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  #21  
Old 01-07-2002, 06:37 PM
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Default More than utility (Re: options not zero-sum...)



A single option transaction in isolation is a zero sum game assuming linear utility of cash. Viewed as closed systems, options markets and futures can be considered zero sum ... but if they were truly closed systems, they wouldn't even exist.


However, the real world is an open (non-equilibrium) system, in which the financial markets are components. So even if we assume linear cash utility of real market participants, it can be a positive sum game because the hedger can now safely make more money from whatever opportunity he needs to hedge ... and in the real world, the hedger can make that money not by swindling it from suckers but by creating value (e.g., by manufacturing or providing services) so that both the hedger and those purchasing what the hedger creates benefit (even in terms of linear cash utility).
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  #22  
Old 01-07-2002, 07:03 PM
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Default my thinking (don\'t read;)...



My thinking is this:


Suppose, based on correlation to other things they own, there are people willing to pay you cash to sell them bond options - and you just swallow the volatility yourself.


Sklansky asks, will not enough people compete for this free money that it should disappear? I mean, even if there were only one guy on Earth who could stomach the volatility, he would quickly get rich enough to sell all the options you wanted, and he'd have to hold some back like OPEC.


More likely, in my opinion, there would also be natural counter-parties on the other side, who based on some natural need would be willing to pay you cash to buy options from them - covered call writers, in effect.


Any one of these people could get free money from the other, even though he would have been willing to pay. As such, whichever side is smaller, it gets made up by cash traders, the theoretical guy with no external utility or correlation.


Ultimately, the only way you can get free money, relative to other opportunities, would seem to be if you are unique. Because, let's be honest, nobody is volatility-indifferent, everybody has a different utility for some payout scheme, and everybody is correlated to something, even if only by being a waitress in the financial district.


I think the last guy who is going to A) get free money, and B) expect it, is the cash guy. And remember, future money which you can't count on today is not as useful as money which you can count on. So either A) somebody is using a bad model, which causes free money to keep popping up over and over "unexpectedly," or B) somebody is missing a cost or utility somewhere when he measures cash payout.


Aren't you glad to know my thinking?


Seriously, this phenomenon of free money...


I give up,


Wait, we can fall back on the laws of evolution! If free money is favoring the survival of people who sell bond straddles, or need them as natural counter-parties, and yet their population doesn't grow to where the nourishment runs thin, there must be some unseen factor killing them off. Who knows, it could be a world of bottomless abundance, bad math, or even disbelief!


elroy


P.S. A quick tutorial in "beta" for anyone bored enough to read this far, and who doesn't know what we're talking about:


Suppose a dollar is worth $1.00, a 50/50 chance of $1.50 or .50 is worth 98 cents to you, and a 50/50 chance of $2.00 vs. 0 is worth 95 cents.


If there are two .50/1.50 investments, and they are perfectly correlated, you will be willing to pay 98 cents for either one. But once you already own one or the other, the second one is now worth less than 98 cents to you. Or, if they are perfectly inversely correlated, you will be willing to pay MORE THAN $1.00 for one, assuming you already own the other! Right?


Buying the beta -1 instrument brings the value of the other instrument from 98 cents to a $1.00, or something, you do the math. So what does this have to do with option prices?


Well, suppose there is somebody who has a use for stock, so he is willign to submit a high-friction limit order to an exchange - and give someone else the opportunity to lean on him - just to get some stock. Notice, a buy-limit order is identical to a put to a market-maker over the time it takes the customer to cancel it!


So, with enough of these high-friction limit orders to lean on, an options market-maker can sell puts, and then sell short stock into limit orders as the market collapses to hedge himself the whole way. And sellers can then sell to the option hedger on the way back up, they all make money, and everyone is happy [img]/images/smile.gif[/img]


Positive-sum game...



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  #23  
Old 01-07-2002, 07:07 PM
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Default wow! you guys are as sweet a read as TTOP! [img]/images/smile.gif[/img] *NM*




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  #24  
Old 01-08-2002, 04:01 AM
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Default Re: Selling Naked Calls?



