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Basic Option Strategies

110 points by karamazov 14y ago

scrumper 14y ago
Not a bad intro at all. That being said, intros to options scare me in the same way a "Beginner's Guide to Fugu Preparation' would scare me: as a novice, you have no business mucking around with such dangerous things, but as an initiate, you have no need of the article. Still, there is a readership for such things, and the author is clear to point out the potentially unlimited downside in the intro. Now, scripting Excel with Python? I'd forgotten about these guys. My interest is officially re-piqued.
- jordan0day 14y ago
  I'm guessing I'm the "readership for such things", as I don't know much about options, but also don't plan on doing much with options in the near future, either. I'm curious to know, though, what you think I should know before looking into options?
  - karamazov 14y ago
    At a minimum, know exactly what the worst case scenario is with each trade. Make sure this isn't more than you can lose. There aren't always market makers in options, so bear in mind that you can buy a lot of options and not be able to sell them later. Worse, you can short a lot of options and not be able to cover your position, so you really do need to be comfortable with the worst-case scenario. You should also look into the details of how your broker deals with options if you hold them until expiration - otherwise you might end up with a lot of stock you don't want (or vice versa). edit: corrected based on chollida1's response
    - chollida1 14y ago
      > There are no market makers in options, so bear in mind that you can buy a lot of options and not be able to sell them later. Where did you hear this? While it's true that not every market has market makers, there are many market makers for CBOE and MEOP options that are blessed by the exchanges. On top of that there are many more funds that make their living solely on being option market makers. We do pretty well in the Canadian markets.
      - karamazov 14y ago
        Corrected, thanks for pointing that out. I heard an anecdote of someone buying a lot of options and not being able to close the position later - I guess it happened in an illiquid market.
        chollida1 14y ago
        Yep, it's not uncommon to look at the book for an option and see huge sizes on one side and no one at all on the other side.
        EvanKelly 14y ago
        Could you explain this a little better? I'm sure you're not contradicting yourself, but that's how I'm understanding it. What risk is there of not finding the other side when you are playing the options game? In your first post you seem to imply that this isn't really a risk.
        chollida1 14y ago
        Ah, I see what you mean. Yes in this case I'm contradicting my self a bit. The thing about options, as compared to stocks, is that they can be literally worthless. A stock that is bankrupt can still have a buy side bid of a few pennies as the buyer can hope for some cash from the bankruptcy proceedings. Consider a Call option on facebook for Nov 16th with a strike to buy at $40. This means you can buy facebook for $40 up until Nov 16th. Currently FB US Equity is trading at $19.50, so with 2 days left and it's historic volatility there is almost no way it's going to get to $40 and make your option worth anything. In this case the Sell side of the book would have many offers as everyone would love to sell this call for any amount of money as it's worthless. On the buy side you'd expect no bids as there is almost no way this could make you money. Now when I mentioned market makers I was referring to trading options that still have some value. I assumed that the OP was talking about not being able to sell options when they had some value, in this case there is always someone willing to act as a market maker in this case.
    - beagle3 14y ago
      > At a minimum, know exactly what the worst case scenario is with each trade. Make sure this isn't more than you can lose. This. Actually, it's not just the minimum - it is the best way, and possibly only way, in many cases. Many traders/investors went bankrupt by assuming some statistical model of how things behave, and using this data, assumed that e.g. with 99.999% confidence, one trade's profit will be able to cover another trade's loss if things go bad. However, when things go bad, they tend to do so in ways that do not match historical patterns, and thus these models are invalid. Also, if you are short call, long put, long underlying (in the right proportion) then theoretically you cannot lose. However, the options and underlying are likely to trade in different markets (with different rules, different margin requirements, and lacking a netting agreement), and as a result, extreme market movements may make your "perfectly hedged position" a huge loss because e.g. your underlying gets liquidated due to a margin call at the bottom of a flash crash, but your synthetic future remains; and now you're exposed.
- karamazov 14y ago
  Thanks! Using options conservatively - buying small amounts, or only writing covered options - can be a great way to mitigate the risk involved in trading just stocks. You're right that writing naked options, or using more advanced strategies, is a great way to lose a lot of money, but commercial brokers usually stop people from doing that unless they have a good reason for it (or at least know what they're getting into).
  - scrumper 14y ago
    Absolutely. Options are a tool, like any other. If you hold it wrong, though, the sharp edge can give you a really bad cut.
- gte910h 14y ago
  Buying options is a great way to derisk your portfolio, as your risks are much smaller than trading real stocks for a given position for most thing. Now SELLING Them, that's a different story. Selling positions when you do not have the stock as security to hand over is pretty risky.
- beagle3 14y ago
  > as a novice, you have no business mucking around with such dangerous things, but as an initiate, you have no need of the article. That reminds me of an ex-girlfriend's "if you don't already know what you did wrong, I'm sure not going to tell you!" More seriously, somewhere along the path from novice to initiate, you have a need for some material, though - be it this article or another. Also, I'm not implying you do, but I find it funny that many people think "stocks are a fine investment, but options are dangerous". The only real difference in risk is leverage, which is always high in options, and usually low in stocks. But you CAN get high leverage for stock trading, and you CAN restrict yourself to a small part of your capital thus "deleveraging" the effect of options on your portfolio. You need to have some experience, but definitely of the calibre of a Fugu chef, to practice these. I think the close proper analogy is the stocks are a sharp household knife, and options are a butcher's knife.
