4 ms·

Could you expand on how that would work? If X is priced at 10 units of currency, and I promise to buy 1 X for 11, and to sell 1 X for 9. And X stays available f

by e12e 9y ago

Could you expand on how that would work? If X is priced at 10 units of currency, and I promise to buy 1 X for 11, and to sell 1 X for 9. And X stays available for 10, I end up paying 11, receiving 9 - netting a loss of 2. If I manage to promise a sell/buy at 10, I even out. What do I lose with low volatility? And how do I make money "both ways"? Clearly I lack a basic understanding of the concepts involved.

skolos 9y ago
In volatility trading you don't cary naked options (you hedge them usually dynamicaly - readjusting hedge every now and then) and usually close positions before options expire. So your analysis does not apply. If you want to get understanding on how to trade volatility the "Volatility Trading" by Euan Sinclair is excelent.
philipodonnell 9y ago
"Volatility" in the term "Volatility Trading" does not mean the stock's movements, it is a way of measuring the excess value in an option beyond what the parameters of the option would imply. That excess value is usually referred to as the market's assumption about the future volatility of the stock, but really its just an error term influenced by market participants based on supply and demand. Low volatility means "pretty close to its theoretical value assuming no volatility" or to put it another way: "cheap" i.e. good for buyers and bad for sellers. Sort of like how different companies with the same cash flows can trade at different multiples, otherwise identical options in two companies (or different expirations/strikes in the same company) can trade at different prices because of the opinions of market participants. Volatility traders act when the different prices/error terms are too far apart, counting on the prices/error terms to converge a.l.a. pairs trading. Since they are trading the error term directly, they attempt to construct positions that remain relatively flat in value as the stock moves around, but are designed to only change in value when the error term changes. That is how they can make money "both ways", because they can profit if the stock goes up, down, or stays the same, as long as the error term moves in the correct direction. The reason you only see sophisticated people doing this kind of trading is because you need a large and complex position with many hundreds of options to be in a truly market-neutral environment. You can't take advantage of mispricing without such a large position because buying/selling single options involves a tremendous amount of risk, so you need to do that as a part of a larger portfolio to spread that risk. Retail traders tend to spread the risk by doing 2 transactions (the mispriced option and a well-priced but mirrored hedge option), but that is a) much more expensive from a commissions standpoint and b) really limits the range of market-neutrality forcing you to adjust more frequently to stay market-neutral, again, with commission costs.
- e12e 9y ago
  So it's "buy low, sell high" - but for options, not stocks? [ed: that's to say, you need a way to get more/accurate pricing information than reflected in the market - but for options, not assets]
  - aerovistae 9y ago
    Yes, this is how the guy I was referring to explained it to me~ he created a pricing model to predict errors/inaccuracies in the market's model, and was thus able to know when an option was likely to move towards a different price to correct itself.
  - philipodonnell 9y ago
    Yes, but its sort of changing the definition of high and low from price (with stocks) to volatility (with options) and having the expertise to trade volatility like that without _accidentally_ trading on price.
rsp1984 9y ago
I think the terms you're looking for are "straddle" and "strangle" options strategies.
rocqua 9y ago
If I recall correctly, your structure describes a future not an option. If you buy put options for X at 10, and call options for X at 10, then if the price moves down you exercise the call option, and if the price goes up you exercise the put. Unless the price is totally fixed, you make some profit. The real question is whether this profit outweighs the price of both your options. You need the price to move sufficiently for this plan to be worth it. Especially because in any case, either your put option or your call option is worthless. Thus, you need twice as large a price move as when buying only puts or calls. The upside is that you don't need to care about the direction of the movement.
steamer25 9y ago
Khan describes the long straddle (3:53): https://youtu.be/2HIRaOQDRho https://youtu.be/2HIRaOQDRho

by e12e 9y ago

skolos 9y ago

In volatility trading you don't cary naked options (you hedge them usually dynamicaly - readjusting hedge every now and then) and usually close positions before options expire. So your analysis does not apply. If you want to get understanding on how to trade volatility the "Volatility Trading" by Euan Sinclair is excelent.

philipodonnell 9y ago

"Volatility" in the term "Volatility Trading" does not mean the stock's movements, it is a way of measuring the excess value in an option beyond what the parameters of the option would imply. That excess value is usually referred to as the market's assumption about the future volatility of the stock, but really its just an error term influenced by market participants based on supply and demand. Low volatility means "pretty close to its theoretical value assuming no volatility" or to put it another way: "cheap" i.e. good for buyers and bad for sellers. Sort of like how different companies with the same cash flows can trade at different multiples, otherwise identical options in two companies (or different expirations/strikes in the same company) can trade at different prices because of the opinions of market participants. Volatility traders act when the different prices/error terms are too far apart, counting on the prices/error terms to converge a.l.a. pairs trading. Since they are trading the error term directly, they attempt to construct positions that remain relatively flat in value as the stock moves around, but are designed to only change in value when the error term changes. That is how they can make money "both ways", because they can profit if the stock goes up, down, or stays the same, as long as the error term moves in the correct direction. The reason you only see sophisticated people doing this kind of trading is because you need a large and complex position with many hundreds of options to be in a truly market-neutral environment. You can't take advantage of mispricing without such a large position because buying/selling single options involves a tremendous amount of risk, so you need to do that as a part of a larger portfolio to spread that risk. Retail traders tend to spread the risk by doing 2 transactions (the mispriced option and a well-priced but mirrored hedge option), but that is a) much more expensive from a commissions standpoint and b) really limits the range of market-neutrality forcing you to adjust more frequently to stay market-neutral, again, with commission costs.

e12e 9y ago
So it's "buy low, sell high" - but for options, not stocks? [ed: that's to say, you need a way to get more/accurate pricing information than reflected in the market - but for options, not assets]
- aerovistae 9y ago
  Yes, this is how the guy I was referring to explained it to me~ he created a pricing model to predict errors/inaccuracies in the market's model, and was thus able to know when an option was likely to move towards a different price to correct itself.
- philipodonnell 9y ago
  Yes, but its sort of changing the definition of high and low from price (with stocks) to volatility (with options) and having the expertise to trade volatility like that without _accidentally_ trading on price.

rsp1984 9y ago

I think the terms you're looking for are "straddle" and "strangle" options strategies.

rocqua 9y ago

If I recall correctly, your structure describes a future not an option. If you buy put options for X at 10, and call options for X at 10, then if the price moves down you exercise the call option, and if the price goes up you exercise the put. Unless the price is totally fixed, you make some profit. The real question is whether this profit outweighs the price of both your options. You need the price to move sufficiently for this plan to be worth it. Especially because in any case, either your put option or your call option is worthless. Thus, you need twice as large a price move as when buying only puts or calls. The upside is that you don't need to care about the direction of the movement.

steamer25 9y ago

Khan describes the long straddle (3:53): https://youtu.be/2HIRaOQDRho https://youtu.be/2HIRaOQDRho