In this issue - Letter To Our Clients - Len Yates - True Delta: Your Competitive Advantage - Steve Lentz - Butterfly Balancing with True Delta - Steve Lentz - Customer Support - Jim Graham INF RMER A Forum for Options Trading Ideas Letter To Our Clients Dear OptionVue Client, Beginning November 1, 2010, we are switching our QuoteVue real-time data feed over to a new source of data. Data from this day forward will now be supplied to us by Track Data Corporation. We have been working hard over the past months to get this ready and you should notice no difference between the data you are currently receiving and what you will receive after the switch. This change will require all QuoteVue subscribers to go back out to the OptionVue 6 management center and accept new exchange agreements for Track Data Corporation. The exchanges require them to have a record for our customers. To accept the new agreements, you can select Help OptionVue 6 Management center from the main menu, or go directly to http://optionvue6.optionvue.com/ov6/home.html and login to accept the agreements. Once this switch has been accomplished we will have more flexibility in improving the speed and quality of the data delivered through our QuoteVue service. There will be no additional exchange fees charged to you as a current subscriber. However, once your subscription comes due for renewal you will begin to be charged monthly exchange fees for the exchanges you then choose to subscribe to. The current exchange fee schedule is as follows: Equities/Indexes + Options Futures+Options NYSE/AMEX: $2.50 CME: $65.00 NASDA $1.25 CBOT: $65.00 OPRA: $1.25 NYMEX: $65.00 CME S&P only: $1.25 COMEX: $65.00 CBOE Indices: $2.00 ICE: $70.00 For current subscribers, the exchange fees for all equities, indexes and OPRA (options) will continue to be included and you will not be charged. Futures exchanges will be charged as they were before. However, as you renew your QuoteVue subscription, and for new subscribers, you will now need to choose exactly what exchanges you want and you would then begin to receive a monthly charge (which is passed on to the exchange) for these exchange fees. If you have any questions, feel free to call your product consultant at 847-816-6610. Sincerely, Len Yates President and Founder Option strategies carry inherent risk of large potential losses. As such, these strategies may not be suited for every investor. Len Yates President Issue 158/159 September/October 2010
DiscoverOptions Mentoring Page 2 September/October 2010
True Delta by Steve Lentz True Delta: Your Competitive Advantage By Steve Lentz, Director of Education A very sophisticated innovation lies within your OptionVue program that could give you a significant trading edge. OptionVue's True Delta calculation is far more accurate than the Standard Delta calculations used by most other options analysis platforms. By using the program's True Delta in your trading approach, you could gain an advantage. Pretty exciting stuff, huh? We'll explore this further by defining delta, examining how True Delta is more accurate, and finally by looking at a real position. Delta We define delta as the level of change in a position's value relative to change in the underlying asset. Not only does each option have a delta, but every trading position, no matter how complex, has a delta level as well. Owning 100 shares of stock gives you a delta of 100, as does owning 1 futures contract. In the case of options, each strike price has different delta levels ranging from 0 to 100. An at-the-money (ATM) call option with a delta of 50 will theoretically increase 50 cents for every dollar that the stock prices increase. However, keep in mind that after time goes by and the underlying price moves, most option contracts will eventually have far different delta levels. True Delta Standard "greek" calculations (delta, gamma, theta, vega, rho) are all theoretical in nature and come from an options pricing model, i.e. Black Scholes, Yates, Cox Ross Rubenstein, etc. OptionVue 6's True Delta calculation seeks to reflect a more "real-world" figure and thus inform the trader more accurately of his directional risk. Although several variables go into the Standard delta calculation, OptionVue's True Delta includes two important variables absent from the Standard approach. Both of these items address the fact that implied volatility (IV) can change as the underlying price level changes. They are: 1) CEV (constant elasticity of volatility), and 2) Volatility Skew. CEV Briefly, CEV represents the historical change in implied volatility relative to changes in the underlying's price level. For example, stock index option traders will notice that the implied volatility (IV) of the options increases as the underlying stock decreases. Conversely, the IV goes down as the index goes up. In fact, many institutions and traders will go long VIX futures to help long stock portfolios, the thinking being that as the SPX declines, then the VIX will rise and the long futures will make money. This shift in IV will have a small effect on how each option changes price relative to how the underlying asset moves in price. For an option's delta to be most accurate, this effect must be factored in. In OptionVue 6, each asset has its own CEV number which is updated each day in files downloaded into OptionVue 6 each morning. (continued on page 4...) Page 3 September/October 2010