  - scrumper 14y ago
    Ex for a reason, I see :) There's a bit more to it than just leverage. Writing naked options carries huge potential downside, unlimited in the case of naked calls. With a stock you're long, or short. Prices go up and down. Four outcomes to consider. Options are a bit more involved: covered or uncovered? call or put? long or short? Then you've got the option price and the underlying price to think about. Until you're comfortable, it's more than most can manage in their heads. Since we're doing 'sharp tool' analogies, I'd be more inclined to go with hand saw and chainsaw. The level of potential harm you can do to yourself in an instant with a chainsaw is far greater than that you can achieve with a hand saw - and it's a much bigger difference than that between the efficiency of using a chainsaw and a hand saw. Yes, it's powerful, but it's disproportionately hazardous in untrained or careless hands.
    - beagle3 14y ago
      I mostly agree with what you wrote, however: > Writing naked options carries huge potential downside, unlimited in the case of naked calls. The same unlimited potential downside exists when shorting a stock. But you have to be a pro to get away from the risk & margin checking. (Unfortunately, it's actually possible to do that, and most pros do). And until you've escaped from it, the downside is limited to not much more than what you have put down as margin.
chollida1 14y ago
I like what these guys are doing, and we tried out their plugin for modelling. However, you can't really do any modelling without factoring transaction costs. For the average retail investor these fees kill the profit on many otherwise theoretically profitable strategies.
- dtromero 14y ago
  I'm interested in an in-depth tutorial that shows how to use the plugin to perform this kind of analysis. While I don't work in trading, I can see a lot of good uses for a tool like this while conducting other financial analysis.
  - karamazov 14y ago
    Send me an email, we'll talk - ben@datanitro.com
photon137 14y ago
Whenever you're talking about vanilla options, _always_ mention the exercise type - European or American (or Bermudan/whatever). Single-name stocks like Facebook, Google have exchange-traded options which are American. Index-options such as those on the S&P500 are usually European. Also, it's a good intro for buy-and-sit strategies but rarely does anyone sit on options till expiry. They try to make some gamma-based profits (delta-hedged option) or some vol-based profits (strangle/straddle etc).
ChuckMcM 14y ago
I liked the intro. There is another use for options, which is insuring against lost gain. Allow me to share a couple of anecdotes. In January of '95 I knew my 3rd child was on the way and wanted a 'sedan' type car to take the family out. (we had my sports car and a mini-van at the time) I was working at Sun and had been participating in the Employee stock purchase program forever, and Sun stock had gone up a bit so I sold 1,000 shares at $37/share which after taxes and fees netted me enough cash to buy a Chrysler sedan for cash. No loan, no payments, pink slip on the first day I owned it. That was an awesome feeling. In March of that year Sun announced Java, the stock ended up doubling and splitting 3 times. The car I paid 'cash' for was worth 1.6M$ (at the peak of Sun's stock value). Youch! So my Dad's buddy, a Swiss ex-banker, chastised me for not hedging my bet by buying an 'out of the money' call option, 12 months out. He explained that if the stock never went anywhere it would lower the effective 'gain' from my sale, but if the stock went up a lot it would protect me against having lost out on that value. Flash forward to 2006, I'm heading for Google, I've got a chunk of NetApp stock and I having lived through the dot com crash I want to diversify. So I sell a lot of my NetApp stock at $35, and buy options for the same amount of stock a year out at $40. (so 'out of the money' by $5). NetApp kept going up and up, and I sold the options a month before they were due (NetApp was trading at $55 and I wanted to keep the gain in the the right tax year) and I got a nice 'bonus' payout on what was essentially the same stock I had sold nearly a year earlier. The option was there only to protect against missing out on a large rise in the stock price. (which it did, not as well as if I had kept it all but I didn't miss out completely either). I found that I would keep stocks longer than I should because I was 'worried' about whether or not it was the right time to sell. Options allow you to 'buy insurance' on against that worry, and for me that has made me more willing to make significant changes in my portfolio over the years.
- karamazov 14y ago
  This is a great example of using options to lower risk. You can also purchase insurance outright against a stock falling - if you own a stock and buy puts for it, you'll be protected against the stock falling below the put's strike (since you can literally sell it for the strike price to the person who wrote the puts). This was originally one of the main uses of options, which is why an option's price is called a premium - it's an insurance premium.
kghose 14y ago
The more I read about the stock market the more it resembles a complex gambling scheme to me. My view of the stock-market limited to high-school economics is the straightforward "here's how you own part of a company and how you can support a company you want", and for companies "if you do good work, people will give you more money to expand and innovate" and I think at the base level that is there, but there is this whole side-show with the gambling that now totally shadows the original intent.
- bennyg 14y ago
  And that's what the thrill of money does.
- marvin 14y ago
  Well, more abstractly, anything you ever do is a gamble. Getting higher education? You're gambling that it'll pay off better than just working in a job that doesn't require a degree. Putting your savings in a bank account? You're gambling that the interest rate will be higher than inflation and also higher than the risk-adjusted returns in any other investment type. Buying a house instead of renting? You're gambling that it'll be cheaper and more convenient than renting, after capital costs and price changes. Renting instead of buying? The opposite. Any choice you make, including not making any choice, has consequences. Putting your money in the stock market? You're gambling that the risk-adjusted returns from the stock market is higher than that of a bank account. Performing stock or option trading according to some strategy? You're betting that you're smarter than your counterparties. Trading any type of paper you don't understand? That's more akin to playing the lotto. It's a continuum.