>>Add that to the fact that there are experts out there with big money who can easily afford the risks on both sides. Doesn't it stand to reason that they will drive down the price of an overpriced option? >Obviously if it is true that selling naked options is a bad play it would be because of the rare calamity that would befall the naked seller. >But because of its rarity, meaning that the great majority of naked sales show a profit, might it not be that this widespread belief that selling naked options is positive EV, is in fact wrong? > I believe we have readers out there who KNOW the right answer to this question and I hope they tell us.
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  #25  
Old 01-08-2002, 04:04 AM
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Default Ignore Above - Hope This Comes Out Better



...Add that to the fact that there are experts out there with big money who can easily afford the risks on both sides. Doesn't it stand to reason that they will drive down the price of an overpriced option?...


Of course this is true for a lot of stocks but as Ray has pointed out many times that the big money stays out some stocks basically because there isn't enough liquidity. I suppose that some opportunities may present themselves because of this.


...Obviously if it is true that selling naked options is a bad play it would be because of the rare calamity that would befall the naked seller. ...


IMO there is a big difference between shorting puts and shorting calls so I assume we're talking about shorting calls.


...But because of its rarity, meaning that the great majority of naked sales show a profit, might it not be that this widespread belief that selling naked options is positive EV, is in fact wrong?...


FWIW I don't think in general that shorting calls is +EV. I don't think options are priced that way and from my understanding market makers generally don't assume the risk of a short call, they transfer the risk and are basically involved in an arbitrage activity for lack of a better term.


...I believe we have readers out there who KNOW the right answer to this question and I hope they tell us. ...


I really don't know of any particular study but I'll try and find one. I can't prove it but I actually believe that right now there are many under priced out of the money calls in several of the big cap NASDAQ tech stocks. Again I can't prove it but I think buying slightly out of the money calls will be profitable for 2002. If I was employing such a strategy I'd go long the calls for the next month the day the previous month's options expired and buy them each month expecting to lose more often than I win but when I win it would more than make up for the losses.



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  #26  
Old 01-08-2002, 08:14 AM
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Default Re: Ignore Above - Hope This Comes Out Better



>IMO there is a big difference between shorting puts and

> shorting calls so I assume we're talking about shorting calls.


Please don't make this common blunder.


There's little difference in the results

of being short massive positions

in low price Calls or in low price Puts.


Almost half the traders mentioned went,

one way or another,

on October 19, 1987.


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  #27  
Old 01-08-2002, 09:13 AM
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Default Re: Ignore Above - Hope This Comes Out Better



I believe you Erin.For the 3 quarters prior to the crash my friends and I talked about pooling about 15k together to buy S&P puts.We felt the market was overvalued and we were going to buy a bunch each quarter.Woulda,shoulda,coulda, we never did.We did sell some way out of the money calls at ridiculous prices after the crash however.


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  #28  
Old 01-08-2002, 09:31 AM
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Default Huang Lee - was that his name? (+blunder)



You know, that average floor-piker who lost 52.5 million in two days? (CBOE, OEX puts.)


I think Tom's blunder may be more accurate when applied to off-floor/retail traders. Floor traders often get wrecked by fast moves and gaps, which happened plenty to the upside in CitiCorp, Chrylser(?), other buyouts, and throughout the Internet era.


But for off-floor traders, usually any big move over time is a gap - since they don't hedge dynaimically - and they are usually net long the market. Since they post monster margins, the move of a size required to blow them out would have to be some surprise negative revelation about a company.


When we talk about stocks shooting to the moon, and covered call writers and mutual-fund investors, usually it feels more like oxygen than the Option Grim Reaper.


Also, it may very well be that bond options have a lot of volatility because people have a long memory going back to 1982, and the absolute Keynesian/Argentina doomsday scenario.


eLROY



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  #29  
Old 01-08-2002, 10:57 AM
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Default About far out of the money options



I am just a mathematician in finance, basically a brownian motion specialist and what I am saying might not be of any interest for you.

However it is worth noticing that far out of the money vanilla options are directly used in the hedging of exotic European options.

This is due to the Peter Carr's theorem which states that the price of every Cē European payoff functional can be replicated as a weighted sum of vanilla options at different strikes (including far out of the money strikes). What is beautiful is that you heve a direct exact hedging of the option without making usual greeks hedging.

This can also be extended to interest rate options as a weight sum of vanilla caps/floors.

And I know for sure that a few years ago some banks did not understand why major banks did sell such far out of the money options and it was because of the above mentionned reason, that is the hedging of exotic OTC options.
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  #30  
Old 01-08-2002, 11:00 AM
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Default Re: About far out of the money options



read "why some major banks did buy such far out of the money options" obviously
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