6 ms·

I've always been curious about trading options. It seems like now is a good time to buy the FB120818P00017000 put for example. I honestly don't see the downside

I've always been curious about trading options. It seems like now is a good time to buy the FB120818P00017000 put for example. I honestly don't see the downside to this. That option is trading at $4 for a block of 100. So investing $400 get's you 10000 options. If the price of the stock dips below $17 the option could trade at 48 cents in which case you've turned $400 into $2400 (minus transaction fees and taxes). On the other hand you could lose your $400 which isn't that bad. What's are the downsides here that I'm missing?

cschneid 14y ago
Downside is obviously the 100% loss you'd take on the $400. Assumption you're making: That FB is overvalued currently, and has 15% to fall (it's at 20 now, and you are saying it will go down by $3 by the 18th [tomorrow!!!]) I'm not sure where that $0.48 is coming from in your comment. At expiration (when an option has no time value), a put should be worth StrikePrice - StockPrice. So if Strike is $17, and stock is... say... $15, the option will be worth $2 ($200 since each option actually controls 100 shares). That math changes with the stock price, so I'm not sure what you're talkinga bout with $0.48... Also note that spreads at the low end of options will eat you alive. Specifically you should expect to pay upwards of $10 or even $15 to get anybody to fill you on those options. The $4 amount is highly unlikely to get filled, especially at the qty you are talking about. Basically, this is a bad idea, and will just lose you $400.
- chucknelson 14y ago
  After reading this, it seems like way too much complexity exists in the market. Me and my naive thoughts of "it's just simple buying and selling, right?" How long has it been like this?
  - lmm 14y ago
    Since the mid 17th century. It's still perfectly possible to be a fundamentals trader/value investor and make a decent income. Look for undervalued companies or those everyone is selling, buy their stocks, hold them for the long term and be prepared for a bit of up and down. But there people who want to buy and sell these complex derivative contracts (well actually an option is pretty much the simplest derivative contract there is), and so the market will join them up with each other.
  - jwegan 14y ago
    Futures and option contracts have been around for hundreds of years and there is some evidence that ancient societies also had similar financial instruments.
  - wutbrodo 14y ago
    To be fair, options/futures are pretty simple and have uses that most people would count as legitimate. A farmer buying oil futures to mitigate the cost of a potential spike in fuel prices (and thus his costs) is basically just him buying insurance; trying to smooth out any crazy volatility his business may face is a fairly legitimate and straightforward application of finance. This is, of course, in contrast to a lot of financial instruments (particularly in the last couple of decades) that are needlessly complex (where at least some of the value for the issuer is in obfuscating the actual implications of the security from the buyer).
  - cschneid 14y ago