  - pm90 14y ago
    Can I just say that this is an incredibly good comment? Seriously, between the finite time that one has to live and the decisions you have to make everyday, I think any notion of "satbility" is at best, an illusion. Only change is constant.
    - marvin 14y ago
tocomment 14y ago
I was wondering if a straddle on GRPN would make sense?
- karamazov 14y ago
  A straddle is a way to trade volatility, so this makes sense if you think the stock's volatility is higher than the market thinks it is. (In other words, you'll make money if the stock will move more than the market thinks it's going to move.)
  - debacle 14y ago
    But only if you buy enough contracts to cover your costs. One of the big hiccups in straddles is that the stock has to move far enough to cover your costs, plus a bit. It's very easy to make small amounts of money on options, but you can probably put that time into a minimum wage job and make more.
  - dllthomas 14y ago
    Is anyone reputable selling options on bitcoins? I'd like to bet on high volatility there...
    - marvin 14y ago
      I can sell you bitcoin options...but they'll probably be more expensive than you want :P
      - dllthomas 14y ago
        Are you reputable? :-P
- premalshah 14y ago
  On a regular trading day (ie no earnings report, no news expected), trading straddles for a short term gain does not make sense to me. The stock has to move more than the price of the 2 legs + commission for you to break even. Feel free to trade straddles on GRPN, FIO, QCOM, AAPL, GOOG, PCLN and other stocks with a history of wild post earning swings. You might get very lucky.
tocomment 14y ago
Do brokers typically exercise your options for you automatically at the end of the term or do you lose all the money if you forget?
- karamazov 14y ago
  They'll usually either be exercised or settled for cash if they're profitable. You should look into your broker's policy, though - if they're exercised, you should be sure you have enough capital to cover the position. You should also not be in a position to forget about your options - they can move very quickly and forgetting about the position can cost a lot of money.
wengzilla 14y ago
You don't mention the downside of buying options... If it goes up, but doesn't hit the strike, you lose all your money. Options are a pretty risky play and it's typically not recommended that your average investor play the options market.
- minimax 14y ago
  From the article: > There are lots of ways to combine options for different stock outlooks. Here are some common ones, not accounting for option cost. He does mention it, but it's not very prominent. I also agree that not including the cost of opening the position in the payoff chart is misleading (and unconventional).
- npongratz 14y ago
  The author mentioned this risk in the second paragraph: > ... in fact, you can lose everything even if the stock goes up, but not by enough.
premalshah 14y ago
Gr8 intro article. Couple of tips. You can buy stock and sell out of the money calls against them, thus reducing the overall purchase price. The stock can be called away if it rises above the strike price thereby capping the profits. However, you can always roll the options when you near the strike price and expiration. That way, you don't loose the stock when its having a great run. This also works in the specific case of sitting on FB stock from day one and being in a big hole at the moment. Keep selling out of the money calls and having them expire worthless, but keep rolling them to the next month when they get close to expiration.
confluence 14y ago
Basic option strategies: the TLDR; guide: If you are buying options - you will consistently lose money. Both time and risk premia overpricing go against you. If you don't make the mark within the time period (and market dynamics are notoriously hard to predict) - you will lose 100%. Breaking even often requires a large 5-7% move in your favour - and that just doesn't happen often enough - especially in the one month buy-to-mark time frame that most options trade at. Nassim Taleb does this - he probably makes more money selling pretty books and giving fancy talks. If you are selling options - you will consistently make fat stacks until you blow up (since you're the counterparty of the above buyers). You can push naked index puts or calls all you want, and make an absolute fucking killing. I'm not kidding. You could easily pull $10-200K a month in profit, depending on how much of a baller you think you are, and how much capital you have backing your risk-taking ass (talking individual traders here). But this money isn't without insane risks, have no doubt - you are playing with an armed thermonuclear warhead. If all the market correlations go to one and you're the last guy holding the bag containing other people's vol - you will get decimated. LTCM did this for 3 years - blew up year 4 - lost $5 billion in one month. LTCM principals went on and started a bunch of similar firms - finance is apparently very forgiving of failure - it shouldn't be. Most of those funds went thermonuclear back during the 2007 GFC. If you do a mixed strategy - you'll end up with mixed results - because you're just mixing the above. No option strategy outside of market making consistently makes money (computational traders making markets and taking hedged spreads). It's exactly like insurance. Insurance buyers pay up, but they never want to actually use it (unless they are committing fraud/market manipulation), and are happy to burn that cash to protect themselves. Insurance sellers are happy to sell, but their industry is commodity, and the only way they make money is by investing the float they have on hand between cash inflows (buyer premiums today) and cash outflows (buyers claiming a year later). Problem is shares aren't like physical goods - they aren't bound by physical laws and hence do not follow the normal distribution. Share prices can go to infinity and hit zero all over the course of a day - their just bits of data in a db somewhere in Jersey. Car crashes, geographically separated houses and diversified mega-cat risk don't do that - often :D. If you put in a costless collar on a stock you already own, you cap both your upside and your downside relatively cheaply (this is how Mark Cuban survived the dot-com crash with $2 billion in Yahoo! stock). Outside of those few lessons - unless you are pushing statistical liquidity or selling millions of options per day - stay the fuck away from them. Individual investors should either go passive index or if they know an industry inside and out value-growth. Everybody else should either be supply liquidity (HFT - not too profitable anymore) or pushing relative stat arb (RenTech/Shaw's + hundreds of PhDs). Individuals should not try to compete in this area - at all. Just like you don't try to build your own car, cruise ship, 747, iPhone or tank, you shouldn't try and trade against stat. arb/HFT guys without the mental or financial backing to hold your own shit. Value-growth/passive works because the market comes to you - hat in hand saying - here take my money please. Stat. arb/HFT also works, but it's much harder, because you have to go to the market and make sure that it isn't you that is saying - here take my money, please.
