How an Options Specialist Prepares for the Market Opening
12449
Finance > Investing
Apr 18, 2007
How an Options Specialist Prepares for the Market Opening
At 6:45 a.m. the traffic already is building on the expressways that feed into downtown Chicago. From inside your car, the only real difference between winter and summer at this time of day is that in summer the sun is already up. In the dead of winter, traders only see the sunshine on vacation. When we drive to work, it's dark; when we're through for the day, it's dark again. But just like the screaming and shoving down in the pits, you get used to it. I've been trading upstairs and in the pits of Chicago for the last 15 years. Getting up early never bothered me as much as how cold it gets in January -- ungodly cold. But I suppose that's just one more thing that separates the players from the pretenders in this high-stakes game we play. While I came to Chicago to play football for the Chicago Bears, all I really have to show for that is four pre-season games and a few great friendships. I took my agent's advice and traded a career as a backup football player for a job on the floor of the Chicago Board Options Exchange (CBOE) -- probably the best trade of my career. While the trading floor immediately was intensely exciting, options trading didn't come easy. My college studies prepared me for a job in advertising or design, not sophisticated financial instruments like options and futures. However, hard work and mentors such as Tom Haugh, general securities principal at PTI Securities & Futures, helped me see the light at the end of the tunnel. Although I've traded everything from equity and index options to futures and warrants, I've never stopped learning. If you ever think your education is complete, somebody else who's hungrier will figure out a better way and take your edge away. Morning prep When I get into our offices at 7 a.m., our clerks already have been at work for about an hour. As we trade tens of thousands of options and 1-2 million shares of stock every trading day, it's extremely important to check our options and stock confirmations vs. what our computers say we've traded the pervious day. Mistakes in clearing of either stock or options could cost us thousands of dollars fast, so this trade-checking session is essential for us to start each day with the correct position. Our main trading room -- the so-called war room -- is an octagon shaped room with 30 running feet of trading desk on the west wall and a 12-foot-by-12-foot conference table in the middle. The room gets more boisterous and energized with each tick of the clock. Our head of research will hand me the critical overnight news stories that will affect our trading that day. By 7 a.m. he will have run several search programs on a host of computers that incorporate fuzzy and Boolean logic to hunt for key words in news stories that he feels will influence the markets. The computers assemble and search through news feeds from more than 20 news services such as Dow Jones, Bloomberg and Reuters. These feeds cost us more than $5,000 per month; such is the value of information. However, it's only slightly less important to get that information to our traders as fast as possible. That's why the computers are networked throughout our offices and down to our traders on the floor. My $1 rule If a story is compelling enough, my next step is to find the average trading range for the stock. If the range between the high and the low is less than $1, I usually take a pass. There simply isn't enough edge for me to jump in and trade when the average daily range of the stock is so small. Just like most traders, when I have to buy, I pay the offer; when I have to sell, I hit the bid. Therefore, if the stock trades an eighth wide between the bid and the offer, I give away a quarter point to trade in and out. With an average daily range of less than $1, an extraordinary percentage of my trades would have to be right to make any money. Hence, my $1 rule. Liquidity My next step is to check the average daily volume the stock trades. I can't step in and buy 1,000 shares of some off-the-wall stock without knowing how much trades each day. In some of these stocks, 1,000 shares could represent nearly 20% of the average daily volume. So knowing there usually is enough volume to get in and out without impacting price helps me avoid the dogs. Timeliness I view the news that is out before the opening in a different way than the news that comes out during the trading day because all option models are forced to make some assumptions as they seek to tell us the correct value of a call or put. One obvious mistaken assumption is that there is continuous pricing of a given stock or future. Only foreign currencies come close to living up to that presumption. Stocks and most futures have specific trading hours and are closed for several hours of each 24-hour day and over weekends. Therefore, the likelihood of news causing a rapid ascent or descent of a stock or futures contract is greatest before the opening. CNBC and CNNfn are likely to have many of the 20 different news sources we have, but clearly the more expensive sources have fewer eyes watching for market-moving information and are, thus, all the more valuable. If a story we deem a market-mover comes out on the Dow Jones news wire, for instance, the world will know about it within minutes. If a similar story comes out from some other vendor, however, that information might not be widely disseminated for several hours. Obviously, the search for market-moving news continues from the beginning of our day straight through until the last trader locks the door. To make sure we stay on top of the stories, we have audio, visual and printed alerts that flash, beep and print throughout the day. Strategy planning Armed with the news of the day, our traders take turns sitting around our conference table going over our stock and option positions and plotting strategies for the day. We begin with our Chicago Designated Primary Market Maker (DPM) group, go through the rest of our specialist books and finish with our independent floor traders. The DPM unit carries our largest positions in about 30 option classes and, consequently, requires the greatest amount of time to complete the daily review and tactics planning. Just as it is important for us to know the average daily range of the stock, we have to know the range of volatility for a given security or future. For instance, if a stock such as Micron (MU) has traded in a range in volatility from 45% to 80%, we would be aggressive buyers of call and put options on the lower end of that scale and an aggressive seller of both if the volatility were on the high end of the range. As we go over the MU positions, for example, we discuss the overnight news that will affect MU. If our position is long gamma (that is, one in which we own option premiums vs. short gamma in which we are net short option premium), and the overnight news is positive, we would plan which calls and puts to price attractively to draw buyers into the market. Conversely, if we were short gamma with the same news overnight, we would bid calls and puts such that we would attract option sellers into the markets. If there were known news events occurring during the day or after the close (such as new product announcements or earnings), we would keep the options bid higher until the news broke and then sell as aggressively as possible. By knowing the dates of the news events (government releases, stock dividends, earnings reports, etc.), we can plan to carry long gamma into those situations. If, however, someone is willing to bet that the news will be either so good -- or so bad -- that it will move the stock outside the expected range, we will sell them options and take the risk of going into the news event short gamma. If we've done our homework, the odds will be solidly on our side. We follow the same procedure for each position each trader has. Between traders in Chicago, Philadelphia and New York, we go through a little more than 100 such positions every morning. By 8:15 a.m. everyone is heading to the trading floor, and I'm sitting in front of the 20 monitors, watching S&P's, T-bonds and CNBC. Just 15 minutes to showtime.
Martin Chandra is a full-time investor. He has been researching investment strategies and make his own living. For more information please go to here.
Write a Review
Add to My Favorite
Refer it to Friend
Report Article
Other links at Finance > Investing
Choosing an investing strategy can be one of the hardest things an investor does. Many investors also change their investing strategy from time to time depending on market conditions and other contributing factors. An investing strategy should accurately
Category:
What to take into account when determining the best way to invest for your retirement.
Category:
The financial services that an investor chooses to use will help them create smart investment strategies for online trading. They might choose to trade with an investment management company or they might choose to go it alone and trade on Wall Street with
Category:
HYIPs bring me $8289.68 in this month. How did I get this money without work?
Category:
Here's surprising advice on how to get the best possible return on your money.
Category:
Site Sponsor
Directory Statistics
Articles: 68309
Categories: 501
Yahoo Entertainment
