I came across this web site that could be useful for investors using options.
I don’t understand it. Maybe someone can explain it to me?
Wendy
3 Likes
Dear Wendy,
In two nutshells,
One statistical models for the values of options.
Two what the underlying equity does which is often completely different as relates to option values.
You are from NYC, you have seen guys on street corners playing craps. The rules keep on changing.
Bottom line the house will win if you play long enough. Hence non applicable literature on the statical modeling of the value of options. When you sign up for permissions to gamble the house will provide these non applicable materials for you to study.
A court of law will say you were warned.
Leap she was asking for help, You really didn’t need to say anything if you didn’t know. You do not have to answer every question.
9 Likes
Neither do I.
Ergo’s version of the Option Selector? 
o o o o o o o o o o o o o o o o o o o o o o o o
To learn about advanced option trading I recommend
The Captain
6 Likes
I did help. It is the set of answers.
Andy when someone answers a question listen to them. If you can not comprehend the answer discuss it with them.
Buy programs occur when the futures market is over-valued relative to the stock market and consists of the index futures being sold and the stocks in the index being bought. Sell programs, the opposite case, occur when the futures market is under-valued relative to the stock market and consists of the index futures being bought and the stocks in the index being sold. Over-valued and under-valued conditions arise because trading in the futures and equities markets occurs independently. The key to determining these over or under-valued conditions is the arithmetic difference between the futures and the spot index (which is known as the premium).
The five terms of fair value, sell active, sell threshold, buy threshold, and buy active refer to specific values of the arithmetic difference of an index futures contract price minus its spot (or current) price
My comment in the statistical model delta is the difference between market value and overvalued or undervalued. The underlying equity news events are not playing a role in delta. That’s the rub.
We know…
AI Overview
While a significant portion of options expire worthless (approximately 80%), only a small percentage expire in the money, meaning they are worth exercising. Specifically, only about 7% of options positions are typically exercised, indicating that these options expire in the money.
Ok Leap thanks that explains what they are doing but now explain this.
How are they coming up with those numbers? Explain it to me like I am a five year old.
I need more detail give me a moment.
Spot prices
Bottom of another dialog box on Wendy’s link. Usually spot values are out three months. I would need more detail to be specific.
Sell
Active (SA) Sell
Threshold (ST) Fair Value
(Premium) (FV) Buy
Threshold (BT) Buy
Active (BA)
This is the “futures - spot” index premium value at which sell programs should be prevalent, producing a meaningful decline in the stock market.
In the graphs above, the sell active value occurs on the left side where the probability of a sell program approaches 100%. This is the minimal “futures - spot” index premium value at which sell programs might be initiated. Sell programs are possible and could cause a stock market decline.
In the graphs above, the sell threshold value occurs on the left side where the probability of a sell program is just greater than zero. This is the “futures - spot” index premium value at which the futures and the equity markets are in equilibrium. No (profitable) index arbitrage type programs will occur at fair value nor when the “futures - spot” premium level falls within the range extending from the sell threshold to the buy threshold.
This range occurs in the middle portion of the above graphs where the probability of any program activity is equal to zero and, hence, falls on the horizontal axis.
An equation for “fair value” is presented in the Help Pages. This is the minimal “futures - spot” index premium value at which buy programs might be initiated. Buy programs are possible and could cause a stock market rise.
In the graphs above, the buy threshold value occurs on the right side where the probability of a buy program is just greater than zero. This is the “futures - spot” index premium value at which buy programs should be prevalent, producing a meaningful rise in the stock market.
In the graphs above, the buy active value occurs on the right side where the probability of a buy program approaches 100%.
Dear Andy,
You can piece together the model. It will not jive with other elements in the trading world. That is why options expire worthless most of the time.
Statistical models do not hold up. Using them repeatedly is more than possible.
If you are selling calls that will work.
I was asking how they came up with those numbers Leap. That seems to be the heart of the system. I still do not understand. So how would I calculate the system to come up with those numbers on the S&P, Nasdaq, and Dow? They are doing an arbitrage between those index’s.
