options trading question
Guys i'm learning the ABCs of options trading. Explain one thing that im unclear on:
Ignoring interest rates, there are 3 factors that change an option's price and thus create profit - change in underlying price, change in implied vol, change in time (time decay).
These 3 factors are expressed and controlled by the greeks: delta and gamma control underlying price, vega controls vol, theta controls time decay.
I've heard traders wanting to be 'long vol' but also heard others wanting to be 'long vega'. So, when a trader puts on any sort of options position, what is he betting on - a certain change in one of the 3 factors or a certain change in one of the 4 greeks?
I don't know if i'd say "control", but delta relates to the price of the underlying, as does gamma (gamma has some element of vol too actually). Vega measures sensitivity to vol.
Long vol or long vega are two ways of expressing the same thing. I tend to say the former.
When you buy a vanilla call option, you get long delta, gamma, and vol, and short theta. you can hedge out the pieces or hold on to whichever you'd like.
long vol = long vega
For simplicity's sake, options traders fall into two main categories: directional traders and volatility traders. Directional traders spec movement in the underlying and its subsequent effect on the option. Vol traders buy and sell options based of their thesis on volatility. If vol moves up options become more expensive and vice versa. Time decay decisions are important for both types of traders, but for differing reasons.
Don't think of the greeks as controlling your 3 factors. Rather, the greeks are trying to capture those factors in easy to use numerical form. The greeks are derived from a model which can have its limitations.
Is options trading really as simple as having either a directional or volatility perspective and looking to the greeks to know how to hedge out the other factor? Also, the bulk of the trading is done in spreads rather than lone calls or puts. Are all these spreads (calendar spreads, straddles, etc) simply bets on vol then?
not putting all your eggs in one basket i see
"ea701
Registered: Jun 2008 Posts: 1
06-19-08 04:13 PM
Please clarify this simple point. You take a position on an option or several options. You then have an exposure to the underlying price, implied vol and time decay (lets ignore interest rates). As those 3 factors go up and down your option price changes. So, to calculate your net PnL from the position, can you just add up how must money you made/lost on each of the 3? Is this equivalent to adding up net change in delta + gamma + vega + theta?
I've seen the PnL of traders' books split up into rates + vol + theta + new deals and am trying to figure out if that's what they're doing.
Thanks!"
http://www.elitetrader.com/vb/showthread.php?s=434a94f6a87d594bff9b6f85…
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"Please clarify this simple point. You take a position on an option or several options. You then have an exposure to the underlying price, implied vol and time decay (lets ignore interest rates). As those 3 factors go up and down your option price changes. So, to calculate your net PnL from the position, can you just add up how must money you made/lost on each of the 3? Is this equivalent to adding up net change in delta + gamma + vega + theta?"
You have the right idea - to be more precise, an approximation for your daily pnl would be:
Deltachange in underlying + gammachange in underlying squared + vegachange in vol + thetachange in time
This applies when the movements aren't too great. If your change in underlying or implied vol is great then higher order greeks and cross greeks are going to come into play and you will need to account for those.
"Is options trading really as simple as having either a directional or volatility perspective and looking to the greeks to know how to hedge out the other factor?"
No it's not - not at all.
After a trader takes risk onto the book (from making a market), in general he'd like to hedge those risks to the greatest extent possible without paying away too much.
(1/2)gammachange in underlying squared
the derivation for PnL comes from looking at the Taylor Expansion of the BSM formula
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