Chirag, I tried replying to your email, but it was sent back to me each time I tried (twice)
Here is my response, since the email wouldn't go through:
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Date:
Thu, 5 Sep 1996 10:42:43 -0700 (PDT)
From:
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To:
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The original message was received at Thu, 5 Sep 1996 10:42:43 -0700 (PDT)
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Subject:
[Fwd: Re: Options]
Date:
Thu, 05 Sep 1996 10:37:41 -0700
From:
"John N." <saguaro@flash.net>
To:
chirag_asaravala@cc.chiron.com
Subject:
Re: Options
Date:
Thu, 05 Sep 1996 10:26:28 -0700
From:
"John N." <saguaro@flash.net>
To:
Chirag Asaravala <Chirag_Asaravala@cc.chiron.com>
References:
1
Chirag,
To answer your question about why I would think calculus would be
needed (or useful) in trading options, I will quote from page 352 of the
book, The New Market Wizards (Conversations With America's Top Traders),
by Jack D. Schwager (This is in an interview with Joe Ritchie, who founded
CRT trading company):
Schwager: "To a major extent, CRT's prominence is due to options.
I assume that CRT is, in fact, the world's largest trader of options. How
did someone without any mathematical training--you were a philosophy major,
as I recall--get involved in the highly quantitative world of options?"
Ritchie: "I have never had a course in math beyond high school
algebra. In that sense, I am not a quant. However, I feel math in an
intuitive way that many quants don't seem to. When I think about pricing
an option, I may not know CALCULUS [emphasis mine], but in my mind I can
draw a picture that looks exactly like the theoretical pricing models in
the textbooks."
The implications of that conversation and what little else I've
read have led me to conclude that options could be mastered only with more
math than the average joe resorts to on a regular basis.
> Unlike stocks, with options there is ALWAYS a winner and a loser. For
> each dollar you make, someone else loses one. Options are merely bets
> placed on which way a certain stock will move. Options work off of the
> true market ideology that 50% of the people may be bears and the 50%
> may be bulls. This is pretty much true every single day. Thus you may
> think IBM will go up 10 points in the next month, and I may think
> it'll stay flat or go down. If you buy a stock, and its share price
> goes up, nobody has lost money on your gain. This is appreciation.
That's understandable enough (and no need for me to complicate the
conversation by pointing out that shortsellers lose when a stock goes up, but
you know that)
> Options were created many years ago between commodities traders and
> harvesters. The farmers had no idea what they could expect for a
> bushel of corn because the price fluctuated throughout the harvesting
> season. Corn traders would sell a contract to the farmer guranteeing a
> fixed price per bushell. For example I may sell you, the farmer, a
> contract for $100, guranteeing you the right to sell 100 bushells of
> corn at $10 a bushell. The reasoning is that you may be bearish on
> corn, thinking on the open market corn may be only selling for say $8
> a bushell. Thus by giving me $100 up front, you lock in $10 a bushell
> from me. I on the other hand am bullish, and may think corn will be
> worth $20 on the open market. The farmer would lose out on profit if
> the corn sells at $20; but remember that he originally felt it would
> not hit 10. On the other hand if it stays at $5, the trader loses
> profit. Someone always "wins" and someone always "loses".
I didn't know that commodity options were introduced before stock
options. But commodities are for more affluent or advanced traders (who can
"afford" to lose or are short-term nimble and skillful at avoiding losses,
respectively)
> Think of it as down payment on a car you are not ready to buy today.
> The dealer may assure you a price of $20,000 but you need to give him
> a deposit. If you renig on the purchase, he keeps the deposit.
Good example.
> So that is the fundamental theory. The above example is a "CALL"
> option. A buyer of a CALL option (the trader) has the right to buy at
> a fixed price. The seller of the CALL has the OBLIGATION to sell the
> securities at a fixed price.
>
> **Note: This is a simplified example. In modern equity options
> (stocks) there is a third party, the OCC (Options clearing corp.) they
> gurantee a market in all listed options. Equity options themselves are
> also traded on the open markets; thus you never really have to buy or
> sell the underlying security. For example I can buy a contract for IBM
> without owning the stock.