@physician @gdett2 Would either of you understand how they are setting up this arbitrage on the indexes. Explicitly how they are calculating the numbers in this:
Wendy after reading the Help portion of the website and not understanding how they are doing it, I came to the conclusion that it is never something I would use. It is based on short term investing and isn’t something I want to do. I am sorry I couldn’t be of any help.
2 Likes
Program trading is a (nearly) perfect arbitrage situation where you are guaranteed to make money. For example, say you look at the current price of the S&P 500 index and the S&P futures contract and see that the premium (the price of the futures contract minus the S&P index) is 34.74, the value the website calls “Buy Active.” The arbitrageurs will be active, meaning they will have their software programs actively trading. They will be buying all 500 stocks in the S&P 500 index in the correct proportion (capitalization weighting) and selling one of the S&P futures contract. When they are done, all they need to do is wait until contract expiration and deliver the 500 stocks to settle their short futures contract and everything disappears. Their profit is the premium they received minus the interest cost they incurred by carrying the stock.
This is the theoretical explanation of the perfect arbitrage. Reality is a little bit different. First of all, you asked for the exact formula they use to calculate the numbers. Part of it is the formula for the interest carrying cost which could be specified precisely to your satisfaction. But the other part is the actual cost of putting on the position (slippage, fees, etc.) That is based on the actual costs they’ve seen historically. I’m sure they have a formula but I’ve never seen anyone share it, but your own typical costs are something you’d learn pretty quickly from experience.
They might trade as I described, but I would guess many program traders only buy/sell 50 to 100 stocks that create a very close, albeit imperfect, correlation with the index. They also probably trade out of the position before expiration if it comes back into line. This would increase their profit by reducing the interest carrying cost.
So, we don’t know their exact formula. But we know that (1) program trading exists, (2) it is based on a theoretically valid perfect hedge, and (3) what parameters go into the formula to calculate the profit/loss (interest rates, slippage). We just don’t know the exact formula.
I would also guess the website operator is not a program trader. Rather, he just notices when they are present in the market, backs out the cost of carry and back calculates their slippage costs to create his numbers. The result should be accurate.
6 Likes
BTW, this discussion has nothing to do with options, rather just the futures markets. I suppose you could use options to enhance your returns, but that is entirely separate from what is being discussed.
6 Likes
Ok Thank you PickTrader that is a very good explanation. That gave me a much better understanding of what they are doing.
4 Likes
Dear Andy,
I haven’t dealt with the math since 2001.
Trades make a market. There is math for the correlation of the scatter data. St deviations are built. The spot price is right now. The future contract is forward looking. Those are probably the prices used to correlate. Its been a while. I believe the st deviations are the triggers.
The word guarantee is a red flag.
Other elements of the math I do not know. But guarantee is not possible.
Thanks anyway Leap. I appreciate your help.
2 Likes
Those types of program traders are part of what [quickly] eliminates those “out of whack” valuations. When the underlying stocks are valued [slightly] lower than what their index represents, the program buys the stocks and sells the index (effectively) and that action tends, by its very nature, to bring the two closer to its “true value”. And the same vice versa, when they sell the stocks and buy the index (effectively). Usually this type of arbitrage opportunity is VERY slim and individual traders couldn’t possible do it on their own. That’s because all the quotes for analysis and all the trades have to be done at once. There was even an article a few years ago about the advantage of location because being closer physically to the exchange (where all the quotes come from) gave them a few millisecond advantage over being located a few states away.
Someone mentioned that most options expire worthless. That’s probably for a similar reason why most annual insurance policies expire “worthless”.
1 Like
Futures and options are vanishing assets. When the price drops quickly it’s time to harvest as little value remains. Not only do you save on interest but you free up capital to go after the next best trade.
The Captain
Let’s say there are ten horses in a race, nine expire worthless! There is only ONE winner. The object of the race track is to make money. The winning ticket has to pay out less than the money collected from all the tickers sold.
In other words, the odds are rigged in favor of the house. A few gamblers make money but the totality of gamblers lose money. How are the odds rigged in future markets? By the fees they charge. Unlike investors, brokers make money coming and going.
Insurance has more uncertainty than horse racing and it relies on the law of large numbers. Just in case the law of large numbers fails them, insurers further diversify with co-insurance and re-insurance.
To understand the trade you need to understand the whole ecosystem.
The Captain
1 Like