Ask HN: Is option trading as bad as gambling? I guess many people here would have expected the Boeing stock to drop in value after the news emerged that a second one of their brand new plane models fell out of the sky. Would it have been an irresponsible financial decision to buy Put options on the day of the second crash with an expiry of 3 months hoping that at some point in the next 3 months the stock would drop a little to sell with a profit? |
These scenarios are daydreams. Picking the winners in the past is much easier than picking winners in the future.
Buying out of the money options is a lottery ticket, where you pay a relatively small premium with the chance of a large payout if the underlying moves favorably or volatility increases. Your potential loss is limited to the premium you paid for the contract.
In the case of Boeing, you're not guaranteed to profit when owning puts even if the stock drops if time decay (theta) saps your premium at a rate faster than the change in underlying price relative to the strike of your option (delta), or if volatility decreased rapidly after the initial reaction to the news (vega).
Selling naked options allows you to collect the premium up front but exposes you to the risk of huge losses, in fact unlimited losses when selling calls.
Credit spread trading [0] also allows you to collect premium up front, but your risk is defined as you buy a cheaper option to hedge the naked position you created by selling the short option. The compromise is that your maximum profit is capped. This is akin to selling someone an insurance policy, with the stock as the underlying asset being insured. If you were bearish on Boeing and didn't expect it to rebound anytime soon, selling a call credit spread would be a good strategy to profit from your sentiment without taking on too much risk.
[0] https://omnieq.com (Disclaimer: This is my product)
This sort of trade is usually done OTC or alternatively using a contingent algorithm (wait passively on one side for one leg, and fire the second leg automatically as the first leg is filled) which allows going from paying 2X spread to 0 - but the latter has the tradeoff of taking longer and potentially missing the opportunity.
I know they are sometimes called like this, but I find the naming "credit spread trading" confusing. Are these strategies different from collars? I traded credit in the past, and my immediate understanding of "credit spread trading" in this context is shorting bonds of Boeing and buying treasuries (or trading US rates) for example. It would also be a valid strategy in this case that would use credit and rates instrument as a vehicle rather than equity instruments, but not accessible to retail traders.
E.g. basic call options: https://www.optiontradingtips.com/options101/payoff-diagrams...
I stopped because it was too stressful. And I was risking only 5k, cannot imagine risking more money to make it worth the stress.
In simple terms, the price of an option at a given time is equal to the product of what you can expect to gain from it (its payout) and the likelihood of each payout (the implied distribution of the asset at maturity). The interesting consequence is that you can reverse-engineer option quotes to derive the "market-implied probability distribution of a given asset at expiry". You can then compare this to your expectations to enter positions (for example if you think the market overpriced/underpriced a given event, trade against it with options).
You first need to calculate the implied volatility of options quotes (both calls/puts on both bid/ask) which requires you to correctly adjust your forward, i.e divs and rates to obtain put-call parity. If your forward is wrong, your implied volatility curves will look off (for example put bids above call asks) which means you have the wrong rates or dividends expectations. Once you computed the implied volatilities and are happy with your forward, you can fit a curve between your 4 series (call ask, call bid, put ask, put bit). This is your implied volatility mark. You can then use this volatility mark to derive an implied probability density. There is a simple example of how this is done here:
https://www.mathworks.com/company/newsletters/articles/estim...
This is actually really useful when you are trying to manage your risk for a given event. It also has interesting dynamics. Back in 2014 for example, we were worried about our risk on PBR US (a massive petro company with strong political links) ahead of Brazilian elections. By using this method, we found out that the implied distribution of the stock was bimodal, each mode corresponding to one outcome of the election. This gave us an idea of how much the stock could move either way and helped us cover the risk.
If you would like to see whether a given event is indeed priced in as you would expect, you can use this method, bearing in mind there is a timing element and you should seek the option expiry just after the event or horizon you are considering.
One last point that is important to consider is that this is “market-implied distribution” and does not imply a future behavior for the asset in question. It merely gives you an idea of the expectations of actors at this moment. Moreover, it is highly dependent on your inputs (dividends, rates and how you fit your volatility curve between bid/ask options quotes, particularly on the wings).
In general, this isn't true of games of chance, except somewhat for games like poker.
That said, I think I recall that pros refer to amateur traders as "stupid flow".
One of the main reasons they are dumbly traded by retail has to do with the ban of CFDs in the US. As retail investors want leverage (attracted by a quick buck rather than making money on the long term), options provide an alternative, and retail brokers push them to customers.
But there is a massively misunderstood dynamic: time. You don't only have to be right. You have to be right by a certain time. Another misunderstood dynamic is risk management. Options are useful as part of a portfolio, but if you use them only as a means to get more leverage on your directional portfolio, you will end up like all traders losing money that don't understand why. Yet the reason is simple: you took too much risk.