If I was sure that the price of a stock would increase and there was 5 days until expiration of a call options, would I buy an at-the-money call or out-of-the-money call? I understand gamma is greatest at-the-money, but the logic is escaping me. Thanks
If you don’t already own the option, the out of money option would be cheaper, but it would really depend on if it would become in the money within the 5 days in order for you to profitably exercise it. Otherwise, you could sell the option with time remaining as it would have likely gone up in value based upon the assumption of a rising stock price.
quantum i think you are misinterpreting the use of gamma. the only way i can think to explain it is if you have a delta hedging strategy, and you look into how stable that strategy is. If you are at the money it means your delta will change quite a lot so your strategy would require a lot of buys/sells (rehedging) whereas if you are massively in or out of the money or gamma will be close to 0, in which case you delta hedge once and (practically) never again. Gamma is more a tool for risk mitigation than gain, so you probably wouldn’t use it to choose between options - unless you’re using the options as a hedging strategy but in that case it would depend on the situation.
If you were delta-hedged and had a positive gamma (that’s the case with a long call), the higher the gamma, the better for you. Because you are loosing on the theta (time decay) the more the expiration approaches. Positive gamma means that when the underlying moves up, the price of the derivative moves also up and vice versa.
im an alpha
Thanks all. I think I may have confused people with the title, having had time to think about it more on the train ride home. My question should have been which trade would you put on if you thought the price of stock was going to go up to realise the greatest profit with 5 days to expiry: a) buy out of the money option b) buy at the money option c) buy in the money option I’m thinking at the money, as this has the greatest delta. Out of the money would be cheaper, but may be difficult to exit if there is a lack of liquidity given near expiry.
My question should have been which trade would you put on if you thought the price of stock was going to go up to realise the greatest profit with 5 days to expiry. The answer: do not buy any option, buy a future and place a stop loss order.
quantum, theres no simple answer, you would choose based on prices, or as pfccfaataf said just buy the underpriced future (underpriced to you as you believe the price will rise more than the market does). in fact assuming ‘correct’ market prices, buying any of them will give you the same payoff in the end, as they will have different premiums Also the at-the-money option has the greatest gamma no the greatest delta. An in-the-money call would have the greatest delta (or out-the-money put). mihau10, i don’t believe what you’ve said is correct, if i have a deep in the money long call option for example, my gamma is going to be 0. also underlying increases meaning an option price increase indiciates a +ve delta not a gamma. positive gamma would mean the delta increases as the underlying increases.
you know what i’ve just udnerstood exactly what you were asking for: you know stock xyz is going to spike tomorrow. so you buy the in the money call option, (which has the highest delta). tomorrow the price spikes, and hence the option price goes up as well, immediately you sell the option on. you are then left with no exposure to the market prices as you have no position, as well as a tidy profit on the small premium you initially invested.
Positive gamma means there will be an increase in portfolio value if there is a Large change in the underlying. For smaller changes the portfolio will decrease…The opposite increase and decrease for negative gammas
presumably when you say ‘positive gamma’ you do not literally mean a gamma>0 ?
Sorry, your right, gamma will always be positive. I meant your portfolio gamma. I.e if you have a short position this will contribute negative gamma to your overall portfolio position… Please correct me if I’m wrong
+1 to Kurupt1 Not relating directly to the discussion of the greeks, but for conversation purposes: The only thing I disagree with is the futures purchase. There’s nothign to say the futures act in the same way as the options. Expecting them to all pay the same is not practicle. Liquidity on the option is of primary concern with such little tim to expiration. Also, why are you buying an option with no time value, especially with a price spike? Ifyou are wrong, you have no value left in the option. Why not buy an option with ONLY time value? It might be worthwhile to look at an options slightly out of them money for the next comming expiration month. The market could vary well roll over their postions from the current month to the next, taking a profit, but also driving up longer term premims…maybe not the view from our textbooks, but food for thought none the less.
