Currency "OPTIONS"

Trading Discussion
61

OK, so the disadvantage is that I’ve got to keep my spot position up until expiry right, which means in short that to make this worthwhile, the downside are

  1. keeping the spot open for longer than you might do ordinarily (costs of the spot)
  2. open margin required for unlimited drawdown.
  3. the inability to go short on spot (because capital is tied up in your long)

Not dismissing it, but thinking this through. Why buy in the money option in the first place? If I went long at 1.3000 spot, wouldn’t I just place a Put at the money instead? What would that cost (say 2 weeks?)

62

Ok.

I don’t know what the margin would be but this is a covered position so the margin would be zero or close to it anyway.

If you structure your positions properly, margin is never an issue.

  1. Cost of carry is never an issue if one does options.

  2. Unlimited drawdown ??..not present… that is why the broking house will zero margin you.

  3. Why would you go short if your view is for EUR/USD to go up ?

If you did at the money, you have 100% extrinsic value as opposed to 48.9% with the in the money option.

Why give away 100% when you can give away 48.9% ?

EXPERT

63

Right… you’re talking about spot and options with the same broker, who then establish your margin requirements and works out your net risk? I was thinking about a different broker for spot vs options, which would require margin considerations for your spot position. (2)

  1. Cost of the carry would be on the spot though wouldn’t it? Say without options, I might go long, goes against me, oh dear, I close it 1 day later. If with options, I’ve then got to keep my spot open for two weeks to ensure the 100 pip profit, cost of the carry is relevant no?

As for 3 - scratches head. Need to think on that.

64

LOL…me thinks you got eyes crossed and knickers twisted.

Take a break and come back to look at it 2 hours later and it would start to look a bit easier.

This is a common trip point. Spot traders visualize in 2 dimensions. option traders by force of nature gets to visualize in 3 dimensions…TIME being the third axis.

EXPERT

65

How dare you!

Yes you’re right, just kidding. I’ll give it till midday GMT, if i’ve not worked it out, I’ll be back…

66

Alright, few minutes later, but I think I get it.

In our eg, with a long spot position and 100 pip ITM put option, if the spot position works, great, say you take profit at say 1.3300 (300 pips) a few days in. But you still paid a premium of 196 pips for the option. So total profits will be 104 pips.

You paid double your stop loss for the ability to allow price to move below your stop price and back up again.

Admittedly, what could happen after a profitable spot position is closed is that the market falls and cause the option to finish ITM. But if price stay above 1.3100 it’ll expire worthless (and you will have paid the 196 pips premium).

Is that about right?

67

We are getting there.

Ok…first off I am assuming that you are comfortable with the situation where you are wrong and the market has exceeded 1.29 and you are protected in a max loss of 96 pips so we have no concerns with market proving us wrong and we still don’t get stopped out so if the market turns around, we end up good anyway.

Now the situation with being right…market goes to 1.33 so we are 300 pips profit with the spot. Well we could take that 300 pips and just smile. Our cost in premium is 196 so nett 104 pips. Well story not ended…we still have our PUT we don’t need to liquidate that because it is paid for already and we still got to pocket 104 pips.

What do we do ?

We could liquidate it if we choose to but not a good idea…lets say we do that anyway…what would it be worth?..well the market moved 300 pips, that is full delta and being in the money moving to at the money and then out of the money…the delta overall for that would probably be 0.5 close enough, this means it would depreciate by half the move ie…150 pips, this leaves 46 pips value if we liquidate so we have total profit of 104 plus 46 that’s 150 pips…zero position then.

Why not too good an idea?..150 pips is sweet !!

Well, if we left the PUT there we already pocket 104 pips anyway…we are already in profit even if we get zero value from the PUT. Leaving the PUT there instead of taking the 46 pips gives us a window for more profits SHOULD the market retrace and let’s say goes to 1.29

Now we re-establish the LONG EUR/USD and what do we have ??

A LOCKED IN PROFIT of 200 pips now !!..this could bounce about a few times !!!