True Delta by Steve Lentz (continued from page 3...) This figure is derived from a 60-day correlation study done for each asset that trades options. For more information on CEV, please read the article, "The Constant Elasticity of Volatility", located in the advanced options trading articles section in the Education tab at www.discoveroptions.com. Skew Volatility skew refers to the change in implied volatility as a strike moves from in-the-money (ITM) to out-of-the-money (OTM) and vice versa. See Figure 1. Here, if the SPX rises 25 points, then the Jan 1150 call option's mid-implied volatility (MIV) would theoretically rise from 22.0% to 23.3%. Consequently, if the SPX dropped 25 points, then the 1150 call contract would drift OTM and its MIV would theoretically drop from 22.0% to 20.8%. This change in MIV can dramatically affect the option price and, hence, the functional or "true" delta experienced in real life. Figure 2 below shows how a 1% difference in implied volatility can change the 1150 call contract's price, assuming all other value inputs stayed the same. So, if our 1150 call drifts further ITM and its MIV rises an extra 1%, then that translates into an extra $3 tacked onto the option price. This is significant. Oddly, broker-provided options analysis platforms, using a Standard Delta calculation, IGNORE the fact that different strikes have different implied volatility levels (skew). They assume that no matter how far an underlying market may move, all options for that market will maintain their implied volatility levels indefinitely. This is simply wrong and unacceptable for serious options traders. In OptionVue 6, the volatility skew is assumed to exist into the future so that an option's IV will change as it drifts further or less in-or-out-of-themoney. This can have a significant impact on delta calculations as you can see in Figure 3. Compare the deltas is Figure 3 with those in Figure 1. Figure 1: Standard Deltas. Figure 3: True Deltas. Figure 2: Prices of the 1150 Call with IV altered just 1%. (continued on page 5...) Page 4 September/October 2010
True Delta by Steve Lentz (continued from page 4...) Impact How will this impact your trading on a personal level? First, the contract size will have a great part to play. The Standard vs. True Delta difference will play out more significantly with a 100-lot position as opposed to a 1-lot position. For example, in Figure 3, a 10-lot 1150 call position will have a True Delta of 534 and a Standard Delta of 498. That's 36 SPX deltas that a trader might decide to easily adjust, depending on the strategy and goals. However, a 1-lot position will have a Standard vs. True Delta difference of just 3.6, a far less manageable figure relative to the contract size. Second, certain strategies will require more attention to the delta figures. Please read the article entitled, "Butterfly Balancing with True Delta" which is included in this Informer Newsletter. The practical use of use of True Delta vs. Standard Delta is brought to life in the form of adjusting a Butterfly position. Join Steve Lentz every Wednesday morning at (8:00am CST) for "Steve's Morning Market Huddle." During these interactive broadcasts, Steve will discuss current market conditions as well as specific option trades that could capitalize on recent technical analysis triggers. View the LIVE and Archived Session Here. Page 5 September/October 2010
Butterfly Balancing with True Delta by Steve Lentz Butterfly Balancing with True Delta By Steve Lentz, Director of Education Butterfly option spreads occupy a major role within our DiscoverOptions Personal Mentoring Program. Although this strategy is commonly described in books, articles and seminars, OptionVue's analytics reveal nuances that make our treatment of this strategy different than what is commonly taught. This article will address these differences so you can be a better Butterfly Spread trader. A Butterfly Spread involves selling two atthe-money option contracts and then buying one out-of-the-money option and one in-the-money contract of the same type, same month, and the same distances apart from the short 2-lot position. A Butterfly Spread can make profits because the short 2-lot position has decaying time premium greater than the collective time decay from Figure 1: Broker Module Settings. the outlying long positions. Figure 1 shows a Butterfly Spread with delta calculations approximating that of typical brokerprovided options analysis modules, i.e. using a uniform model with the CEV and True Delta settings turned off. The overall delta is calculated by adding all the position deltas together, i.e. 78.1 + 25.4-51.5-51.5 = +0.5. Visually, this translates into a very flat T+0 line in the Graphic Analysis screen in Figure 2. Figure 2: Graphic Analysis using typical Broker Module settings. (continued on page 7...) Page 6 September/October 2010
