trade AMZN with options, you only use up $350-400 of your buying power and still have $5,600 left to trade the other candidates.
April 30th, 2007 at 6:47 am
Off topic. So, CM, Catherine Zeta Jones is your idol? Now your secret is out. ^_^
April 30th, 2007 at 7:45 am
brian: Thanks for your charts; I was looking at the 27th, but the 26th is fine too since it was “in play” both days.
Lyyn: I’m a big fan of Catherine Zeta Zeta and featured her back on June 16, 2002. She’s one of the few white women I find attractive.
April 30th, 2007 at 8:27 am
C. Maoxian: Here you go, .ZQNEL is more ATM and liquid on the 27th so I included that as well.
AMZN
.ZQNEK
.ZQNEL
Slippage is much more apparent on the 27th and is definitely an issue.
April 30th, 2007 at 9:44 am
brian: 12 hours ahead? Are you in my time zone?
April 30th, 2007 at 9:55 am
C. Maoxian: I’m based in Hong Kong
April 30th, 2007 at 10:04 am
brian: Makes sense, thanks.
May 1st, 2007 at 4:02 am
Brian,
Can you expand on your statement :
“If I play with options I would only sell time premium and volatility.”
What is the strategy is doing this? Trying to learn…
Thanks.
May 1st, 2007 at 8:31 am
Amir,
As a general rule, option value = intrinsic value + time value + volatility value. ATM options are especially sensitive to the value of time and volatility.
I prefer to sell time and volatility by wrtiting options as the odds of better returns are more favorable over time. Volatility spikes on big moves but tends decrease over time as prices consolidate.
The most common strategy to squeeze extra return out of a stock that you want to hold on to is to write covered calls as prices hit support/resistance.
For an intraday Dummies options trade, the decrease in time value is negligible and volatility is up, so buying options would give better returns.
May 1st, 2007 at 11:17 am
Brian,
Please explain why you would write covered calls at support. Would not your security be called away from you as it bounced off support? Or are you initiating the position and writing the call at the same time? I’m a novice at options, so just trying to understand the mechanics. CM can you chime in too?
May 1st, 2007 at 1:08 pm
Brian,
Thanks for the follow up. I’ve got some good experience buying options but have never been on the sell side. I’m familiar with the pricing models for options but I was curious as to your statement you made since I’ve never thought about how to sell them and thus wanted to find out more.
But your latest response arises another question: when you state the odds of better returns are more favorable over time, do you imply that you would rather sell the option now, take the cash and use that money somehow? What specifically do you mean with respect to return over time. Also, Groucho brings up a good point as to why you would want to sell off of a support or even want to write a call when a stock is breaking through resistance levels because the chances of it getting called are fairly good and you could lose the potential upside if in fact the stock continues to go higher.
Thanks for your response and time.