TDIGZ i believe quantum was looking to understand it in a very hypothetical simplified situation to get a grasp of delta/gamma. manstey, gamma can be negative or positive depending on the portfolio. but in either case it does not necesarily mean your portfolio will increase/decrease in value when the underlying moves. gamma effectively shows the rate at which delta moves, the delta showing the rate at which portoflio value moves. to understand gamma first understand delta, the best way to do that is to look at payoff diagrams, delta at any point on a payoff diagram is going to be the slope of the curve ie the rate at which value will change. the obvious thing to note here is that the rate of change will not be constant (depending on payoff mechanism). ie delta is the first derivative of value wrt to underlying price gamma is then going one step further and looking into how the delta will change as the underlying moves around. ie 2nd derivative of value wrt to underlying price. conceptually the greeks can be difficult to understand without looking at diagrams
kurupt1, my point was more of a conversation starter as I feel the topic has been clearly laid out by a few people to answer quantum’s question.
fair enough. imo if i was expecting a price rise to occur on a stock in the short term, my options would be purchase the stock and sell it after the rise purchase the future and sell after the rise purchase an option with long expiry purchase option that expires soon purchasing the options would require the least investment initially so obviously either of those startegies would be better than buying the stock itself. if i was to purchase a long expiry option with the intention of selling after the price rise that i anticipate, it would be most profitable if it was deep in the money (delta=1), however with the short expiry option, as there is little time value it would have a lower premium if it was out of the money or at the money, so provided the price rise pushes it beyond the strike you would get the same gain as a deep in the money long expiry option, but at a lower initial investment. obviously the downside of this is that its a much higher risk strategy as if the price rise takes longer than you expect or doesn’t happen at all you’re left with 0.
nobody says that futures and options are the same but with this view "If I was sure that the price of a stock would increase and there was 5 days until expiration " I dont see added value in bying an option, but of course depends on the risk aversion and time value of the option.
kurupt1 Wrote: ------------------------------------------------------- > TDIGZ i believe quantum was looking to understand > it in a very hypothetical simplified situation to > get a grasp of delta/gamma. > > manstey, gamma can be negative or positive > depending on the portfolio. but in either case it > does not necesarily mean your portfolio will > increase/decrease in value when the underlying > moves. gamma effectively shows the rate at which > delta moves, the delta showing the rate at which > portoflio value moves. > > to understand gamma first understand delta, the > best way to do that is to look at payoff diagrams, > delta at any point on a payoff diagram is going to > be the slope of the curve ie the rate at which > value will change. the obvious thing to note here > is that the rate of change will not be constant > (depending on payoff mechanism). ie delta is the > first derivative of value wrt to underlying price > > gamma is then going one step further and looking > into how the delta will change as the underlying > moves around. ie 2nd derivative of value wrt to > underlying price. > > conceptually the greeks can be difficult to > understand without looking at diagrams I agree with all the above. But generally speaking a postive portfolio gamma will mean your portfolio increases in value for large changes in the underlying and decreases for smaller changes, assuming your portfolio delta is zero (i forogot that part lol). Anyway im realizing this is probably irrelevant for CFA!
WHOA - SLOW IT DOWN. Options are about LEVERAGE! Easy answer, and i’ll draw it out using AAPL today, half hour from expiration. You have 10,000 of capital to invest. Maximize your profit. the stock is 194.40 right now. and its going to close 210, so we believe. If you bought the stock: you can buy 51 shares and now have a tidy profit ~710 clams. You can buy ~22 Dec 190 calls for 4.40 - at close you now have ~34,320 You can buy ~1,428 Dec 195 calls for 0.07 - at the close you now have ~2.1 mln You can buy 5,000 Dec 200 calls for 0.02 - at the close you now have just a hair under 5 mln. GET IT?
Thanks Infinitesun, I tried to articulate this in words, but your example proves much better