OldSchool 14y ago
This is a good intro to something everyone analytical should know something about. It's also worth knowing that overall, most options expire worthless, so apparently selling them is a better game than buying them. Also spreads are typically pretty large so trading them profitably requires big moves. The built-in 'cost' of options and futures is of course 'time decay' as they are all dated and you pay more for a date further in the future. I think they'd be very useful if you found yourself in a position with a large amount of restricted publicly-traded stock. I'd imagine you couldn't legally just lock in your equity by going short in a retail account but markets are so highly-correlated now that you probably wouldn't even need options on your particular stock to afford yourself some protection against many downside situations. Rather you might just own puts on the closest-related index. It won't be free of course but if you spent 5% of your position as "insurance" until you could sell it could prove to be worth it versus weathering a loss due to overall supply/demand forces that could take the sector and market down 50% or more without any substantial change in your own company's numbers.
- confluence 14y ago
  Mark Cuban did this back when he sold Broadcast.com - see here: https://www.quora.com/How-did-Mark-Cuban-survive-the-dot-com-crash https://www.quora.com/How-did-Mark-Cuban-survive-the-dot-com...
BenoitEssiambre 14y ago
I'm a buy and hold long term investor for whom options seems ill suited. However sometimes I feel they might be useful to me because I could focus my investments on my area expertise and hedge against everything else. As a developer and tech business owner I feel I have an edge when it comes to picking stocks in the tech sector. However, I'm not very good at predicting macroeconomic issues. Even though I think my stock picks will do well compared to larger sectors and markets, I'm always nervous my savings will be decimated by such things as europe/fiscal cliff/china which I'm not very good at predicting. Unfortunately, I'm not sure how to edge against those things. I read on wikipedia that I could short sell an index or buy put options to protect me against this macro volatility but I'm not sure how to decide which to do, how to do it through my online broker, how to pick the parameters, how to decide if it's worth the premium or if it's worth doing at all given my relatively small and passive portfolio I use simply for saving for retirement. Are there resources for simple savers like me who'd like a simple solution to hedge out a bit of the unknowns out of their portfolio and focus it more on their area of expertise?
- confluence 14y ago
  You know John Maynard Keynes was once asked the same thing: > Investment board: What happens if the world goes off a cliff? > John Maynard 'The Badass' Keynes: There will be bigger things to worry about if that happens - stocks will be the least of your worries. If the economy tanks - everything will tank. Your house, your job, industry production - everything. Trying to protect yourself from the market in this case is like those people who worry about possessions in a burning house - possessions mean nothing, just try and get out alive. You can't hedge the end of the world. You can only prepare to die. Because in those situations - luck keeps people alive, not money. See all revolutions, the Holocaust, uprisings and rebellions. Money doesn't save you - property doesn't exist - titles don't matter - law vanishes into thin air - there are no rules and who you are means nothing. If you're a passive investor - suck your shit up - that's your strategy. If you don't sell you'll be fine. If the world ends you'll be dead. Currently, I'm long TSLA, and have been long GOOG and AAPL. I've had huge drawdowns - 10%-20% within a month, and I've had huge gains. My largest draw down on a position so far has been 60% - that's 60% gone into thin air. And guess what? I don't give a shit. You ain't a real investor until you've had a position blow up in your face and drawn down nearly 100% at least once, and not sold because you knew you were right. That's the nature of the game. Investors are lonely - they look at the world and stand there and say: No you're wrong world, so very wrong, and here, I'll put my life on the line to prove you wrong. I'm a value investor and I'm in here for the long haul. I play vol sometimes, huge drops below margin of safety I go all in, huge rises above, I'll just exit. But I'm always net long. Everyone is always net long.
xpose2000 14y ago
I'm shocked to see Options being mentioned on hackernews. Though, I have been doing options for the past 6 months. Previously I had never even heard of them and knew nothing. Here are some insights as to what to expect... Options are not for the faint of heart. If you are brand new to options and are just starting out then I suggest having a friend/expert help you. I also suggest you use very little money at first to get a feel for it. (Less than $300 at a time). Otherwise you will lose money, and quickly. The only way you'll get good at options strategy is to practice them. There are no shortcuts to success (aside from getting lucky). You will likely lose money at first, unless you have a good teacher to hold your hand. There are a lot of little nuances and safer ways to make money with options that I've slowly discovered over the past few months. Earnings are an exciting time. One could safely make several thousand each quarter if they are smart. I am just getting the hang of it after 2 quarters. I personally stick to tech stocks like apple, google, and facebook. I usually only do weekly options. Ideally, you want to dabble in stocks that move as much as possible. (For example, if you had Apple PUTS this past week, you would have made a killing. This is true for Straddles or Strangles). After dabbling in options for 6 months I would say that the average person should avoid them at all costs. You really can lose a lot of money and sleep. You need to be a certain type of person to do this as a hobby. For those of you willing to take the risk, best of luck to you. With options, you are better to be lucky than good. It is true that you can make a lot of money if you are smart and patient. However, you will lose a lot of sleep either way.

