I have grown to prefer intraday trading options instead of
underlying stocks/futures because of the theoretically superior risk management;
this allow us to circumvent
need for Stop Loss Orders . While the math
for options valuations remain somewhat complex, I believe options markets
are close enough to “efficient” that a
robust edge purely in direction (1 of many Option Greek uncertainties)
would be good enough to make money.
Trading Strategy
Long only ATM (At The Money)/OTM (Out of The Money) options,
this gives the trades a limited downside while leaving the trader open for
potentially much higher reward. Pretty simple right? Well there’s a bit more to
it as risk management still depends on the core logic of the trade. Viability still
depends on several risk-related areas.
Risk Management- Theta
Off actual trading experience, I’ve noticed that theta does
not kick in like clockwork as academic theory implies; in the short span within
the trading hours option prices are very much dependent on supply/demand within
the exchanges, i.e. Market Microstructure. So what does this mean for practical trading?
Trade logic of shorter average position would have a greater
advantage. Don’t worry about it in the short run. On some days time value would
go in your favor, and some days it wouldn’t. In the long run, the
near-efficiency would equal to a pretty small negatively Statistically
Expected Value (EV) of roughly the expected Theta * Average Position Time (hours)
/ 24.
Therefore, the directional edge must overcome Theta + other
transaction costs. A theoretical edge that takes your attention is likely to
have a much higher EV than the expected damage off Theta. If not, move on and develop another trade.
Risk Management- Liquidity
If the options are relatively illiquid (such as
the ASX200 Index
Options), bid/offer
spreads tend to be significantly wide, and if the underlying volatility
remains relatively low, the inherent transaction cost could sky rocket and make
the trade negative EV
. Trade the Limit
Order Books, blindly putting in Market Orders
puts the trader in additional, undesirable risks.
Risk Management- Time Value
Of course we want to buy the cheapest options possible and
work the gamma.
We can simply buy the ATM/OTM option(s) at the lowest points off the Volatility Smile.
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