If I may jump in on this (and get hectored for being OT? :)
The figure used to be 60%, but perhaps the number of option players entering and losing has gone up. Be that as it may, a large segment of this crowd is gambling. Strictly speaking we shouldn't count them. There are a small number of perfectly intelligent and prudent stock buyers who venture into options and also lose money. I think, and this is speculation, that that is because they don't apply the same kind of strict analysis and discipline to options that they take to their stocks. For the nonce, succumbing to an itchy palm, they become gamblers as well; or can be interpreted as such. And the anecdotal winners, the mega-baggers, are the bread and butter of the options industry.
As Lawrence and Robert have pointed out time is your worst enemy in options. Unless you're playing a news event about which you have some conviction, why would you pay for the privilege of holding an instrument with uncertain payoffs for any length of time? Black-Scholes need not necessarily be black holes if you price out time from your options position to whatever degree and duration you want. In the normal course, if you can make a stock portfolio work for you there is is no reason why you cannot make options work. If you buy a stock today on the expectation that it will have a price of x+30 at the year end, you can mimic that dollar movement by jacking up delta as close to one as possible. Since you're playing on a lower dollar base relative to the stock your percentage returns will still sparkle and shine. (I'd say ignore percentages and focus on absolute dollars.) The option performance will only be as good as your initial stock analysis. If your stock picking record is good, given a time frame the normal trend and volatility of your stock will play out as expected. If you're buying options that expire in April, you must have a basis on which you expect your stock to reach a certain level above the strike by that time. If you expect a 20 dollar stock to hit 50, you'd better be talking about a cyclical stock on the verge of a serious mega breakout, or an (impending) news event not already priced into the stock (yeah, yeah, efficient markets - bunk!), or a stock that's just finished an abnormal correction. Whatever the basis, you must have a sound basis and a high probability of occurrence and you must cover the time frame, and then some, that you applied to the stock. I'm willing to bet that if you look at most option buys of otherwise smart investors you'll find a disconnect. They've got the stock analysed well but have picked the wrong strike or picked the wrong expiration or, all too often, a combination of both. Somehow they've ended up playing gamma acceleration - they're expecting the option to do things they may not really be expecting the stock to do. (Spreads are neither here not there - by the time your order flows through the system the bid/ask have changed, you get a fill for whatever reason and there ends the matter. When you buy a stock you're not looking at spreads most of the time - let them take their teenies, eighths and quarters and gambol in penny heaven.)
Focus on the stock, not the option. What do you want the stock to do and what has it historically done vis-a-vis your expectations? If you can answer that question you're well on your way to making options work. If I may be so presumptuous as to take Stitch's 37.5 calls as an example. I don't recall if they were March or April, but let's assume there were for March. Now also assume that SEG is a normal stock, in a normal sector in a normal market. Also assume it has annual volatility of 30% translating into a monthly figure of about 8 or 9%. That is, one month from now SEG will be within +/- about 9% 68% of the time and within 18% about 95% of the time. At $30 the up and down range is around 25 to 35. (Ok, maybe the volatility is slightly higher, but that's another matter). The important thing is - your initial assumptions - are they intact and correct? If they are, you can arrive at your strike and expiration with just one other number - volatility. Or even simple eye-balling. Again, and I cannot emphasise this enough, are your assumptions about stock price movement sound? Is SEG a normal stock in an uptrend or downtrend? The sector? The market? If it is a clear uptrend what is the probability that it will hit 35 a month hence? If in a downtrend? You don't have to necessarily do all the math but you do need to do your stock homework.
Unfortunately, with options people either do none of the math or are sitting around doing too much and calculating vega, theta, gamma and every possible greek letter to the 14th precision. There is such a thing as a happy medium (keg party over at psychic friends network). Common sense will give you most of the answers if you pose the questions - obviously SEG is a "normal" stock - it can and does move up or down scattering joy and woe with equal abandon. The trend is up or down or flat depending on what time frame you use. What kind of stock strategy would you have? Buy, buy, buy? Or, buy, accumulate on weakness and hold? Sell and hover like a vulture? Having answered that question - how can you mimic the stock performance using options? Notice I am not asking how much you should "sink" into options, how much "leverage" you want or what the premiums are. Which components of the option pricing model will you minimize and which, maximize? Do you need to know what the model is at all? If you want to - yes, but I'd hazard the guess that you really don't if all you want to do is make money. Knowing the model helps if you want to win friends and influence people in academia, in LTCM and so on. (Or for rambling posts on SI, you say? <g>) For the most part you can look at bid/asks (not "last trade" prices) and get a pretty good "feel" if you closely follow a few option strikes and expirations for a few weeks. Atleast a couple of expiration cycles. Put them in Excel and graph them every now and then.
Ok, I should probably get some sleep now. Sorry if all that sounds like a rant, but heck! options are getting a bad rap and somebody has to plead the devil's case..... <G>
mano |