EXPERT

68

OK cheers that makes sense. Two more qs for you:

  1. In your experience, is it better for these hedges to have a longer expiry date than your typical trade rather than a shorter one?

So, typically, a trade for me will last anywhere between 1 & 10 days, thereabouts, usually 4 or so. Presumably it’d make sense to keep a hedge on in this way to last at least as long as my trade?

  1. What’s the downside then? Three scenarios- we’ve covered in profit.
  • Price closes below entry. Say close of option at 1.2900. Option is 200 pips+, spot is -100 pips, less 196 costs = -96 (same as stop loss)
  • Price closes at entry, 1.3000. So spot closes down at 0, option is at +100, less costs of 196 = -96 (same as stop loss)

So by using options to hedge in this way you’re effectively increasing the chance of a profitable trade (by ensuring that if it goes below SL and comes back up again, you’re still in with a chance), at the (potential) expense of future profits (because the maximum costs paid are only when your spot position works as expected)?

Never given them much thought before now. It’s tricky to work out how they would affect my bottom line without combing through old trades.

69

Actually, this is not how I would do it because there are many far better ways of doing it.

It is only that this is an easy way of showing what can be done.

Simple, effective but not very efficient.

There is only one downside and that is if the market goes against you and never came back at all.

96 pips lost.

4 pips better than if you had a stoploss but then here you have the chance that it could bounce back…you are still in the market.

EXPERT

70

…of taking a directional view or trading options?

71

…of making money. There is no need to have a directional view in order to have a consistent profitability and there is no real need to be trading the options going in and out either.

More of a set and wait and collect.

EXPERT

72

I’m getting a headache just thinking about it.

Ratio spreads?

Anyway, either way, I’m more knowledgeable than I was when I woke up this morning, thank you.

73

Well, I am quite surprised at the number of viewers on this thread and some of the requests to learn about this method of trading.

I have decided that I will train a small group to use this method to work off a DEMO account and see the results for yourself then decide what you choose to do with it.

I could use MSN messenger to coach you with it. First come first serve basis, I will charge a nominal $100

You could send me a message by clicking on my user name, I found that out…lol

EXPERT

74

For those of you who would like to follow through on what I discussed on this thread with the use of spot and a SYNTHETIC. I will go through it on this thread for the benefit of those who want to gain the knowledge on the method.

Learning to use options is very much a HANDS ON thing, trying to read up a book and hoping to get it all just makes it very much more confusing.

The first thing to do is to get a demo account with an options provider.

SAXO is a good place to start and they provide a 20 day DEMO account you could just sign up for.

I could walk those of you who want to participate in this by posting what you have to do on this thread. Those that need intensive personal coaching would have to make arrangements for a one on one intensive.

PS. Ok… moderator here thinks I make a commission out of the link…lol…I have no need for small commissions, not worth the hassle anyway. Do a google for SAXOBANK. Or just surf around financial pages and SAXO will pop in your face anyway. They are getting to be really HUGE.

75

Now if you have your DEMO account all set up, we can start.

Let’s say we feel the dollar will rise against the Euro, we don’t need to be right here as we are always covered when we are wrong but because we feel USD will rise, we want to short the EUR/USD and have a protective CALL to back it.

So this is what we do.

SHORT 1 million EUR/USD 1.2952
LONG 1 million EUR/USD 1.2900 CALL

We have 52 pips locked in.

We have only an 8% margin requirement and our account should look like below.

start.jpg700×362 39.9 KB

76

Well, the dollar did rise, not a lot but enough for us to take a profit.

We could take a profit by liquidating the spot position but I did say earlier on down the thread that it was not an efficient way of allowing the market to deliver the goods.

So what is a good way ?

Our spot became profitable not because we are smart or could tell where the market was headed, we were just LUCKY and we want to capitalise on that LUCK by locking in some profits and allowing a window for the market to deliver more.