    Options are really cool since they are so well named. They really do give you a ton of options to adjust your risk to exactly what you want. On one hand, you can have infinite risk strategies, on the other, you can lock in a stock price almost exactly, with little market risk. And then everything in between (ie, you can easily build something that's like: "I think this stock will go up a few bucks, but nothing crazy", or maybe: "I'm worried about a horrible plunge, but a minor decline is fine, I'll buy a put out of the money and have coverage for the plunge".) And really, it's fairly simple, a lot of the stuff I said about "time value" and such was related to how you value options, not the actual complexity of the thing itself. "How much is this worth" is always tricky, even for something as easy to understand as a bond. Organized markets, and bubbles, and derivatives are all old. And they aren't inherently bad either. You have to look at futures & options as a way to sell or buy risk. If you're willing to pay somebody, they'll take your risk away. And the other way, if you want to take on some risk in exchange for money, you can do that. (note, that last thing sounds scary, but how about this: sell a put [ie, promise to buy a stock at a certain price] right near where you want to buy the stock anyway [with a traditional limit order]. If it gets to below that level, you get 'assigned' the stock, which you wanted anyway, at the price you wanted anyway. If it doesn't hit that, then you wouldn't have bought the stock anyway. The counterparty gets insurance against their stock dropping. You take on the "risk" of it dropping, but you've set yourself up so that it works out for everybody involved). (note that last strategy doesn't work if the stock temporarily dips, then pops back up. You probably won't get assigned in that situation, where a limit order would have triggered. That risk is what you get in exchange for getting paid for selling the put).
- spaghetti 14y ago
  Good point about the expiration. If I was betting on the $17 figure I would buy options that expire in a few months. The 48 cents was just a conservative number to throw out there (value of puts w/ $17 strike price would probably be higher if the stock is significantly below the strike).
retube 14y ago
That option expiries in 2 days - very unlikely it will drop $3 in that time. Historical volatility for FB is around 6% for a 2 day move which at current level is about $1 in price terms. So you need a 3 standard deviation move for this thing to be in the money, i.e about 1 in 1,000 chance. I'd sell you that :)
- Silhouette 14y ago
  Historical volatility for FB is around 6% for a 2 day move which at current level is about $1 in price terms. Presumably the point is that not everyone is expecting the next couple of days to be "normal", given the amount of shares potentially going on the market as the lock ups end. Obviously that doesn't necessarily make the mentioned deal a good one, but it doesn't make much sense to assume anything about the stock price movements today based on the limitations of yesterday.
  - retube 14y ago
    Oh sure - and indeed 3-out puts are about double the price of 3-out calls.
- apw 14y ago
  Do you actually invest using these ideas? Why is a univariate Gaussian fit to recent sample data a good way to estimate risk!?
  - retube 14y ago
    I don't mean to imply that stock prices are perfectly normal/lognormal/insert your favorite distro here. Nor do I mean to imply that future price action will match past price. It's just a simple model to illustrate that compared to historical price action you'd need a pretty big 2 day move for the stock to hit $17. How would you evaluate the risk/reward profile of this option?
debacle 14y ago
When you buy a put, it's usually for a price per share. In this case, $4 means investing $400 for 100 options.
msellout 14y ago
The downside is that you lose $400. Just because the last transaction of that option was at $4 doesn't mean you can buy it at $4. Options are relatively illiquid.
chollida1 14y ago
That's an enormous time premium that you are paying. If you're a large holder then it might make sense as downside protection but otherwise I can't see the reason for it.

