LevelTrading

Option Volatility and Pricing - Natenberg

Ch1

Options futures are settled like stock, so they are unrealized gains / losses until position closes. This is in contrast to futures, which are settled at the eod where all gains / losses are realized and deposited into each person's acct.
Modelling

With stock type settlement - higher interest rate lowers value of option
Higher interest raises stock price, but also increase carrying cost, which lowers value of option
If you have 60 days until expiration, use 60 day t bill, find the appropriate t-bill that matches the option expiration

Daily STD - 256 trading days / year, so divide annual volatility by 16 to get the 1std of daily returns. Ie: if 20% volatility, one would expect < 1.25% or less daily price change 2 / 3 days, and < 2.5% 19/20 days (2 std)
Weekly STD - 52 weeks / year, so divide by 7.2. 20%/7.2 = < 2.75% for every 2/3 weeks

Delta is also approximately the % that option will finish in the money. It's also the hedge ratio against the underlying

For contracts w/ longer expiration the ATM 50 delta option will not always be the one closest to the current price, but the price * interest rate

gamma and theta have opposite signs and are negatively correlated. the market will either move (gamma) or stay still (theta)

Vega of all options decline as expiration approaches, so long term options are always more sensitive to vega than short term
These greeks help you identify risks to make good decisions, not remove risk. A trader that over analyzes these greeks will suffer analysis through paralysis and will be unable to make money. The point is to find out which risks are acceptable and which are not.

these are concerned primarily with the magnitude of movement in the underlying, not the direction
volatility consideration should always be more important than delta consideration, if not, the trade is not a volatility spread

Spreads which are helped by movement in the underlying have positive gamma, and hurt by movement have negative gamma

positive gamma is said to be long premium and hoping for a volatile market with large moves in the underlying
negative gamma is short premium
any positive gamma trade will have a negative theta, and vice versa

if IV is high, look for spreads with negative vega, if IV is low look for spreads with positive vega
long time spreads are likely to be profitable when IV is low but expected to rise, short time spreads is opposite

adjust at regular intervals - adjust based on your volatility estimate, ie: daily volatility estimate, require daily adjustments
adjust at predetermined delta - if you're willing to take directional risk, allow for delta up to a certain point
adjust by feel - if the position's gamma will put you at a certain level of delta at a particular price level(positive delta at support), and you're correct, you will have saved yourself an unprofitable adjustment

Theoretical Edge is what you determine to be the correct value for the option greeks.
Delta Risk - risk that underlying will move in one direction over the other

neutral position doesn't eliminate all risk, but it is immune to directional risk in a limited range

negative gamma position can quickly lose its theoretical edge with a large move in the underlying contract. the consequence of this move must always be evaluated when analyzing each position

if you have positive gamma, how long can you wait before the theoretical edge disappears. If the movement fails to appear in 1 day, 1 week, ect...does that negate the edge?

vega is a risk present in every position, how much can volatility move before the potential profit from a position disappears

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