I didn't hear the presentation but I can maybe add a comment or two that
might help understand the "market maker mindset." Mr. Cottle comes from a
floor tradition. Once upon a time - surprisingly not that long ago - market
makers had to manage their positions using a basic handwritten carding
technique. With that method everything traded was resolved into a synthetic
equivalent call or put unit plus or minus stock (or whatever the underlying
happened to be) and marked on a trading card like so many notches on a
chalkboard. Perhaps not so surprising is that this is still a very good,
fundamental way to manage a dynamic position and to recognize where all your
risk resides in a momentary glance.
The reason why floor traders decompose positions into flies is that these
are excellent ways to tell you just about everything you need to know about
options. If you know how a fly behaves (e.g. how they change based on time
and/or volatility) and how they are priced relative to each other you can do
your job as a market maker (i.e. make fair markets without creating
arbitrage situations or mis-pricings) and you can effectively see ways to
attack any risk in your current position. further, changes in those
relative fly prices tells you a great deal about the underlying
supply/demand characteristics of the market.
example: with abcde at 100 if you have the +95/-100/-105/
decompose this into two flies, namely the 95/100/105 and 100/105/110 flies.
If you recognize that the atm fly is at its max value then you can see what
is (admittedly obvious) that the 95/100/105 fly is vulnerable to any price
movement away from the 100 strike. Depending on the market and your net
position cost, you may want to seize on any opportunity to close that atm
fly. Further, if you want to hold onto the atm fly in anticipation of
further theta accumulation, you can look to the cheap outside flies (or
components thereof) as very easy ways to mitigate the risk of that atm fly.
e.g. if you can see the put side flies starting to skew up in value, add the
+90/-2 95/+100 fly to net into a +90/-95/-105/
protect against some downside threatening movement in the underlying, and so
on. With the stretched condor you have effectively added some downside gamma
protection while retained the embedded value of the atm fly to bring in all
that theta decay.
It takes some getting used to when trying to analyze a position in this
manner but the old coaching cliché of "drill to build skill" makes the
effort worth it in my opinion.
-----Original Message-----
From: OptionClub@yahoogro
Behalf Of Ricky Jimenez
Sent: Sunday, September 06, 2009 6:11 PM
To: OptionClub@yahoogro
Subject: Re: [TheOptionClub.
On Sun, 06 Sep 2009 17:17:28 -0000, "janzen257"
<yahoo.to.mj257@
>As for Ricky's request for risk graphs at expiration..
same way; I think that this is how most of us envision our trades. But if
you look at pictures of the CBOE floor, for example, and look closely at the
hundreds of screens, you don't see any graphics at all -- no price charts,
no risk graphs, nothing! Clearly that's not how the professionals manage
their positions. I'm nowhere near ready to give up my training wheels yet,
but it doesn't surprise me that someone as experienced as CC doesn't have
risk graphs for his example trades.
So what do you see on the screens? If a trader is always doing the
same kind of spread, he knows what the risk graph looks like very well
and can figure out where he is by checking a few numbers.
By the way, I tried to understand what Cottle's dissection algorithm
is, by reading in his book, and got nowhere. Can anybody here explain
it? His books get enthusiastic reviews on Amazon but these reviews
say little about the content.
------------
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