We SELL 1,500,000 1.29 PUT

Notice we have brought the Margin down to 6% from an 8%. What does this mean ? Simply put, we are SAFE, very safe and that means we need less margin to hold a BIGGER position.

You should have a screen that looks like below.

1.jpg700×382 41.8 KB

77

Not familiar with currency option pricing… does that “0.0245” opening price for the long call at 1.2900 mean you paid 245 pips worth of that 1M unit contract to open it???

78

Yes. That is correct.

EXPERT

79

What we have achieved here in a very short period of time is to have hedged in a short 1,000,000 EUR/USD position with a locked in profit of 40 pips.

There was no effort in trying to predict the market direction nor any seeking of pivot points, support or resistance.

We went in, established, waited and allowed the market to dictate what our next action should be. We let the market dictate where and what we should do.

Now if all things remain as they are and the market stayed where it is till expiration, we would reap a 40 pips profit ie $4000.

Look at the cash balance, it is actually already in the account. The cash balance is $104,000

We have an account value of $97,400 because we are carrying a float of minus $6,600

As we move towards expiration this float will reduce to zero provided the market stays where it is.

As we wait, we get paid !!!

One thing we can ALWAYS count on is that the market will not stay where it is so that means that as we move towards expiration, things will change and we need to action accordingly but note that we DO NOT predict what the market will do, prediction brings ruin… we LET the market go where it wants to and we let it do what it wants to and we action accordingly, taking a profit or locking in one.

The market will NEVER fail to deliver !!..that is an ever present CONSTANT.

The account will look like below. We do nothing now until the market gives us the opportunity to do something. I suggest we go for a swim, the weather is always hot in Singapore !!

EXPERT

2.jpg700×377 41 KB

80

This looks interesting, but let me make sure i got my math right…

Ok, so that means your long call option won’t be profitable until it reaches above 1.3145 (1.2900 strike + .0245(purchase price)).

And by 1.3145, your short spot position [1M EUR/USD] will be down 192.7 pips [1.3145 - 1.29523], or -$19,270 (192.7 pips * $100 [value per pip on 1M position of EUR/USD]). But that will be offset by the short put that you received .0190 pips on a 1.5M unit EUR/USD contract. That would be worth $28,500 (190 pip premium price * $150 [value per pip on 1.5M EUR/USD]. That’s a profit of at least $9,230 if the pair closes above 1.3145 at expiration.

So, the breakeven price is 1.30835

($9,230[put & short spot profit diff.]/ $150 [value per pip on short put contract])= 61.5 pips. Breakeven call price is 1.3145 - 61.5 pips = 1.30835.
So, the true breakeven price if EUR/USD rises is when it closes above 1.30835 by expiration.

If EUR/USD falls below 1.2900, then you lose your premium on the long call option 245 pips or -$24,500 ([$100/pip on 1M EUR/USD] * 245 pip buy price). But the short spot position gains. So, it would have to fall 245 pips from 1.29523, or to 1.27073, before it you hit breakeven… except one thing. You are short a 1.5M unit put on EUR/USD at 1.29 strike. That means at expiration you owe the put buyer $50 per pip ($150 [value per pip on 1.5M put contract] - $100 [value per pip on 1M unit short spot position])

So if EUR/USD fell below 1.2900 at expiration then not only do you lose the Call premium paid of 245 pips, or $24,500, but also $50 per pip below 1.29. Because below 1.2900, that Put you sold cancels out the short spot position and puts you in debt to the Put buyer by what ever the price closes at below 1.2900. And the short spot position only makes a profit of $5,230 at 1.2900 [1.29523 [open price] - 1.2900 [max profit level on combined short put and short spot position]] = 52.3 pips. 52.3 pips * $100 [value per pip on 1M EUR/USD position.

Did I do my math right? If I did, where is the profit window, or where does EUR/USD need to close at expiration in order this position to be profitable?

I know above 1.3085 it is profitable, but is there any area between there and 1.2900??

Also, this is a net positive delta position right??