110 points by karamazov 14y ago

Not a bad intro at all. That being said, intros to options scare me in the same way a "Beginner's Guide to Fugu Preparation' would scare me: as a novice, you have no business mucking around with such dangerous things, but as an initiate, you have no need of the article. Still, there is a readership for such things, and the author is clear to point out the potentially unlimited downside in the intro. Now, scripting Excel with Python? I'd forgotten about these guys. My interest is officially re-piqued.

jordan0day 14y ago
I'm guessing I'm the "readership for such things", as I don't know much about options, but also don't plan on doing much with options in the near future, either. I'm curious to know, though, what you think I should know before looking into options?
- karamazov 14y ago
  At a minimum, know exactly what the worst case scenario is with each trade. Make sure this isn't more than you can lose. There aren't always market makers in options, so bear in mind that you can buy a lot of options and not be able to sell them later. Worse, you can short a lot of options and not be able to cover your position, so you really do need to be comfortable with the worst-case scenario. You should also look into the details of how your broker deals with options if you hold them until expiration - otherwise you might end up with a lot of stock you don't want (or vice versa). edit: corrected based on chollida1's response
  - chollida1 14y ago
    > There are no market makers in options, so bear in mind that you can buy a lot of options and not be able to sell them later. Where did you hear this? While it's true that not every market has market makers, there are many market makers for CBOE and MEOP options that are blessed by the exchanges. On top of that there are many more funds that make their living solely on being option market makers. We do pretty well in the Canadian markets.
    - karamazov 14y ago
      Corrected, thanks for pointing that out. I heard an anecdote of someone buying a lot of options and not being able to close the position later - I guess it happened in an illiquid market.
      - chollida1 14y ago
        Yep, it's not uncommon to look at the book for an option and see huge sizes on one side and no one at all on the other side.
        EvanKelly 14y ago
        Could you explain this a little better? I'm sure you're not contradicting yourself, but that's how I'm understanding it. What risk is there of not finding the other side when you are playing the options game? In your first post you seem to imply that this isn't really a risk.
        chollida1 14y ago
        Ah, I see what you mean. Yes in this case I'm contradicting my self a bit. The thing about options, as compared to stocks, is that they can be literally worthless. A stock that is bankrupt can still have a buy side bid of a few pennies as the buyer can hope for some cash from the bankruptcy proceedings. Consider a Call option on facebook for Nov 16th with a strike to buy at $40. This means you can buy facebook for $40 up until Nov 16th. Currently FB US Equity is trading at $19.50, so with 2 days left and it's historic volatility there is almost no way it's going to get to $40 and make your option worth anything. In this case the Sell side of the book would have many offers as everyone would love to sell this call for any amount of money as it's worthless. On the buy side you'd expect no bids as there is almost no way this could make you money. Now when I mentioned market makers I was referring to trading options that still have some value. I assumed that the OP was talking about not being able to sell options when they had some value, in this case there is always someone willing to act as a market maker in this case.
  - beagle3 14y ago
    > At a minimum, know exactly what the worst case scenario is with each trade. Make sure this isn't more than you can lose. This. Actually, it's not just the minimum - it is the best way, and possibly only way, in many cases. Many traders/investors went bankrupt by assuming some statistical model of how things behave, and using this data, assumed that e.g. with 99.999% confidence, one trade's profit will be able to cover another trade's loss if things go bad. However, when things go bad, they tend to do so in ways that do not match historical patterns, and thus these models are invalid. Also, if you are short call, long put, long underlying (in the right proportion) then theoretically you cannot lose. However, the options and underlying are likely to trade in different markets (with different rules, different margin requirements, and lacking a netting agreement), and as a result, extreme market movements may make your "perfectly hedged position" a huge loss because e.g. your underlying gets liquidated due to a margin call at the bottom of a flash crash, but your synthetic future remains; and now you're exposed.
karamazov 14y ago
Thanks! Using options conservatively - buying small amounts, or only writing covered options - can be a great way to mitigate the risk involved in trading just stocks. You're right that writing naked options, or using more advanced strategies, is a great way to lose a lot of money, but commercial brokers usually stop people from doing that unless they have a good reason for it (or at least know what they're getting into).
- scrumper 14y ago
  Absolutely. Options are a tool, like any other. If you hold it wrong, though, the sharp edge can give you a really bad cut.
gte910h 14y ago
Buying options is a great way to derisk your portfolio, as your risks are much smaller than trading real stocks for a given position for most thing. Now SELLING Them, that's a different story. Selling positions when you do not have the stock as security to hand over is pretty risky.
beagle3 14y ago
> as a novice, you have no business mucking around with such dangerous things, but as an initiate, you have no need of the article. That reminds me of an ex-girlfriend's "if you don't already know what you did wrong, I'm sure not going to tell you!" More seriously, somewhere along the path from novice to initiate, you have a need for some material, though - be it this article or another. Also, I'm not implying you do, but I find it funny that many people think "stocks are a fine investment, but options are dangerous". The only real difference in risk is leverage, which is always high in options, and usually low in stocks. But you CAN get high leverage for stock trading, and you CAN restrict yourself to a small part of your capital thus "deleveraging" the effect of options on your portfolio. You need to have some experience, but definitely of the calibre of a Fugu chef, to practice these. I think the close proper analogy is the stocks are a sharp household knife, and options are a butcher's knife.
- scrumper 14y ago
  Ex for a reason, I see :) There's a bit more to it than just leverage. Writing naked options carries huge potential downside, unlimited in the case of naked calls. With a stock you're long, or short. Prices go up and down. Four outcomes to consider. Options are a bit more involved: covered or uncovered? call or put? long or short? Then you've got the option price and the underlying price to think about. Until you're comfortable, it's more than most can manage in their heads. Since we're doing 'sharp tool' analogies, I'd be more inclined to go with hand saw and chainsaw. The level of potential harm you can do to yourself in an instant with a chainsaw is far greater than that you can achieve with a hand saw - and it's a much bigger difference than that between the efficiency of using a chainsaw and a hand saw. Yes, it's powerful, but it's disproportionately hazardous in untrained or careless hands.
  - beagle3 14y ago
    I mostly agree with what you wrote, however: > Writing naked options carries huge potential downside, unlimited in the case of naked calls. The same unlimited potential downside exists when shorting a stock. But you have to be a pro to get away from the risk & margin checking. (Unfortunately, it's actually possible to do that, and most pros do). And until you've escaped from it, the downside is limited to not much more than what you have put down as margin.