cschneid 14y ago

Downside is obviously the 100% loss you'd take on the $400. Assumption you're making: That FB is overvalued currently, and has 15% to fall (it's at 20 now, and you are saying it will go down by $3 by the 18th [tomorrow!!!]) I'm not sure where that $0.48 is coming from in your comment. At expiration (when an option has no time value), a put should be worth StrikePrice - StockPrice. So if Strike is $17, and stock is... say... $15, the option will be worth $2 ($200 since each option actually controls 100 shares). That math changes with the stock price, so I'm not sure what you're talkinga bout with $0.48... Also note that spreads at the low end of options will eat you alive. Specifically you should expect to pay upwards of $10 or even $15 to get anybody to fill you on those options. The $4 amount is highly unlikely to get filled, especially at the qty you are talking about. Basically, this is a bad idea, and will just lose you $400.

chucknelson 14y ago
After reading this, it seems like way too much complexity exists in the market. Me and my naive thoughts of "it's just simple buying and selling, right?" How long has it been like this?
- lmm 14y ago
  Since the mid 17th century. It's still perfectly possible to be a fundamentals trader/value investor and make a decent income. Look for undervalued companies or those everyone is selling, buy their stocks, hold them for the long term and be prepared for a bit of up and down. But there people who want to buy and sell these complex derivative contracts (well actually an option is pretty much the simplest derivative contract there is), and so the market will join them up with each other.
- jwegan 14y ago
  Futures and option contracts have been around for hundreds of years and there is some evidence that ancient societies also had similar financial instruments.
- wutbrodo 14y ago
  To be fair, options/futures are pretty simple and have uses that most people would count as legitimate. A farmer buying oil futures to mitigate the cost of a potential spike in fuel prices (and thus his costs) is basically just him buying insurance; trying to smooth out any crazy volatility his business may face is a fairly legitimate and straightforward application of finance. This is, of course, in contrast to a lot of financial instruments (particularly in the last couple of decades) that are needlessly complex (where at least some of the value for the issuer is in obfuscating the actual implications of the security from the buyer).
- cschneid 14y ago
  Options are really cool since they are so well named. They really do give you a ton of options to adjust your risk to exactly what you want. On one hand, you can have infinite risk strategies, on the other, you can lock in a stock price almost exactly, with little market risk. And then everything in between (ie, you can easily build something that's like: "I think this stock will go up a few bucks, but nothing crazy", or maybe: "I'm worried about a horrible plunge, but a minor decline is fine, I'll buy a put out of the money and have coverage for the plunge".) And really, it's fairly simple, a lot of the stuff I said about "time value" and such was related to how you value options, not the actual complexity of the thing itself. "How much is this worth" is always tricky, even for something as easy to understand as a bond. Organized markets, and bubbles, and derivatives are all old. And they aren't inherently bad either. You have to look at futures & options as a way to sell or buy risk. If you're willing to pay somebody, they'll take your risk away. And the other way, if you want to take on some risk in exchange for money, you can do that. (note, that last thing sounds scary, but how about this: sell a put [ie, promise to buy a stock at a certain price] right near where you want to buy the stock anyway [with a traditional limit order]. If it gets to below that level, you get 'assigned' the stock, which you wanted anyway, at the price you wanted anyway. If it doesn't hit that, then you wouldn't have bought the stock anyway. The counterparty gets insurance against their stock dropping. You take on the "risk" of it dropping, but you've set yourself up so that it works out for everybody involved). (note that last strategy doesn't work if the stock temporarily dips, then pops back up. You probably won't get assigned in that situation, where a limit order would have triggered. That risk is what you get in exchange for getting paid for selling the put).
spaghetti 14y ago
Good point about the expiration. If I was betting on the $17 figure I would buy options that expire in a few months. The 48 cents was just a conservative number to throw out there (value of puts w/ $17 strike price would probably be higher if the stock is significantly below the strike).

retube 14y ago

That option expiries in 2 days - very unlikely it will drop $3 in that time. Historical volatility for FB is around 6% for a 2 day move which at current level is about $1 in price terms. So you need a 3 standard deviation move for this thing to be in the money, i.e about 1 in 1,000 chance. I'd sell you that :)

Silhouette 14y ago
Historical volatility for FB is around 6% for a 2 day move which at current level is about $1 in price terms. Presumably the point is that not everyone is expecting the next couple of days to be "normal", given the amount of shares potentially going on the market as the lock ups end. Obviously that doesn't necessarily make the mentioned deal a good one, but it doesn't make much sense to assume anything about the stock price movements today based on the limitations of yesterday.
- retube 14y ago
  Oh sure - and indeed 3-out puts are about double the price of 3-out calls.
apw 14y ago
Do you actually invest using these ideas? Why is a univariate Gaussian fit to recent sample data a good way to estimate risk!?
- retube 14y ago
  I don't mean to imply that stock prices are perfectly normal/lognormal/insert your favorite distro here. Nor do I mean to imply that future price action will match past price. It's just a simple model to illustrate that compared to historical price action you'd need a pretty big 2 day move for the stock to hit $17. How would you evaluate the risk/reward profile of this option?

debacle 14y ago

When you buy a put, it's usually for a price per share. In this case, $4 means investing $400 for 100 options.

msellout 14y ago

The downside is that you lose $400. Just because the last transaction of that option was at $4 doesn't mean you can buy it at $4. Options are relatively illiquid.

chollida1 14y ago

That's an enormous time premium that you are paying. If you're a large holder then it might make sense as downside protection but otherwise I can't see the reason for it.