|
PureBytes Links
Trading Reference Links
|
Regretably this issue requires a much more length response than my
calander allows this morning. I'm in San Francisco and it kinda screws
up my midwestern clock.
The essential issue isn't if option models work or not. They
work...there is no problem modeling a value. I can model a value of
anything out there. What I CAN'T MODEL simply is what is left out of
the model is liquidity.
For genuine liquidity...a model assumes I can buy/sell at the input cash
price(unlikely to be really true over the last few days....especially
shorting stock). To manufacture an option I essentially need to have
assurance that I can hedge.....to hedge I need to adjust deltas
constantly and manage gamma risk.
Just a quick review:
Delta -- rate of change for change in price of underlying
Gamma -- rate of change of Delta(second derivative)
Theta -- time erosion
AS you approach expiration....% theta is very high....the more theta you
experience the more gamma you experience. In essence for very short
term option the numbers change quickly. Additionally VEGA(the rate of
change for changes in Volatility)risk is the highest it has been in
recorded history. Intraday volatility is the highest continuous level
we have ever experienced....EVER recorded...and EVER simulated if you
went back before option trading.
So here is the challange...for very short options Theta is huge...if
you've ever seen an erosion chart you see that this is the point where
the line really begins a drop in slope...THAT is actually a
understatement...the line almost..almost goes vertical the last few
days.
Accordingly hugh theta means from the long side my options dies very
quickly...but I have to manage huge gamma risk. There is less two sided
option volume than before...it is much more one sided....so to manage
gamma I have to try to trade the stock like a banshee. In essence I may
make the Vega risk worse because now the stock is getting whipped by
everyone..and some gamma risk cannot be eliminated at all. The easiest
way to eliminate gamma risk is to BUY some out of the money options. If
I'm the dealor/specialist/market maker...where do I buy them? The only
way I can MAYBE get the community to sell them to me is to skew
volatility. Say I desperately need some OTM puts because the stock is
in freefall and I'm net long...what can I do.
1. Sell stock (I'm pouring gasoline on the fire)
2. Sell Calls (fabulous idea....ONLY TO WHOM?)
3. Buy Puts (See sell calls)
So what I might attempt to do is skew the implied vols of the OTM's(this
has been the case in OTM puts pretty much for the last decade...post
10/87....hmmmm wonder why?
If you ever get a chance...simulate a short term option and graph Gamma
against Theta...you will find the relationship approaches a 45 degree
line.
More later....
Thanks for the opportunity to respond...To an options person this is the
top you never want to get without being there in person.
Are there enough Forum memebers in any one geographic location location
to do a class? CBOE would love to put on a free..advanced option class
for forum members if enough could be gathered in on location. Anybody
got any ideas.....let me know.
|