chollida1 14y ago

I like what these guys are doing, and we tried out their plugin for modelling. However, you can't really do any modelling without factoring transaction costs. For the average retail investor these fees kill the profit on many otherwise theoretically profitable strategies.

dtromero 14y ago
I'm interested in an in-depth tutorial that shows how to use the plugin to perform this kind of analysis. While I don't work in trading, I can see a lot of good uses for a tool like this while conducting other financial analysis.
- karamazov 14y ago
  Send me an email, we'll talk - ben@datanitro.com

photon137 14y ago

Whenever you're talking about vanilla options, _always_ mention the exercise type - European or American (or Bermudan/whatever). Single-name stocks like Facebook, Google have exchange-traded options which are American. Index-options such as those on the S&P500 are usually European. Also, it's a good intro for buy-and-sit strategies but rarely does anyone sit on options till expiry. They try to make some gamma-based profits (delta-hedged option) or some vol-based profits (strangle/straddle etc).

ChuckMcM 14y ago

I liked the intro. There is another use for options, which is insuring against lost gain. Allow me to share a couple of anecdotes. In January of '95 I knew my 3rd child was on the way and wanted a 'sedan' type car to take the family out. (we had my sports car and a mini-van at the time) I was working at Sun and had been participating in the Employee stock purchase program forever, and Sun stock had gone up a bit so I sold 1,000 shares at $37/share which after taxes and fees netted me enough cash to buy a Chrysler sedan for cash. No loan, no payments, pink slip on the first day I owned it. That was an awesome feeling. In March of that year Sun announced Java, the stock ended up doubling and splitting 3 times. The car I paid 'cash' for was worth 1.6M$ (at the peak of Sun's stock value). Youch! So my Dad's buddy, a Swiss ex-banker, chastised me for not hedging my bet by buying an 'out of the money' call option, 12 months out. He explained that if the stock never went anywhere it would lower the effective 'gain' from my sale, but if the stock went up a lot it would protect me against having lost out on that value. Flash forward to 2006, I'm heading for Google, I've got a chunk of NetApp stock and I having lived through the dot com crash I want to diversify. So I sell a lot of my NetApp stock at $35, and buy options for the same amount of stock a year out at $40. (so 'out of the money' by $5). NetApp kept going up and up, and I sold the options a month before they were due (NetApp was trading at $55 and I wanted to keep the gain in the the right tax year) and I got a nice 'bonus' payout on what was essentially the same stock I had sold nearly a year earlier. The option was there only to protect against missing out on a large rise in the stock price. (which it did, not as well as if I had kept it all but I didn't miss out completely either). I found that I would keep stocks longer than I should because I was 'worried' about whether or not it was the right time to sell. Options allow you to 'buy insurance' on against that worry, and for me that has made me more willing to make significant changes in my portfolio over the years.

karamazov 14y ago
This is a great example of using options to lower risk. You can also purchase insurance outright against a stock falling - if you own a stock and buy puts for it, you'll be protected against the stock falling below the put's strike (since you can literally sell it for the strike price to the person who wrote the puts). This was originally one of the main uses of options, which is why an option's price is called a premium - it's an insurance premium.

kghose 14y ago

The more I read about the stock market the more it resembles a complex gambling scheme to me. My view of the stock-market limited to high-school economics is the straightforward "here's how you own part of a company and how you can support a company you want", and for companies "if you do good work, people will give you more money to expand and innovate" and I think at the base level that is there, but there is this whole side-show with the gambling that now totally shadows the original intent.

bennyg 14y ago
And that's what the thrill of money does.
marvin 14y ago
Well, more abstractly, anything you ever do is a gamble. Getting higher education? You're gambling that it'll pay off better than just working in a job that doesn't require a degree. Putting your savings in a bank account? You're gambling that the interest rate will be higher than inflation and also higher than the risk-adjusted returns in any other investment type. Buying a house instead of renting? You're gambling that it'll be cheaper and more convenient than renting, after capital costs and price changes. Renting instead of buying? The opposite. Any choice you make, including not making any choice, has consequences. Putting your money in the stock market? You're gambling that the risk-adjusted returns from the stock market is higher than that of a bank account. Performing stock or option trading according to some strategy? You're betting that you're smarter than your counterparties. Trading any type of paper you don't understand? That's more akin to playing the lotto. It's a continuum.
- pm90 14y ago
  Can I just say that this is an incredibly good comment? Seriously, between the finite time that one has to live and the decisions you have to make everyday, I think any notion of "satbility" is at best, an illusion. Only change is constant.
  - marvin 14y ago

tocomment 14y ago

I was wondering if a straddle on GRPN would make sense?

