TRADING FLOOR SECRETS: Why the Greeks are Crucial
October 17, 2006
The saying, “If you can''t measure it, you can''t manage it” is why every time I had employees, I made them get on a scale every morning. There''s also an old saying from either the Bible or Mad Magazine (I can''t recall which) that states, “Give a man a fish and he will eat for a day. Teach him how to fish, and he will sit in a boat and drink beer all day,” but that has nothing to do with this article.
There will inevitably be a time in your options trading when, either because of negative complications or massive opportunities, you positions may become to complicated to manage. Attempting to keep track of 4, 5 or 12 separate positions may get too complicated by simply saying to yourself, “Okay, I have 12 short butterfly spreads, 18 long call spreads, a long collar, short 10 contracts of the double diagonal, 9 condors, 25 broken-winged butterflies, etc.” This is when a working knowledge of the greeks becomes not a luxury, but a necessity.
You may have a lethargic or reactive stance regarding taking your education to the next level whether you have reached your goals or have gotten disappointed and unmotivated. You may have the attitude of, “Eagles may soar, but weasels don''t get sucked into jet engines.” I strongly urge you to break out of this reactive mind frame and begin getting comfortable with the greeks. Like CPR, it may feel like it is something you will never need, but the life you save one day may be your own.
Many people get suckered into the belief that the greeks are some esoteric concept and theoretical material that does not have any practical application, and that they are difficult to understand. Nothing could be further from the truth. Not only are the greeks practical, but they are easy to understand if presented correctly. It was not until I got very good at the greeks that I began to understand the real forces at work behind the scenes with my trades.
Prior to understanding the greeks, I would sit in amazement, frustration and confusion as to why I could be right and wrong at the same time. I would pick a bottom in the market perfectly (more by chance than brains) and watch in amazement when the calls I bought didn''t budge even though the Dow Jones subsequently ran up 200 points.
The remedial understanding I did have initially confounded me. I thought to myself, “I have 8,000 deltas and the market ran up the equivalent of 2 points. I should be up $16,000, but instead I can''t even sell these calls out where I bought them.” It was at these times I felt my mother must have had too much to drink during her pregnancy as I could not for the life of me understand why things didn''t work as they should have.
It was not until after I shed my neophyte cocoon that I understood how powerful vega (volatility) is to trading, and how vega can be more powerful than delta. Yes, I had theoretically made $16,000 because of delta, but I lost roughly $16,000 from the subsequent collapse in vega which usually occurs after a bounce from the bottom of a market. The greeks we had did not cease to work, it was just my remedial understanding of the greeks that failed to work. I had delta down cold, but was clueless as to how the greeks interacted with one another.
Being intellectually challenged and sloth-like, I didn''t learn this lesson at first opportunity. My attitude of frustration impeded me from getting to the bottom of the matter as I accepted the unrealized potential profit as a blip and something having to do with the “new math” of options trading. I literally felt, “Give me ambiguity or give me something else.” You have to remember that I am so lazy that I married a pregnant woman and became a trader because 9-5 seemed too difficult to squeeze in between television commercials. I would literally stop to think and forget to start again.
Not wanting my only purpose in life to serve as a warning to others, I broke down and became familiar with the greeks. It also helped that at the same instance, my television broke, but that is a different story about gun safety that I will discuss another time. Knowing that 74.4% of all statistics are made up on the spot (this one included), I decided not to be a statistic of the markets. I knew that copying the trades of the guy next to me in the pit wasn''t going to work as well as that same technique served me in school, so I delved into the material.
The problem I faced at the time, as this was the mid 1980s and a good easy read of the greeks was not available, was that we had basically one option book that was readily available on bookshelves and that talked of intrinsic value and spreads. There were a couple books on the greeks that were published by universities and it looked like one long math problem that took up 300 pages. So my journey was a lot more difficult than what you have in front of you, and there is absolutely no reason not to learn 5 new things (delta, gamma, theta, vega and rho) right now.
All you have to do to get a basic understanding is to find your old Optionetics books. They are probably propping up one end of the couch that was broken as it was put in the basement. Shame on you, by the way. I say that as I am one of you, so I know you didn''t read them. Dust them off, break the shrink wrap and get to work.
If you find yourself going beyond what is presented in the Optionetics materials, sign up for an advanced class and/or get an options book to master the greeks. I have already printed a list of my recommended reading on the boards that does an excellent job of covering the greeks. You usually get what you pay for in life, and in this case, the more expensive texts usually do a better job at explaining the subject matter better than the garden variety of rehashed materials.
Keep in mind that as expensive as you think your education is, it is much less of an investment than I likely made trying to learn the material without the benefit of someone smarter than myself assisting me. You have the benefit of learning from other''s mistakes while I had to learn by making my own mistakes and stepping on land mines.
“Experience is what you get when you didn''t get what you wanted.” I prefer education at this stage in my life. It is cheaper and less painful. But like the old commercial for muffler shops used to say, “You can pay the mechanic now, or you can pay later,” and that comes in blood, sweat and often tears.
Scott “Spilt Milk” Kramer
Staff Writer and Trading Strategist
Optionetics.com ~ Your Options Education Site
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