A Day In The Life Of An Options Trader

5:45 – early rise, whichever desk you end up on you are most likely going to be waking up around this time. Adjust your sleeping habits accordingly or suffer for most of the day.

6:30 – Arrive on the desk, market opens in 90 minutes so its really a countdown from here. 20 minutes is spent just turning on all the systems, with 4 computers and basically each running 10-15 different applications this is quite time consuming. Its inevitable, but you will every morning forget to log in into one crucial system and realize at the worst absolute moment.

6:50 – Start reading various new sources, generally FT, Bloomberg, City AM, and then the internal research that comes out. Finish off with a couple broker chats.

7:15 – look at the largest positions on the book and try to come up with a rough game plan for the day. I generally like to make a list of risks I don’t like, in order of priority, and then work down the list throughout the day. You want to make sure you know the biggest risks in every category (ie gamma, vega, delta, decay, skew, div).

7:30 – Morning meeting with sales and research, generally a hard time if you have had a rough night

7:50 – Just do a last glance over the stock news to make sure nothing has been missed before the open. Last thing you want is to be surprised by a big move on the open. One good thing to keep in mind is that you never want your boss to ask you a question and you cant answer. If you are running risk, you need to be aware of everything at all times.

8:00 – Market opens, watch any big movers on the day, cash equity prices find their levels fairly quickly, vol levels adjust a bit slower, generally within the first 10 minutes you get an idea of where vol is on most names.

8:15 – First wave of client requests comes in. I cover several of sectors so you can get a backlog of 7-10 prices pretty quickly. Prioritize them by clients and size. It is crucial that even when you only have a couple minutes for each price you make sure you have all your bases covered. With options because you have so many different risks, you need to make sure you are not being picked off on vol (so check if anything similar is in the broker market already trading, this is also a venue to hedge out risk and allows you to skew your price accordingly), make sure you aren’t being picked off on divs and make sure that you can find borrow on the stock if you are selling shares as part of the trade. With the rules on short selling in Europe this has become more of an issue recently.

8:30 – Finally send off last of the prices, and get some time to look at how the book is doing, start phoning up brokers and start working some trades. Options on single stocks in European trade a bit differently than in the US, the liquidity is not the same. The issue is that screen prices are kept very tight in extremely small size, and clients expect the same spreads in size that is 50x larger. Problem is that unless you can find someone to find the other side in the broker market, you will get wider prices with brokers than you give to clients.

This means to survive you need to be constantly aware of what brokers are working so that you can spot chances to offload risk. So when a client request comes in you can skew it appropriately. The best case scenario is when you know someone is a buyer in the broker market, buy it from a client at a vol from mids, and then offload it in the broker market at a vol above. However, this is very rare, so most of the time you need to make a price based on a prop view if you will. You need to price it according to your view of the trade, instead of where you can offload it

9:15 – On a typical day, this is around the time when things calm down, generally chat with co workers or use the time for a bathroom break. Always go when you have a chance and not when you need to, nothing unfocuses the mind more than having to go to the bathroom, and sometimes you just cant go for 30 minute stretches.

10:00 – Still fairly quiet, finally get to fire up Excel and work on some longer term projects. It gets difficult on a flow book because you need to find the balance between looking after the risk, but at the same time explore opportunities to move the business forward.

10:15 – spoke too soon, big client request comes in, good client so the price needs to be very competitive. Basically a double edged sword, you can take a lot of PNL upfront on the trade, but you know that getting out of the position is impossible and will take a couple weeks. Price it with the help of the senior guys on the desk and get back to excel.

12:00 – company announces a profit warning, unfortunately you have a short gamma position and the stock is down 5%. This is one of the situations you hate to be in. The stock is down 5% and because of the short gamma you are long a lot of delta. Now do you sell the shares 5% down or hold on and hope it rallies back. As a personal rule I like to keep my delta’s from my short gamma’s to a certain limit, and I hedge so that it never crosses that limit. You do not want to be stuck with a stock that drops 20% in a day and you just sit there watching it.