karamazov 14y ago
A straddle is a way to trade volatility, so this makes sense if you think the stock's volatility is higher than the market thinks it is. (In other words, you'll make money if the stock will move more than the market thinks it's going to move.)
- debacle 14y ago
  But only if you buy enough contracts to cover your costs. One of the big hiccups in straddles is that the stock has to move far enough to cover your costs, plus a bit. It's very easy to make small amounts of money on options, but you can probably put that time into a minimum wage job and make more.
- dllthomas 14y ago
  Is anyone reputable selling options on bitcoins? I'd like to bet on high volatility there...
  - marvin 14y ago
    I can sell you bitcoin options...but they'll probably be more expensive than you want :P
    - dllthomas 14y ago
      Are you reputable? :-P
premalshah 14y ago
On a regular trading day (ie no earnings report, no news expected), trading straddles for a short term gain does not make sense to me. The stock has to move more than the price of the 2 legs + commission for you to break even. Feel free to trade straddles on GRPN, FIO, QCOM, AAPL, GOOG, PCLN and other stocks with a history of wild post earning swings. You might get very lucky.

tocomment 14y ago

Do brokers typically exercise your options for you automatically at the end of the term or do you lose all the money if you forget?

karamazov 14y ago
They'll usually either be exercised or settled for cash if they're profitable. You should look into your broker's policy, though - if they're exercised, you should be sure you have enough capital to cover the position. You should also not be in a position to forget about your options - they can move very quickly and forgetting about the position can cost a lot of money.

wengzilla 14y ago

You don't mention the downside of buying options... If it goes up, but doesn't hit the strike, you lose all your money. Options are a pretty risky play and it's typically not recommended that your average investor play the options market.

minimax 14y ago
From the article: > There are lots of ways to combine options for different stock outlooks. Here are some common ones, not accounting for option cost. He does mention it, but it's not very prominent. I also agree that not including the cost of opening the position in the payoff chart is misleading (and unconventional).
npongratz 14y ago
The author mentioned this risk in the second paragraph: > ... in fact, you can lose everything even if the stock goes up, but not by enough.

premalshah 14y ago

Gr8 intro article. Couple of tips. You can buy stock and sell out of the money calls against them, thus reducing the overall purchase price. The stock can be called away if it rises above the strike price thereby capping the profits. However, you can always roll the options when you near the strike price and expiration. That way, you don't loose the stock when its having a great run. This also works in the specific case of sitting on FB stock from day one and being in a big hole at the moment. Keep selling out of the money calls and having them expire worthless, but keep rolling them to the next month when they get close to expiration.

confluence 14y ago

Basic option strategies: the TLDR; guide: If you are buying options - you will consistently lose money. Both time and risk premia overpricing go against you. If you don't make the mark within the time period (and market dynamics are notoriously hard to predict) - you will lose 100%. Breaking even often requires a large 5-7% move in your favour - and that just doesn't happen often enough - especially in the one month buy-to-mark time frame that most options trade at. Nassim Taleb does this - he probably makes more money selling pretty books and giving fancy talks. If you are selling options - you will consistently make fat stacks until you blow up (since you're the counterparty of the above buyers). You can push naked index puts or calls all you want, and make an absolute fucking killing. I'm not kidding. You could easily pull $10-200K a month in profit, depending on how much of a baller you think you are, and how much capital you have backing your risk-taking ass (talking individual traders here). But this money isn't without insane risks, have no doubt - you are playing with an armed thermonuclear warhead. If all the market correlations go to one and you're the last guy holding the bag containing other people's vol - you will get decimated. LTCM did this for 3 years - blew up year 4 - lost $5 billion in one month. LTCM principals went on and started a bunch of similar firms - finance is apparently very forgiving of failure - it shouldn't be. Most of those funds went thermonuclear back during the 2007 GFC. If you do a mixed strategy - you'll end up with mixed results - because you're just mixing the above. No option strategy outside of market making consistently makes money (computational traders making markets and taking hedged spreads). It's exactly like insurance. Insurance buyers pay up, but they never want to actually use it (unless they are committing fraud/market manipulation), and are happy to burn that cash to protect themselves. Insurance sellers are happy to sell, but their industry is commodity, and the only way they make money is by investing the float they have on hand between cash inflows (buyer premiums today) and cash outflows (buyers claiming a year later). Problem is shares aren't like physical goods - they aren't bound by physical laws and hence do not follow the normal distribution. Share prices can go to infinity and hit zero all over the course of a day - their just bits of data in a db somewhere in Jersey. Car crashes, geographically separated houses and diversified mega-cat risk don't do that - often :D. If you put in a costless collar on a stock you already own, you cap both your upside and your downside relatively cheaply (this is how Mark Cuban survived the dot-com crash with $2 billion in Yahoo! stock). Outside of those few lessons - unless you are pushing statistical liquidity or selling millions of options per day - stay the fuck away from them. Individual investors should either go passive index or if they know an industry inside and out value-growth. Everybody else should either be supply liquidity (HFT - not too profitable anymore) or pushing relative stat arb (RenTech/Shaw's + hundreds of PhDs). Individuals should not try to compete in this area - at all. Just like you don't try to build your own car, cruise ship, 747, iPhone or tank, you shouldn't try and trade against stat. arb/HFT guys without the mental or financial backing to hold your own shit. Value-growth/passive works because the market comes to you - hat in hand saying - here take my money please. Stat. arb/HFT also works, but it's much harder, because you have to go to the market and make sure that it isn't you that is saying - here take my money, please.

