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Choice # 2 and #3 are functionally the same, except with different
transaction costs.
The benefit of of short + call is ... you could leg around the position....
if the position ran up AND YOU ASSUMED THE DM had topped out you could exit
the call and then hold the futures contract, obviously the risk is you would
be in a short unhedged at that point. Buying the put is outright cheaper.
As to liquidity.. if the futures is liquid the floor should be able to
create options fairly easily ... if the product gaps a lot(overnite moves as
you describe) the vol. of the options will be higher than normally
expected. Exit liquidity is not an issue if you trade American options as
you can exercise to buy the future. The PHLX futures market traded both
American and european options for a while ... the MERC options(If I remember
correctly)are only American, but check to make certain.
Mervin Yeung wrote:
> Hi RTs,
>
> I rarely trade options or use options as a risk-control tool. So, I am
> going to ask a few naive questions about using options instead of
> stops.
>
> I trade currency futures contracts but I find stops are almost
> completely useless because of over-night moves. Also, in some futures,
> such as T-Bond, I had a first-hand experience of my stops being filled
> 30 ticks away from the intended price.
>
> Say, if I am bearish on D.Mark and I want some protection, I can:
>
> (1). Short D.Mark futures and then place a stop loss order (buy stop);
>
> (2). Short D.Mark futures and then buy D.Mark call options;
>
> (3). Buy D.Mark put options.
>
> Which is the best way to do it? I think (2) and (3) are the better way
> to go because (1) cannot protect you from over-night moves. However, I
> was told (by a friend) that by buying options, I paid more than the
> "fair" (relatively speaking) price. Options writers are not dummies who
> allow you to transfer all the risk to them without asking "high"
> (relatively speaking) premium. Is that true?
>
> Also, I am concerned that the liquidity in options market is not as good
> as in futures market. Correct me if I am wrong.
>
> I am so inexperienced in options that I worry I may have a bad trip if I
> try to explore the unfamiliar.
>
> Thanks in advance for any comments.
>
> Mervin
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