Help with some jargon
Hi All, I am a newbie FX trader and just learning the jargon.
I saw the following notes from a trader and am not sure I follow this entirely:
Note 1 -
"EURCHF vols have collapsed, for those who want to bottom pick some gamma, i can sell 25sept 1.24 eur call at 4.85 vol, and/or 1w 1.2290 eur put at 4.0 vol. "
1. If vols have collapsed and are expected to increase, how do you decide whether to buy a put or call? as both options will increase in value if vols are expected to pick up. I am assuming here there is no specific directional view
2. Or if this is merely a view on vols, why not trade a straddle?
3. What does 'bottom pick some gamma' mean? Does it mean buying short dated ATM options?
Note 2 -
"EURGBP vols have sold off; for those looking to pick up some cheap gamma, I can sell 1w 0.8470 at 6.0 vol. Spot ref 0.8425, cost 13.3bp. axe in 100."
1. This note doesnt even say whether it's a put or call
2. Is vol level always a part of the quote? What does 'at 6.0 vol' mean? What if vols move fast, and how can the trader control this?
3. What is 'axe in 100'??
Please bear with me if these are very basic questions, but I am just starting like I said.
thanks,
Steve.
Option positions are generally vol plays, you're not trading underlying directional views. This is why positions are delta hedged, but you do have gamma positions. If you buy options you're long gamma, so it means being able to buy cheap gamma. Vol is what determines the option price as the rest of the parameters can be observed, which is why option prices are quoted in vol. You can trade a straddle or a strangle, but you need to consider b/a spread, so it will be more expensive. You decide based on the rest of your portfolio what's the position you want to take. Axes are trades you really want to do. Sales people pass them on to clients, which in turn get a really good price in the axes and we are able to get out of positions we don't want to run.
Hopefully they aren't real examples or else I'll be reading your direct calls.
1.1 Vols have fallen in EURCHF. The market tends to get carried away either direction, so the trader is saying if you think things have become too cheap buy X. Depending on the customer, they might want to have a directional view as well, so they could decide to buy a call or put. In EURCHF, most people would likely be more inclined to run long delta so might buy a EUR call. If it's a pure vol trader, they could buy a call, put, straddle or strangle and delta hedge.
1.2 They could, as mentioned above. But most customers aren't vol traders, they are directional players, so they like leveraged cheap options.
1.3 Bottom picking in anything just means buying things because you think they are oversold. Gamma means short dated options. Bottom picking gamma therefore means buying short dated options (doesn't have to be ATM, but they will have the most gamma per notional) because you think they are oversold (ie the breakevens look too cheap).
2.1 Oh but yes he did! Look at the basis point price and at spot. It's then immediately evident whether this is a put or call given the rest of the parameters (and common sense, he's not going to be talking to someone about putting on an ITM vanilla option...).
2.2 Holding constant known parameters such as Strike, Option Maturity and Spot/Forward, you then want to know the price of the option. In FX, generally we quote prices in terms of vol as convention. With a vol you can back out a price. Similarly, given a price, you can back out a vol via B-S. Other markets usually quote premium price and not vol, but this is just how FX is. The vol is the implied term volatility of the contract, ie the standard deviation of lognormal returns from now until expiry that the trader is quoting. If the trader thinks vols have moved, he will adjust his vol quote which therefore will also adjust the premium price of the option.
2.3 An axe in anything is the desk's way of saying "I am a better insert buyer/seller of this object than the market." In this case, it's likely that the trader is long 100 of 1w 0.8470 calls and wants to get rid of them because he is paying too much decay. In this case, the customer can get what they think is a cheap option, and the market maker's decay bill is lower so mutually beneficial. Not all "axes" are true axes, so if a customer asks 2 other banks and gets 5.8 and 5.7 offers while you said you were axed as a 6.0 seller, he's probably going to be annoyed. Axed is generally accepted to mean at or better than market-mid.
This type of context is why I come here. +1
Thanks Revsly - very helpful indeed!
Just a cpl of follow up queries:
If prices are quoted in vols as a convention, what does that really mean in $$ terms? or how does the client know intuitively? In the above example, if the client wants to buy EURGBP call for EUR1mn notional (at 6.0 vols mentioned by the trader), what premium does he pay?
By 'breakevens look cheap', you mean the BE point on the payoff profile? So I suppose it's the same as saying 'option premiums are cheap'?
Got your other points and this is far more helpful than reading a book!
best, Steve.
Well that's why we use the B-S model. You easily can plug in an implied vol and your other fixed parameters and come up with the premium price.
Yeah you could say that, if the break-evens look cheap then basically your assumption is that the implied vol looks low relative to your expected realised.
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