This is where some of my questions start to emerge from the mist. I've
seen ads about brokers who specialize in options vs those who don't. At the
moment, my account is with E Trade, but they aren't very swift at confirming
orders and I'm wondering if they would be suitable as broker for trading options.
Which leads to another question, wondering about the time frame I should
consider for trading options. Options with expiration only a few weeks away vs
those that expire a lot further out, options "in the money" vs those "out of the
money" (I would assume that when an option gets "in the money", it might behave
a little differently than one that is out of the money)
> CALL OPTION: A buyer of a call option reserves the right to buy the
> underlying security at a fixed price by a set date.
> A seller has the obligation to sell that security at that price to the
> buyer by that date. (Stock is CAlled away from your account.)
>
> PUT OPTION: A buyer of a put reserves the right to sell a security at
> a fixed price by a set date.
> A seller of a put contract has the obligation to buy that security at
> the fixed price by that date. (Stock is PUT in your account)
So, the seller of a put option, if it is exercised, is effectively going
short in that stock at a price about equal to the strike price (minus a little for
the premium he earned)? The mechanics of WHAT HAPPENS (or what can happen) when a
person sells either covered or naked options is something else I wonder about.
> How to interpret an options contract quote:
>
> example: IBM 130 JAN CALLS @ 2
> each quote has 5 components:
> Note: ONE EQUTY OPTION CONTRACT IS ALWAYS 100 shares
> 1) underlying security: IBM
> 2) strike price (target price at which you will buy or sell): 130
> 3) expiration month: JAN
> 4) type (put or call): CALL
> 5) premium (the cost of the contract PER SHARE) $2.00
>
> If you buy this contract it means that you expect IBM to go above $130
> by January (1997). You will pay $200 for this contract (2 x 100
> shares). The $200 goes directly to the seller of the contract. He is
> not expecting the stock to go above 130, because he doesn't want to
> sell his shares (if he owns them) or have them sold on margin if he
> doesn't own them.
>
> Now say in December IBM is at 150. You now have made a $18 profit per
> share! (subtract the 2 you paid per share) for a total of $1800.
> The premium you paid $2.00 will go up or down, dollar for dollar, with
> the stock price. So you can either SELL your contract back at about
> $18 (per share for 1800). ---OR--- exercise the contract, meanining
> buy the 100 shares for $130 each. Then you may sell them on the market
> at $150, or whenever you want.
>
> That is the confusing part. A contract can be traded or exercised.
> Many people exercise (the right to buy or sell) because they actually
> want to own the stock. You may want to buy IBM today, but are not sure
> if it will stay at $130, perhaps it will go to $100. So for a couple
> hundred dollars you can lock in the $130, and if it goes down, you
> only lost a couple hundred, if it goes up you still got it at $130!!!
This is what I wonder about also. It seems to me, that trading options
vs exercising them is a big point, with a lot more ramifications in the direction
of trading them.
> This is known as LEVERAGE.
Leverage, I like, for its profit potential. Realizing also that there
is a trap therein to lure us, depending on whether greed in taking the reins or
suppressed in favor of rationality.
> Well that is the basics. If you want to know more about the differnent
> stategies (covered, naked, straddles...), and risks involved, let me
> know. I sell a very comprehensive manual for $35.00 Trust me you will
> make it back your first options trade. I have a strategy which is
> statistically the safest options strategy! You cannot lose money on
> that particualar trade!
I also wonder about the process for finding options to trade. What
screening processes can be used profitably, without being overwhelmingly
time-consuming. That is one reason I inquired about software, such as
Option Vue, which I have seen ads for. Does your book cover that? If a person
is going to trade options, he needs a good method for discovering opportunies.
> give me a call direct, be more than happy to chat
I'll be happy to call you. I subscribe to Sprint, which is $.10/min
before 7 am and after 7pm locally. When is generally the best time to call
you without interupting trading, meals, family activities, etc?
John |
