what is volatility?

Volatility on an instrument can be defined in terms of the normal distribution curve, a bell shaped curve, if curve is flatter and wider, it represents the occurrences of a wider range of prices for a particular period of time. A more narrow and cylindrical (taller) curve, representing a narrower range for the price occurrences. In the first case the instrument will be considered a high volatility vs the latter case.

Lets say we have two stocks each priced at $100, we buy a $110 call expiring in 30 days. Now lets suppose the 1st stock moves only $.5 each day, while the 2nd one moves $5 each day. In 1st scenario the of the $110 call option, the stock has to move up for 60 consecutive days  for the option to end up in the money. The 2nd stock with price moving $5 each day the stock has to move up only two days for the option to end up in the money. That is why volatility matters and options are priced differently.

options education site

Best for learning stock/index options:

http://www.cboe.com/LearnCenter/Tutorials.aspx?id=cboe

What is Volatility? And, How Do I Use it?

What is options skew?

Options at lower strike prices (OTM puts) have higher volatility than higher price options (ATM puts) and the OTM calls.

IV OTM puts > IV OTM puts

This higher volatility exists for two reasons:

• The vast majority (pension funds, mutual funds, 401(K)s, and the retail public), of the equity positions are long. Long investors, purchase puts as insurance against a portfolio drop, which increases the demand for puts. Increases in demand create increases in price. The way to make an option more expensive is to raise the volatility.

• Since the market moves down faster than it moves up bear markets are much more abrupt and realize outlying returns faster than bull markets. The more expensive OTM puts compared to OTM calls is simply a reflection by the options market that downside risk is greater than upside risk. 

Stock Pinning

What is 'Stock Pinning'?

Action/activity at a certain strike price

To find pinning activity look at the open interest and daily volume of a particular strike.

If there is a significant change in daily volume for a particular strike call or put that would be considered as the pinning point for the stock.

It is better to open a position at the pinning point.

There is a potential pinning activity in few stocks such as AAPL GS AMZN BIDU  

Iron Condors

Never “leg in” to the Condor like with the HP (High Probability) spreads.

The trade is always placed with a limit order asking for a minimum of a $1 credit.
Cedit spreads are 2 strikes apart between short and long Options.

Example:
Submit an limit order for an Iron Condor that uses the 118/120 strikes for the put spreads (118 long, 120 short) and 126/128 strikes for the call spreads. (126 short, 128 long).

These trades are VERY Vega sensitive so you would want to enter at the time of maximum implied volatility.

Start by looking to see if you can secure at least a $1 credit for the entire condor using “2-wide” spread strikes at the .30 delta level on the short calls and puts.

The LP (low Probability) Condor trade does not perform well during times where the chart is really moving. This trade performs exceptionally well during times where the market has just finished making a big move and then consolidates sideways for a few weeks.

Spread Types

Credit Spreads: (Bull Call Spread, Vertical Debit Call Spread)

Give you maximum credit on day one and you carry that obligation until trade closure or expiration. Losses that are not riskmanaged can be staggering. These are typically set up so that the price must do nothing, or at least move AWAY from the spread in order to profit.

You are bullish on the underlying instrument.
This is a Long Vega trade.

Buy a front month Call option that is slightly in the money and to help reduce your cost basis, you sell a front month Call option somewhat out of the money.

Credit spreads are always “Negative” or “Short” Gamma” positions. This feature of Gamma works against the position as price gets closer to your short strike.

Bull Put Spread Construction:

     Buy 1 OTM Put (cheaper)
     Sell 1 ITM Put   (expensive)

Debit Spreads:
Require cash to set up on day one however your maximum risk is normally limited to your initial investment. Profits can be several times what your initial investment was. These are usually set up so that the price must MOVE for you to profit.

Options Greeks

Delta:

Positive Delta positions gain value as the price of the underlying instrument goes up, while Negative Delta positions gain value as the price of the underlying goes down.

Buying calls creates a Positive Delta position.

Selling puts creates a Positive Delta position.
Buying puts creates a Negative Delta position.

Selling calls creates a Negative Delta position.

Options Spreads - will provide Deltas equal to the positive Delta Options minus the negative Delta Options, and the final result can yield negative or positive Deltas depending on the composition of the spread.

A Credit Spread Call Vertical (Bear Call Spread) that is set up OTM will be a negative Delta position, since the negative Deltas of the short strike will be larger than those of the positive Deltas of the long strike.

A Credit Spread Put Vertical (Bull Put Spread) that is set up OTM will be a positive Delta position, since the positive Deltas of the short strike will be larger than those of the negative Deltas of the long strike.

Delta Size:

A long call will generate positive or “long” Deltas equivalent to the number of contracts traded times the actual Delta value of that Option. A long put will generate negative or “short” Deltas equivalent to the number of contracts traded times the actual Delta value of that Option.

Gamma:

Is the measure of the change of an Option’s Delta value with respect to a one point move in the price of the underlying instrument.

As Options sellers, we will almost always be dealing with Negative or Short Gamma positions. Negative Gamma positions lose value as the price approaches the position.

When Options are well out of the money, Delta values change very slowly with changes in the underlying price. The closer that the position gets to the money, however, the faster that Gamma ramps up and “accelerates” the movement in Delta.

A Credit Spread position has Negative Gamma characteristics which means that it will lose value as price approaches the short strike price.

A Debit Spread position has Positive Gamma characteristics which means that it will gain value as price approaches the short strike price.

Theta:

Is the measure of the change in an Option’s value with respect to a one-day change in time.Should be positive, If this “Theta” number is positive, then it illustrates how much your position is gaining value every day as a result of Theta.

If you see a positive number that represents the Theta of your entire position, then you’re doing something right with your Option selling strategy.

Selling Puts creates a Positive Theta position, and Selling Calls creates a Positive Theta position.

Selling a Credit Spread means that the Positive Theta of the short Option is larger than the Negative Theta
of the long Option, so the position will be Positive Theta overall.

Vega:

Is the measure of the change in an Option’s value with respect to a one-percent change in volatility.

If this number is positive, then it illustrates how much your position will gain with a rise in implied volatility.

Generally when you sell an Option, it’s better to have volatility contract after you’ve entered the position, as opposed to expand after you’ve entered the position.

Credit Spreads and Short Options are SHORT VEGA positions, which gain value when implied volatility drops.

Debit Spreads and Long Options are LONG VEGA positions which gain value when implied volatility rises.

Credit spread is a Short Vega position, it will gain value as the implied volatility drops.

Much like Theta, the effects of Vega dissipate with time.

The effects of a change in implied volatility will have the most dramatic effect on longer-term Options vs. those about to expire.


For the purposes of a Credit Spreads you want:

Delta:      Neutral
Gamma:  Negative
Theta:     Positive
Vega:     Negative