I am getting killed on options
Long story short, I am up 18% on my long equities but down almost 50% on my call options. However, the stock prices of my options have been rising and they still have a month until the exercise date. Is this typical or do I have a fundamental flaw in my thinking?
Is it more logical to buy in the money calls and hope they continue to increase? Or buy cheap out of the money calls that I feel will reach the strike price.
I have been going with the latter. But it has fucked me.
Well, have you quantified the impact of time decay in some way that you can incorporate it into your buy / sell decisions? If the underlying's on your calls have been rising, but you're still down 50% on the options, and you're out of the money a month from expiration, then you've clearly underestimated that impact.
Volatility has been going down = decreased value of options. You could hedge and short the volatility index.
Full dislosure: Long XIV. Also, not an active trader and this is conjecture.
You are getting fucked by theta on the OTM calls.
two things: theta and volatility crush -- more so the latter in your case
You make/lose more money in options from (predicting) volatility than you do in predicting direction.
In your case, the implied volatility has most likely decreased significantly from that of purchase date.
This is not true. It all depends on the greeks of the option.
Anyway, as people have mentioned, while you likely made on delta, you lost on vols getting hammered in this massive rally. Long story short, the significant decrease in volatility likely made your option more out-of-the money than your delta brought it closer to being in-the-money.
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Review Natenberg, Baird, and the Greeks.
Don't worry about reading books (you should start with Hull btw, buy the latest edition). Simply program the BSM formulae into Excel (PM me for the code to copy paste into the editor). Then take your original position, input S0, sigma, etc., and output the greeks of your position. Yeah, it's not perfect. Yeah, there's no modified gamma, you're not looking at 5th order derivatives, etc. Who cares. If you don't understand what happened to you you should be worrying about your understanding of the BASICS. You'd be amazed how many traders with years of experience - including structurers - don't have a clue.
This is then how you understand your PNL, if you are long a call and dynamically hedging: Theta: this is how many USD you will lose if the thing doesn't move, every day. If your theta is 10k and the stock hasn't moved much in the last 4 days you will have lost 40k USD. Very rough. Theta increases rapidly (so does gamma) as you near expiry. One month is already into the danger zone. However gamma also increases rapidly so if the violent move you presumably were expecting when you went long gamma does happen you will make a lot more money compensating you for the deeper wounds your wallet took on the decay.
Gamma: only thing you care about at this point is whether you are long or short. You are long (shortcut: long option = long gamma). Thus, take the implied volatility, divide it by 16, call that your breakeven vol. Every day that the realized vol (i.e. the daily return) is below that vol, you get screwed by aforementioned theta. Every day that it's above, since you are long gamma, the further above the more money you make, in a convex manner. The P&L is proportional to the SQUARE of the difference in vols, not just the difference, so if your breakeven vol is 2 (i.e. implied of 32%) and the stock moves 10%, you can take a lot more than 8 days' theta. If move higher than breakeven, you $$. If not move, you not $$. Simple. If move much higher than breakeven you $$$$$$$$$$.
Vega: implied vol won't move that much in the short run, but easy way to calculate P&L from vega is to take vega, multiply it by the difference in implied vol between when you went long and now. So if your implied was 60% when you went long, and now it's 70%, and for every 1% you make 1k from your long vega position, you should be up 10k from vega.
Don't look at anything else for now. Think about these as your source of $$.
By the way don't think that implied and realized vol bear much relation, especially on individual stocks. I could name quite a few with implied of over 80% which don't budge more than a couple % a day. This is not a good time to be short vol on small things that are easily affected by events.
Deep out of the money options has the drawback of small delta, the delta could be seen approximately as the probability of the option of expiring at the money, for example a delta of 0.15 suggests that there are 15% probability that the option will expire at the money. I don't know when you bought this option but if you did that during a high volatility period then it was maybe a mistake, because volatility will tend to go down after a period of high volatility and vice versa (volatility is volatile itself). Another observation with regard to options with a relatively high theta is that such options tend to have a low Gamma in other words they don't carry to much explosiveness, so for instance ahead of an earnings announcement it is better to buy an option that have 1 week or few to expiration.
To be more precise: http://www.condoroptions.com/wp-content/uploads/2009/01/call_theta-full… https://sites.google.com/site/cdmurray80/call_gamma.jpg
Theta and gamma will BOTH increase near expiry and in general high theta = high gamma. Theta is the "rent" you pay for the gamma position.Accusamus architecto dolor est aut. Exercitationem temporibus eum sed perspiciatis aut fugiat nobis. Aliquid sunt ut ea dolorem qui doloremque. Officiis sit id pariatur quasi et. Et eos magnam harum rem.
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