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Technology Stocks : PSFT - 1997 Outlook [closed thread] -- Ignore unavailable to you. Want to Upgrade?

To: Rick who wrote (849)	2/3/1998 1:09:00 AM
From: Robert Graham	Respond to of 940

Hmm...Melissa, I think you did rain on someones parade and they got all bent out of shape. Earnings plays are very risky. That is not to say that this risk cannot be manageable. But if you have been making plays on earnigs announcements last year, you would definitely know what I mean. The beginning of this earnings seasons was even more unpredictable. The company misses by two cents and the stock can go through the floor. Furthermore, the stock is played in anticipation of the earnings announcement. In other words, the stock tends to reflect the crowds expectations on earnings before the earnings announcement comes out. The crowd is well guided by consensus and whisper numbers. So there likely needs to be an earnings surprise to keep the stock from selling off. Oh, and the crowd is usually wrong, particularily in the reactive options game. Some win, but many more lose. The call to put ratio is a contrarian indicator. This is useless as a way of timing the market. Still, I will acknowledge that there can be exceptions. Some institutions purcahse calls before they enter a stock. This helps hedge their large block purchases in that the price of the stock is temporarily driven by their purchases which can work against them. Also, if there allot of calls to puts being purchased in the stock, this can be an indicator of an impending drop in the price of the stock. This contrarian indicator can be very good in the right situations. One reason behind this is delta neutral hedging. This is where if the price of the stock were to move down toward its strike price, the delta neutral option players will short stock to hedge this price action against their call option. This will cause the variations in the price of the stock which causes the price to move down to be exaggerated by this type of options trading, and the greater the open interest is on CALLs, the more likely this effect will happen. Another reason is that when options are taken out (exersized) by traders or the MM, for instnace on options expiration day, they will short the stock in order to hedge they market efforts on that day. This is one reason why options are likely to sell at a discount on that day. Most importantly, the earnings announcement is the news that once released will determine all in this situation. This is independant of the call to put ratio of a stock. All this ration is now telling you is that the crowd has a very bullish sentiment on this earnings release. That is all. The only way this most of this crowd is likely to benefit from the earnings announcement is if the company exceeds earnings expectations. Now is there something you know that most others do not know? Do you have a line directly to the CFO of this company? Of course you probably do not. So you are gambling. You are gambling against the analysts who set those consensus estimates for instance. No big deal here, but nothing to dismiss as "those mere peasants" as far as those who "bet" on the consensus estimates. The reason an options play on earnings may work is becuase of earnings momentum. Earnings estimates are usually a straight line extrapolation on the previous quarters eanrings and earnings growth. Now if the company is in a strong growth phase, then they can actually over the short term increase their earnings growth. Indications of this is when the company has a recent history of beating estimates. The greater the margin this ends up being, the more of an indication there is that earnings growth rate is accelerating. This increases the probability that the next earnings announcement will exceed current eaernings expectations by the crowd as defined for instance by the consensus numbers. Notice I use the word probability here?? Now what makes this job more risky is that earnings usually does not continue to accelerate over a long period of time. There will be disappointing quarters. Also, there is the whisper number that gets updated right to the last day. The whisper number on higher growth rate stocks tends to be a bit optamistic which has an upward effect of the price of the stock which is a discounting of the whipser number taking place. So I agree with Melissa that it is a high risk trade in using options to make earnings plays. Perhaps you are counting on PSFT being still oversold with expectations on the stock low compared to where they normally would be. So you see some upside that may be encouraged by a blowout quarter being announced. Then I can see the rational behind this move, but do not count on it. For that matter, I find that it is smart to trade the option before the actual announcement. This way you get the effect of a possible rise in the stock price in anticipation of a reat earnings announcement, but get out of the risk involved with the company coming out with a disappointing eanings. Heck, in this way you can make money even when the reality turns out to be disappointing. So my question to you is why do you think it is necissary to incur the additional risk of holding on to that option through the actual earnings announcement? Will the potential profits outweigh the additional risks involved? Do you know what the risk is for holding onto an option in this way? If you think there is no additional risk involved with this strategy which can turn out to be substantial, then I can tell you right now you have not been trading options long at all. This is not rocket science here. If you do not understand that options are a risk that most people do not successfully manage, that you have your entire sum of money at stake unlike stocks that rarely go to zero and do this possibly inside of one day, that for instance trading options is very different from that of trading stocks, then I suggest that you reveiw what the option market is all about and what drives the prices of the options. Bob Graham

