zico wrote:Grateful if you could explain your thinking here (and maybe some basic principles about option trading - I have traded in them many years ago, but it's always useful to get views on underlying principles.)
My understanding is that unlike most other stock market investments, options are simply a bet against other people in the market, and have no intrinsic value in themselves, but there are 3 ways to make (or lose!) money from them (and of course, various combinations of these factors).
A) Getting the direction right. So buying calls and then seeing the market go up.
B) Getting the volatility right, when others underestimate it. So buying calls and puts, and then seeing lots of wild see-sawing in the market, so making money on both.
C) Getting the timing right. So buying a short-dated call just before the market moves up.
Zico, I couldn't possibly do this subject justice in a single post. I did a very brief summary somewhere further up the thread but there is a huge amount of material online about options. What I'll do is just answer this part, in the context of the thread/OP about timing the recent crash and its aftermath.
If I've understood you right, you think the options market is underestimating the volatility of markets, so pretty much all calls/puts are underpriced - is that correct?
Also, unlike straightforward betting, is there something about options markets where perhaps big institutions are affecting the price in such a way that there are clear opportunities for small investors? (Defining "small investors" as <£100,000 trades!).
The kind of example I'm thinking of is where big investors are staying more or less fully invested, but hedging their options by buying puts.
I said pretty early on in the thread that I wasn't confident calling the market, and that trading options was an alternative that I would try and document. The reason is that options allow a variety of very flexible trading strategies which are not biased to the upside or the downside: IOW, a similar outcome occurs whether the market moves up or down. Instead of direction, what you are looking for is either big moves or little moves in prices.
Now clearly these highly volatile markets are a good time to use the strategy because: if options buyers expect large moves they will pay a premium for options which can be harvested by option sellers. OTOH if the market does move fast and you have bought options, then they quickly move into the money and become profitable. The trick is to figure out when to be buying the options and when to be writing them. Obviously you want to but in advance of or during big moves. You want to write (sell) options most of the rest of the time.
I like this approach because it means one can be somewhat detached from the actual gyrations of the market. If you are directionally invested then seeing the market plunge is painful, and the temptation is to sell as the pain builds up. Conversely when a huge rally is happening, you wish you'd bought stock and then end up buying far into the rally or even before a further drop. Of course, people using options for directional bets are subject to the same psychology: they want to buy puts at the bottom and pay a premium to do so and buy calls or ignore puts near the top, not paying as much premium as at the bottoms, but also experiencing less price movement because markets are far less volatile near tops (tops are round, bottoms are sharp).
So what you're doing i seeing everyone panic around you, and then trading something somewhat orthogonal to the main action. You can focus on the strategy rather than get caught up in the emotion. Not only tht, calling fast moving markets is hard and it gives me something to do while waiting for things to calm down and resolve themselves.
Personally I don't believe in zero-sum trading. I believe every trade thoughtfully entered into contributes to price discovery and produces a better outcome for everyone. Even options are more useful to certain people at certain times, so if you can supply those options at a sensible price (for yourself) then you are helping those people. What is crucial to understand though is what you are aiming to achieve, both in terms of diversity/risk management and also the amount of profit that can realistically be extracted. This is true of all investment not just options. It's easy to be daft and try to get rich overnight when that is simply not realistic.
Having committed to trading options, there is a bit of learning to do, but it's not that hard. I don't trade options exclusively. They are a diversifier and I increase and decrease activity as market conditions change. When I said at the beginning that I couldn't call the market and so was shunning directional trades, that wasn't entirely true. When it looked to me like there was some indiscriminate selling happening, I did dip in and buy a fair amount of stock. But I did so knowing that I had option positions that would protect me by delivering profit if the markets fell much further. It gave a bit of peace of mind when there was panic all around.