This is also important that you know everything about your short gamma’s, more so than your long’s, because if something gaps down you need to know what your pnl and delta is. With longs its fine because its positive pnl, but negative pnl always brings more senior attention. You also need to make sure you know not just your local risk, but your risk as spot moves. Because in a client flow book you have thousands of positions, your risk can quite easily flip as parameters move. That is why you need to look at your risk in three dimensions, time and spot. Its what makes derivatives more interesting than delta one products, but it also takes a bit more effort in terms of risk management.

12:30 – stock has calmed down so get back to excel, keep an eye on the chart in the corner of the screen though if it has any follow up move.

13:30 – Attend an IT meeting for 30 minutes, just really listen to updates on various projects that are being worked on.

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ETF Call And Put Options Explained

ETFs are great portfolio building blocks thanks to the low-cost, well-diversified nature of these products. Aside from buy-and-hold investors, active traders have also embraced these financial vehicles as viable tactical tools thanks to their ease-of-use and unparalleled liquidity. Furthermore, sophisticated investors have come to utilize options in conjunction with ETFs, further expanding the arsenal of available trading strategies that are ultimately designed to minimize risk [Download 101 ETF Lessons Every Financial Advisor Should Learn]. 

Options are a financial product that allow you to profit from fluctuations in an ETF without actually buying the ETF itself. Ultimately, this means it is less capital intensive to purchase an option. For example, if an ETF is trading at $50, to buy 100 shares costs $5,000 plus fees. Since an option only captures fluctuations, it may sell for $1—called the option premium–so controlling 100 shares only costs $100 plus fees [see 5 Important ETF Lessons In Pictures].

Options do have an expiry date though, and whether that expiry date is far away or near is a large determinate in the cost of an option; the further the option from expiry, the higher the cost of the option. The relationship of time-to-expiry and price is represented by the term Theta.

Since you’re not buying an actual ETF, you’re buying a derivative of it, the option will increase and decrease in value as the price of the ETF fluctuates. How much the option price moves relative to the underlying ETF is defined by Delta—or the relationship between changes in price of the two assets. Another measure used in options trading is Gamma. Gamma is primarily used to see how risk will change (delta) as the price of the ETF changes.

While these terms, called the Greeks, are important for developing a full understanding of how options work and are priced, most traders will benefit from simply knowing how, why and when to buy and sell call and put options. Option trading doesn’t need to be complicated [see 3 ETF Trading Tips You Are Missing].

A call option gives the right to buy an ETF at a specific price–called the strike price–within a certain time period.

Assume you believe the price of the S&P 500 SPDR ETF (SPY) will rise over the next month. If it currently trades as $135, you can buy a call option with a strike price of $135 and with an expiry date of one month or more away. Remember though, the further the expiry date the more expensive the option, so don’t choose a further away expiry date than necessary. If the ETF moves above $135 your option will increase in value.

While the price of the options will vary with volatility and time to expiration, assume that buying a call option with a strike of $135 and an expiry date 6 weeks from today costs $1.20 per share, or $120 to control 100 shares. If the price rises to more than $136.20 ($135 + $1.20) you will have covered the cost of your option and any further upside is pure profit. If the ETF price rises to $138 and you decide to sell your options, you will reap a profit of approximately $138 minus $136.20, or $1.80 per share, or $180 less fees — not bad for a $120 investment [see also 5 Simple ETF Trading Tips].

On the other hand, if the ETF price declines, the most you can lose is the $120 you paid for the option, or you can try to sell the option before expiry to reduce the loss.

Your loss is limited to the amount you pay for the option. As the ETF or stock price rises it eventually reaches your break-even point. If it continues to rise your profits are unlimited.

Figure 1: Buying a Call Profit/Loss Graph. Source: CBOE Profit Diagrams

Most options traders choose to sell the option when they have accumulated a profit, instead of letting the option expire and exercising their right to buy the ETF shares. If the option is not in a profit position, it can be allowed to expiring worthless and you will lose the amount you paid for the option, or you can try to sell it before expiry to minimize the loss [see also Low Volatility ETFdb Portfolio]. 

