This post assumes basic knowledge of Options and Mathematical Expectation. Most of the features that you observe about options are simply due to the fact that they are expiring bets. And the features we observe in option pricing are observed in any other expiring bet. The complicated maths and terminology that surround options can make it ... Read more The post Pricing a Sports Bet like an Option appeared first on Robot Wealth ..read more

There are 2 good reasons to buy put options: Because you think they are cheap Because you want downside protection. You want to use the skewed payoff profile to protect a portfolio against large downside moves without capping your upside too much. The first requires a pricing model. Or, at the least, an understanding of when and under what conditions options tend to be cheap. The second doesn’t necessarily. We’ll assume that we’re going to have to pay a premium to protect our portfolio – and that not losing a large amount of money is more important than the exact price we pay for it. Let’s ..read more

In this article, we explore the payoff to holding long options positions. Payoff Profile of a Long Call So far, we’ve plotted the value of an option at expiration. This is useful (as we’ll see later), but it doesn’t represent our profit and loss from being long that option. For that, we need to subtract the amount we paid from the option from the payoff for all values of the underlying asset price. Example: Long a call option expiring “in the money” Pam pays $2 for $100 strike calls on product X. At the expiration date, product X is trading in the market at $130. What is Pam’s net P&L ..read more

Options have value because the future is uncertain. One thing that is known and always unchanging, however, is the value of a given option contract at expiry. This is the most fundamental thing about an option. Value of a Call Option at Expiration A call option gives the holder the right to buy the underlying at the strike price on or before the expiration date. That means that the value, \( V_{call} \), of the call option at expiration, is described by a step-wise function in the price at expiry,  \( p_e \) and the strike, \( s \): \( V_{call} = \begin{cases} 0 & p_e \leq s ..read more

At its core, an option is about choice—the choice to buy or sell an asset at a specific price within a set timeframe. In this article, we’ll explore exactly what this means. An option gives the holder the right, but not the obligation, to trade a certain amount of the underlying asset at a specific price on or before a certain date. Let’s break down each of the terms. An option gives the holder the right, but not the obligation, to trade… What makes options useful is that they, err, give you options. If you buy a call option, it gives you the option to buy the u ..read more

Financial options contracts are really just options. That is, they give us a choice or an option to do something. We’ll go through a simple example of why options are valuable. Let’s say I offer you the option to use my truck. What might the value of this option be to you? Is it Intrinsically Valuable? Maybe you need to pick up a bath from the hardware store today. In this case, the option to use my truck would be intrinsically valuable to you right now. The option is worth more to you the more intrinsically valuable it is (the more you need the truck). How ..read more

In much of life, success results from doing what other people expect you to be doing. You get top marks in an exam by answering the way the marker expects you to. Rising up the corporate ladder has as much to do with “being seen to do the right thing” as it has to do with results. I’m not judging. I played these games – and I played them well. Unfortunately, “being good and playing by the rules” isn’t going to help you in trading. As hedge-fund-manager-turned-vision-questing-FinTwit-celebrity Hugh Hendry is fond of saying, “You need to be a pirate”. Lots to unpack here… You need to zig w ..read more

Back in May 2020, in the eye of the Covid storm, we looked at overnight vs intraday returns in US equities. Intuitively, we’d probably expect to see higher average returns overnight when the market is closed – because it’s much more difficult to hedge and manage our exposures when the cash market is closed, so we might expect to get paid a premium, on average, for taking that risk. And that’s exactly what we found: Most of the returns have indeed come overnight – which is quite remarkable in my opinion – but at the same time, most of the big negative returns have also come overnight, which ..read more

Industry veterans sometimes remark that successful gamblers tend to make good traders, and engineers tend to make lousy traders. This is a gross generalisation, of course, but one reason is that trading, at the most fundamental level, is a game of pricing uncertain outcomes. This requires probabilistic thinking, and engineers tend to be trained to think deterministically. Indeed, thinking probabilistically is hard for most people. That’s why so much retail trading tends to involve buying when the news is good and the price is increasing, and selling when the news is bad and the price is decre ..read more

The first thing you need as a trader is a clear edge. What do I mean by “edge?” Edge comes from a market inefficiency that means you can buy cheap and sell rich on average over the long run. Said differently, edge is positive expected value. Expected value is the return you expect to realise from the edge if you could hit it an infinite number of times. Sophisticated people might describe it as the probability-weighted value of all payoffs summed over all possible outcomes. The idea of positive expected value simply captures the notion that any single trade could go either way (even the best ..read more