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Doesn’t Stock Option Trading Require The Use Of “Greeks”?

Posted by Pete Stolcers on July 18, 2007

Option Trading Question

Why don't you talk much about the Greeks?

Option Trading Answer

What an astute observation and a great question! I don’t dwell on the “Greeks” like many option sites do.

There are two approaches to trading options.  One focuses on the option prices and it looks for pricing disparities. It plans strategies around those disparities.  Using that approach, the “Greeks” are very important. One example might be a volatility skew. A back-spread strategy might be used to take advantage of it.  Another example is an implied volatility deviation where the options are relatively cheap relative to their historic value. In these cases, buying straddles or strangles might make sense. Neutral trading like condors and butterflies also requires extensive knowledge of the price behavior for each leg of the position and the aggregate position. The “Greeks” are also used to estimate profit loss scenarios over various price levels and time horizons. This is a valuable tool for complex multi-legged positions. After trading this way for many years I learned that this method was not nearly as effective as what I do now. 

The second approach to option trading starts with extensive market and stock analysis. I’m a directional trader and I use options to leverage surrogate stock positions. I use my opinion of the underlying stock to guide me to the optimal strategy. It’s critical to nail down the direction, duration, and magnitude of the move.  These variables along with my level of confidence (in the market, in my analysis and in my recent performance) determine the strategy.

This is how I trade and this is what I teach.  I do reference delta when I talk about my expectations for a stock.  In instances where I’m looking for a nice steady long-term trend, I suggest buying long-term in the money call options that have very little time premium.  Translation: the delta is high and I want to gain point for point with the underlying stock.  In other instances where an explosive move is projected, I suggest out of the money options.  Translation: get long gamma.  When I sell a front month put credit spread I talk about accelerated time premium decay. Translation: get short theta.

I discuss all of the option pricing principles without having to get into the Greeks.  When I talk about implied volatility I reference how it compares to its historical implied volatility and that is used as a gauge to determine if the options are relatively cheap or expensive.  I don’t need to use the term Vega and I don’t need to discuss how it is calculated.  I don’t want someone to have to take an advanced math course to understand why a particular strategy makes sense.  Option trading can be very intuitive and I find many “educators” want to complicate it so that they can feel important. If you are accurately predicting the market and you’re accurately forecasting the price movement of the underlying stock, you are in great shape. You just need to use a handful of basic strategies to capitalize on the move. Let your opinion drive your strategy and you will do well trading options (if you know how to pick a stock).

I have attended seminars where the instructor is teaching students the importance of identifying a kurtosis probability distribution - give me a break. Keep it simple. It is good to know what the “Greeks” represent and to understand option pricing principles. You don’t need to use the actual value for each to construct a position. The most optimal “Greek” position won’t make any money if you can’t get the stock right.

Thanks for the great question. This was something I should have addressed long ago.

Option Trading Comments

  • On 07/27, cougarjump said:

    Hi Pete Stolcers,
    I totally agree with your strategy to trade options. Personally, I use this same approach to trade - find the correct direction and trade it. If thing get wrong, I will try to use the repair strategy or cut loss. There are many ways to find the direction.
    I always keep this in my mind—KISS!
    Thank you for your wonderful site.

  • On 07/30, Pete Stolcers said:

    Thank you for the compliment. Options can be dificult enough to understand. Why complicate it.

  • On 08/09, Larry said:

    Do you still trade weekly?
    How can I best see your choice of plays, an dread your current blogs?

  • On 08/15, tdl138 said:

    I just happened to chance upon your site and find that your commentaries are really valuable. I am gonna dig up all your pages for some good readings.

    TDL

  • On 08/15, Pete Stolcers said:

    Thank you. My intent was to create a library of timeless articles. Please use the search feature to find specific articles. The alternative is to just knock through all of them using the Categories/Option Q&A;sections. Most importantly, please spread the word. The more readers I have, the more I blog.

  • On 08/12, tony mangrum said:

    i’ll be back. after reading about your attitude on greeks, and likeing it, i am once again told to go learn the greeks. you see, i am drawn overwhelmingly to non directional trading. i’ll be back a few times to see what’s up in your diary.
    thanks
    tony

  • On 08/13, Pete Stolcers said:

    When you’ve worked months to consistently grind out non-directional profits and it is all taken away by one trade, come back and read my blog. 20 years of experience have taught me to be directional. Great research is rewarded by big profits.

  • On 07/22, Jay Salzman said:

    Pete:  As you know, I have joined ALL your groups and you have msde very good money for me.  I commend you as one of a very few who really has a tremedous program for picking options. However (isn’t there always a however) you could do a great service for your students and followers if you were to offer some repair strategies-- particularly when a spread you have recommended goes amiss.  I’ve been doing some of this on my own, but it would be lots better from an expert.  I’m only talking about a situation where you have made a specific quantiy and option selection.  Just an idea-- not a criticism.  I’m amazed that every time I have a question, you are “johnny on the spot” with an answer.  I suspect my trade results would be even better if you were to implement this in some way.

    Jay

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