Options from a Value Investors Point of View

I'll preface this by saying I do understand the basic (stressing basics) of option pricing and theory.

Recently, some heavily shorted names have seen their prices run up in their prices (and also crash sporadically). Focusing on these companies fundamentals, I came up with a fair price with margin.

And because these names are so heavily shorted (or followed by retail investors), the option prices start to get wacky (borrowing becomes harder). Obviously I'd like to throw straddles on (with some bearish bias), but how do you options traders decide on a strategy based off the option prices when you have a fundamental price point in line? Or is it entirely based off short term volatility and time convexity?

Something crude I came up with is percent at risk (when compared to value of underlying e.g. option value is 10% of security value) times the percent move needed to be ITM (overall). E.g. option value is 10% of security value times the 20% move needed to be ITM=2% movement for every percentage risk I take. Some strategies will end up having less movement per risk put upfront.Some require more upfront but a smaller risk.

The problem here is that options value are path dependent, so unless I plan on holding to maturity and converting, this isn't the whole picture. So how do you investors who use options think about which strategy to use & how to value an option when you have a fair price of the underlying derived?

 

Start by checking out an undergraduate textbook on investments and learning the fundamentals of options. For your purposes, you wouldn't even need to use or learn calculus if you didn't want. You will gain far more from that than just asking on a forum.

 

I have Hull's options textbook handy, as well as learned option theory (with stochastic calculus) when I was at university.

But again, their is a fundamental difference between deriving option values based off time/volatility metrics and the price of the underlying.

The question is this: how can an investor with a reasonable price target use options while also considering the path dependencies? Assuming the investor does intend to hold till maturity, can he really ignore these decays?

Btw this is for my personal account as an exercise (as well as a proxy to avoid borrowing), and all the strategies are really volatility strategies (so either the retail investors take over, or the true price eventually is reflected). I think we all can acknowledge that this would be even more complicated as the margin value of the option would be important, and the path dependencies could not be ignored, regardless of the intention to hold to maturity.

 

There are a few well-known options strategies that have been considered in the traditional long-only asset mgmt context. Tthe most common of these is the "protective put buying" (PPB), which has been studied since the 1980s. There are a few others, but there's really no silver bullet. The strategy choice will have to depend on many specific details.

 
Best Response

What exactly are you trying to do? Your first post isn't particularly coherent. You talk about prices running up in heavily shorted names, are you meaning a short squeeze causing the shorts to cover? You then say you've come up with a fair-value price target but you want to buy a straddle. Then you talk about OTM moves to ITM. None of these make sense together. You would use a straddle for a trade with no directional bias. Also a straddle is buying the ATM call and put so you shouldn't be worrying about how far the stock needs to move to get your options ITM. If I understood your goals a little better you might get better advice.

There are so many different options strategies depending on what you are trying to accomplish. If you think the shorted companies are trading below fair value and the volatility has shot up then look to sell OTM put spreads. When vol drops to normal levels you will profit and you will profit from a rise in, or even flat, prices. Or if it is a stock you want to own but think it has run up in price you can short puts at the price you want to own the stock. That way you collect income while waiting for the price to come down. If it comes in to where you think the stock is attractive you own the stock and the option premium, if the stock doesn't drop you keep the premium and either short another put or find a more fairly valued stock to purchase.

I love options because there are so many ways to express your thoughts than simply buy or sell.

 

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