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August 10, 2011, 09:37:58 PM *
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Author Topic: do ppl use the action on options as an indicator for trading stocks?  (Read 19 times)
Ad
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« on: July 26, 2011, 12:15:35 AM »

do ppl use the action on options as an indicator for trading stocks?
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John_W
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« Reply #1 on: July 26, 2011, 04:30:26 PM »

It is naive to believe that people trade in options purely on speculation of whether the underlying stock will rise or fall, that's only the simplest possible mechanism for profit.   Options have a nonlinear relationship of price to profit hence they are far more useful in combinations to reduce risk than to just buy in hopes their price will go up.   For example, if you buy an at the money call and an at the money put then you will make money if the underlying stock price goes up or goes down, it would then just be a matter of the stock rising or falling enough to recoup the costs of the options which are a fraction of that of the options, this is called a long straddle.   If you buy an out of the money call and an out of the money put then you make money if the underlying stock rises or falls enough for one of the option to be in the money but the cost of the options are much lower than that of ATM options, this is called a strangle.   If you sell an at the money put and an out of the money call then you immediately make the money from the sale of the options and you lose money if the underlying stock price rises or falls but it has to rise or fall a certain amount before you lose the money that you've made from the sale of the options, this is a short straddle and reaps the extrinsic time delay value of the option.   The disadvantage of the short straddle is that extreme price movements can mean an extreme loss in that the potential for loss is unlimited but this can be countered by surrounding the short straddle with an inexpensive long strangle, the combination of the two strategies is called a butterfly.   So what do the actions on options indicate?   Is the purchase of a call option because someone thinks the underlying stock will go up or does that somebody even care as they're setting up a delta neutral position to remove the risk of loss in a combination play?
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drmark27
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« Reply #2 on: July 26, 2011, 05:33:33 PM »

Yes they absolutely do.  

However, the question you should really ask is whether action on options is a reliable indicator for securing future profit?  

No, it's not.  Looking at open interest, for example, you never know if options are bought or sold so you have no idea which direction to pursue.
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JoeyV
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« Reply #3 on: July 26, 2011, 09:49:30 PM »

I think you can use option implied vol in Bollinger Band-like trading systems...
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