To: Rick who wrote (849)	2/3/1998 1:18:00 AM
From: Robert Graham	Read Replies (1) \| Respond to of 940

[Part II] Your description of the MM in options indicates a lack of knowledge to me on what is involved in determing option prices. Also, since when for every transaction there is a "winner" or "loser"? Who told you this??? Seriously. This is nonsense. That "winner" you speak of can become the next trade's loser. Both can go home losers. Or that "winner" who initially sold that option made their profit on a long term hold while the purchaser of that option may have been a scalper that turned around and sold it on a 1/2 point pop. In this case both are winners. Think about this and what this means. What matters is first what the option seller purchased the option at compared to the sale price. Most importantly, success is defined by what the trader goes home with: a loss or a profit. Isn't this how you define these terms? I hope so. Furthermore, I wish the world was as simple as one buyer, one seller, and one market maker. But this is not the case. Have you ever been on the floor of an exchange? Have you ever at least read about what this is like? I do not think so. There are many traders of the floor of the options exchange. I think you are confusing the NASDAQ MM with the MM from the CBOE for instance. They are not the same. The options exchange is made up of many traders on the floor of an exchange, both individual traders and firms that specialize in making a market in an option. Each trader is vying for those options that are being bought and sold. Do you know what this means? That any one of them can take the other side of the option transaction. Any one of them can step up to the plate and take the other side. A sale for instance can happen at the bid or between the bid and ask. Do you know what determines the current bid and ask? The most recent highest bid and lowest found on the floor of the exchange. The options market is an auction market like the commodities market in this sense, and definitely not anything like the NASDAQ. Only on illiquid options will the spread be determined by a MM. A sale happens when a bid of one trader meets the ask of another, a meeting of the minds so to speak. So when an option transacts at a price, there is both a buyer and a seller. Do you know this market to be any different? I think you need to understand more about auction markets. As far as who pays for this "comission", this is not as neatly defined. The only time the spread means anything as something significant is for those intraday edge traders that sit on the floor and trade for the juice by taking the MM position in the trade, and the MM themselves. Also there are those players that make intraday scalps on a fraction of a point of change in the option. As time increases, so does the probability of the option to move in value. So by the time the trader unloads, his selling price may even be at the same price he purchased the option at. The greater the time period, the greater the possble gain (that is why there is a time premium in the option), and therefore the greater possibility that the move in the price of the option will be very large compares to the spread at the time the option was initially purchased. So for short term intraday trades, I agree that the spread can become a significant obstacle to a profit for the intraday trader, depending on the volitility of the option that day and the size of the spread. When I trade options, I trade them to increase in value much more than the spread. Still, due to the actual volitility of the option, I can much of the time sell the option for what I paid for it. So are you saying that I shared in the "cost" of th spread of this option? I do not think so, at least in a very real and practical sense. This is because you are underestimating the most essential component of options plays which is volitility. Even intraday volitility can render the spread inconsequential depending on when you choose to enter the option. So if you as an options trader sell the option for what you paid for it due to volitility, why do you consider this a "cost"? The cost in effect has been passed on to someone else like those scalpers, edge traders, and possibly even the MM of the option. You seem to be quoting some common phrases bandied about by traders and utilize them in an improper context like the statement "options is a zero sum game" you made in that post of yours to Melissa. However, I will end here. I do not wish to become a book on optiions trading. That is your job to find this out. There are many books available that were written for this purpose. But I assure you Melissa understands options more than many do who play with options. Perhaps she was giving you observations instead of the supporting rational that would satisfy you. But I think she expected you to fill in some of the blanks, or at least ask her intelligent questions about some of what she was said. I also suspect that she thought you were aware of the risks that involve options which goes without saying. But then this is where she may have made her mistake. I highly recommend the book "Sure Thing Options Trading" by George Angell for you to read. Who knows? You may end up learning something you do not know. I think this is a definite possibility. Bob Graham