Selling a call option–called writing a call option–means you are giving someone else (the buyer) the right to buy an ETF at a specified price within a certain time frame. In exchange for this, you receive the premium that is paid by the buyer. Since you are giving someone else the right to buy the ETF at a specified price, if you don’t own the ETF—this is called “naked” call writing–and it rises in price considerably, you face infinite losses. At the same time your profit is limited to the premium you received for writing the option.

If you already own the ETF and write a call option—“covered” call writing—then your risk is limited, since you simply give your ETF shares to the buyer if they choose to exercise their right. In this case, you give up the upside potential of holding onto the ETF shares, but receive the option premium in exchange. Most traders write covered calls, as writing naked calls can be financially dangerous [see Buy-Write ETFs].

Assume you own 100 shares of the SPDR Gold Trust (GLD). You believe gold will rise over the long-term so you want to hold onto your shares, but believe gold will stay near current level, or even drop over the next month. To generate some money from your holdings, you decide to a write a call option.

As of December 14, 2012, GLD trades at $164, so you will write a call that will expire in one month, for a price higher than the current price – $170, for example. This is called an out-of-the-money or OTM call.  You receive $0.46 per share for writing this option, or $46. If the price of GLD stays below $170 you keep the $46, and still own your ETF shares. If the price rises above $170 you will need to give your shares to the option buyer at $170, but you still keep the $46 [see 25 Things Every Financial Advisor Should Know About ETFs]. 

Figure 2: Covered Call Profit/Loss Graph

In general, as the ETF or stock price rises, your profit is limited. If the stock drops, you still face the loss from the declining ETF price, but it is at least partially offset by the premium your received.

A put option gives the right to sell an ETF at a specific price within a certain time period.

A put option gives you the potential to profit from a price decline in a specific ETF. Therefore, by buying a put option you hope the price of the ETF declines so your put option will increase in value.

Assume you believe that the price of oil will fall over the next month, and along with it the price of US Oil Fund ETF (USO). The ETF currently trades at $32 so you buy a put option that expires one month from now with a strike price of $32.

The put option costs $1.15, or $115 to control 100 shares. Therefore the price needs to drop below $30.85—your breakeven point–in order for you to start seeing a profit. If the price rises or stays above $32, and you and allow the option to expire, your loss is limited to $115  [see The Total Cost Of ETF Investing].

Figure 3: Buying A Put Profit/Loss Graph

In general, your loss is limited to the amount you pay for the option. As the ETF or stock price falls it eventually reaches your break-even point. If it continues to fall your profits continue to rise, but are not infinite since the lowest price an ETF can go is $0.

Selling or writing a put option means you are giving someone else (the buyer) the right to sell an ETF at a specified price within a certain time frame. In exchange for this, you receive the premium that is paid by the buyer.

Since you are giving someone else the right to sell  the ETF at a specified price, if you aren’t short the ETF—“naked” put writing–and it falls in price considerably you face large losses. At the same time your profit from the option is limited to the premium you received for writing it.

Covered put writing is not that common either, but is used in some cases to incrementally increase the return on your short positions. Assume you are short the Silver Trust ETF (SLV), and believe it is going to stay stagnant or maybe even slightly increase in value, but not enough for you to worry about closing out your short position. You sell a put option that expires in one month at $29 – well below the current market price of $31 for example. For this, you receive an option premium $0.15 per share, or $15 for 100 shares.

If the price rises slightly the premium serves to offset some of the loss on your short position. If the price declines you profit on your ETF position down to $29, plus the premium you received. If the ETF continues to drop below $29 though your gains are capped as the put buyer will exercise their rights.

Figure 4: Covered Put Profit/Loss Graph

Option prices are determined by measures such as delta, gamma and theta. Yet, simply understanding how, when and why to buy or sell call and put options can get you started. Adding options to your ETF trading strategy can help maximize your risk-adjusted returns over the long-haul, however, keep in mind that it takes both dedication and patience when it comes to mastering these powerful financial derivatives. Current option prices are found on the CBOE website.

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Disclosure: No positions at time of writing.

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