True Delta by Steve Lentz (continued from page 6...) However, there is a big problem with typical broker module settings: They ignore the vertical skew and treat it as if it does not exist! Take another look at Figure 1 and in particular at the Mid Implied Volatility (MIV) levels for each call option. Now, answer this question: If the underlying market rises in value, will the 113 contract's MIV go up or down? Clearly, the in-the-money (ITM) calls have higher MIV levels than the out-of-themoney (OTM) calls. One can therefore surmise that if the underlying asset rises in value, then the 113 call will adopt a higher MIV level as it moves more and more in the money. Since delta measures how an option price changes value relative to movement in the underlying asset, then all of the call option deltas should be higher if this skew is incorporated into delta calculations. In Figure 3, OptionVue's True Delta feature is turned on and this effect is incorporated in each option's delta level. Let's now do a position delta Figure 3: Variable Model with CEV and True Delta activated. analysis with these new, more accurate delta calculations. 12.3 + 83.7-54.5-54.5 = -13.0 So, this Butterfly Spread actually is delta short (-13) rather than nearer to "delta neutral" (+0.5). That's right. In options with vertical skews like this one, ATM Butterfly Spreads are actually delta short rather than delta neutral. Figure 4 shows a clear Graphic Analysis screen. Notice how the T+0 line (dotted) is slanted upward to the left. This means the position can make money with a downward move and Figure 4 (continued on page 8...) Page 7 September/October 2010
True Delta by Steve Lentz (continued from page 7...) lose money with an upward move. So, how can we balance this position and make it so that our directional exposure is more balanced? Well, with an overall delta of -13, we just need to acquire positive deltas to counter this. Figure 5 offers one suggestion. By purchasing an extra OTM 119 call with a delta of 12.3, the position's delta is now just -0.7. Figure 6 displays a Graphic Analysis of this adjusted position. See how the T+0 line is much flatter now. The underlying will have to move pretty far in either direction before this position gets in serious trouble. So, when looking at Butterfly Spreads, make sure you use OptionVue's True Delta feature to get as accurate of a view as possible. Then, propose adjustments needed to properly balance your position if you truly want delta neutrality at the start. Figure 5: Buy an extra OTM call to help balance deltas. Figure 6: A much flatter T+0 line. Page 8 September/October 2010
Customer Support by Jim Graham Customer Support Section by Jim Graham, Product Manager Is there a way to see the average volatility readings in the past in a more precise form rather than just eyeballing the Volty Chart? A statistics block showing average SV and IV over various lengths of history can be viewed in a Volty Chart by clicking the "V" button in the lower left corner (Figure 1). Is there an easier way to enter an offsetting (closing) trade into the matrix than by just typing it into each trade field that has an existing position? From Account Status, it is possible to send the trade(s) that would close an existing position directly into the Matrix. Simply right click on a position in Account Status and choose the "Send Closing Trade to Matrix" entry in the menu. It seems like the amount of slippage that OptionVue 6 is estimating in the Graphic Analysis is larger than I have actually seen occur. Is there any way to adjust this? There is no way to adjust this other than to actually change the slippage model you are using (this can be seen by selecting View Default Models from the main Figure 1 (continued on page 10...) Page 9 September/October 2010
Customer Support by Jim Graham (continued from page 9...) menu). However, in version 6.27, in consideration of today's tighter options markets, the slippage model was adjusted to ½ of the previous amounts when using the Small, Medium or Large degrees. I noticed that there is now a percentage number shown next to the Breakeven (B.E.) in the Graphic Analysis. What does this number represent? On the Graphic Analysis screen, the B.E. number(s) in the bottom left area continue to show the underlying price at which the risk graph crosses the zero (break even) line. It now also shows a percentage number(s) with them, e.g. B.E. 56.60 (+7%), which tells you what percentage the underlying price has to change to reach them. How do you use the Volty Chg field in the Graphic Analysis? Is this an absolute or percentage change in the implied volatility? Next to every Volty Change field in the program we added the label "Pts" to make it more explicit that when you enter a number for volatility change, the program interprets this as a change in terms of percentage points. For example, if the normal volatility is 30% and you enter +4% in the Volty Change field, the program will now use 34% (it does not increase 30% by a factor of 4% -- to 31.2%). Why is there a 15:30 (Central Time) available in BackTrader when most things are done trading by 15:00 or at least 15:15 during the regular market? The options on several popular indices and ETFs continue to trade past 3:00 Central Time - up until 3:15 usually. For this reason, and to capture the day's closing prices for the ES and other futures based options, we began storing one extra set of prices each day for BackTrader. From Feb. 16, 2010 on we have been storing a 15:30 (Central Time) snapshot and you may access these prices using OptionVue in BackTrader mode. If you have a question for Len, Steve, Jim, Product or Tech Support, email it to: feedback@optionvue.com Page 10 September/October 2010