OldSchool 14y ago

This is a good intro to something everyone analytical should know something about. It's also worth knowing that overall, most options expire worthless, so apparently selling them is a better game than buying them. Also spreads are typically pretty large so trading them profitably requires big moves. The built-in 'cost' of options and futures is of course 'time decay' as they are all dated and you pay more for a date further in the future. I think they'd be very useful if you found yourself in a position with a large amount of restricted publicly-traded stock. I'd imagine you couldn't legally just lock in your equity by going short in a retail account but markets are so highly-correlated now that you probably wouldn't even need options on your particular stock to afford yourself some protection against many downside situations. Rather you might just own puts on the closest-related index. It won't be free of course but if you spent 5% of your position as "insurance" until you could sell it could prove to be worth it versus weathering a loss due to overall supply/demand forces that could take the sector and market down 50% or more without any substantial change in your own company's numbers.

confluence 14y ago
Mark Cuban did this back when he sold Broadcast.com - see here: https://www.quora.com/How-did-Mark-Cuban-survive-the-dot-com-crash https://www.quora.com/How-did-Mark-Cuban-survive-the-dot-com...

BenoitEssiambre 14y ago

I'm a buy and hold long term investor for whom options seems ill suited. However sometimes I feel they might be useful to me because I could focus my investments on my area expertise and hedge against everything else. As a developer and tech business owner I feel I have an edge when it comes to picking stocks in the tech sector. However, I'm not very good at predicting macroeconomic issues. Even though I think my stock picks will do well compared to larger sectors and markets, I'm always nervous my savings will be decimated by such things as europe/fiscal cliff/china which I'm not very good at predicting. Unfortunately, I'm not sure how to edge against those things. I read on wikipedia that I could short sell an index or buy put options to protect me against this macro volatility but I'm not sure how to decide which to do, how to do it through my online broker, how to pick the parameters, how to decide if it's worth the premium or if it's worth doing at all given my relatively small and passive portfolio I use simply for saving for retirement. Are there resources for simple savers like me who'd like a simple solution to hedge out a bit of the unknowns out of their portfolio and focus it more on their area of expertise?

confluence 14y ago
You know John Maynard Keynes was once asked the same thing: > Investment board: What happens if the world goes off a cliff? > John Maynard 'The Badass' Keynes: There will be bigger things to worry about if that happens - stocks will be the least of your worries. If the economy tanks - everything will tank. Your house, your job, industry production - everything. Trying to protect yourself from the market in this case is like those people who worry about possessions in a burning house - possessions mean nothing, just try and get out alive. You can't hedge the end of the world. You can only prepare to die. Because in those situations - luck keeps people alive, not money. See all revolutions, the Holocaust, uprisings and rebellions. Money doesn't save you - property doesn't exist - titles don't matter - law vanishes into thin air - there are no rules and who you are means nothing. If you're a passive investor - suck your shit up - that's your strategy. If you don't sell you'll be fine. If the world ends you'll be dead. Currently, I'm long TSLA, and have been long GOOG and AAPL. I've had huge drawdowns - 10%-20% within a month, and I've had huge gains. My largest draw down on a position so far has been 60% - that's 60% gone into thin air. And guess what? I don't give a shit. You ain't a real investor until you've had a position blow up in your face and drawn down nearly 100% at least once, and not sold because you knew you were right. That's the nature of the game. Investors are lonely - they look at the world and stand there and say: No you're wrong world, so very wrong, and here, I'll put my life on the line to prove you wrong. I'm a value investor and I'm in here for the long haul. I play vol sometimes, huge drops below margin of safety I go all in, huge rises above, I'll just exit. But I'm always net long. Everyone is always net long.

xpose2000 14y ago

I'm shocked to see Options being mentioned on hackernews. Though, I have been doing options for the past 6 months. Previously I had never even heard of them and knew nothing. Here are some insights as to what to expect... Options are not for the faint of heart. If you are brand new to options and are just starting out then I suggest having a friend/expert help you. I also suggest you use very little money at first to get a feel for it. (Less than $300 at a time). Otherwise you will lose money, and quickly. The only way you'll get good at options strategy is to practice them. There are no shortcuts to success (aside from getting lucky). You will likely lose money at first, unless you have a good teacher to hold your hand. There are a lot of little nuances and safer ways to make money with options that I've slowly discovered over the past few months. Earnings are an exciting time. One could safely make several thousand each quarter if they are smart. I am just getting the hang of it after 2 quarters. I personally stick to tech stocks like apple, google, and facebook. I usually only do weekly options. Ideally, you want to dabble in stocks that move as much as possible. (For example, if you had Apple PUTS this past week, you would have made a killing. This is true for Straddles or Strangles). After dabbling in options for 6 months I would say that the average person should avoid them at all costs. You really can lose a lot of money and sleep. You need to be a certain type of person to do this as a hobby. For those of you willing to take the risk, best of luck to you. With options, you are better to be lucky than good. It is true that you can make a lot of money if you are smart and patient. However, you will lose a lot of sleep either way.