20 Things to Do Before You Ask for a Price (Part 3)
Nov 26, 2024
Explore the essential steps before pricing in options trading, including how to assess corporate actions and their impact on risk capital. Delve into implied versus realized volatility and its significance in market maneuvers. Discover the importance of strike skew in evaluating potential gap risks. With practical insights from financial experiences, this discussion emphasizes strategic decision-making while wishing listeners a wonderful Thanksgiving.
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volunteer_activism ADVICE
Check for Corporate Actions
Check if a stock is involved in a corporate action before pricing options.
Use Bloomberg's CACS function to identify potential deal names.
insights INSIGHT
Risk Characteristics of Deal Names
Deal names possess unique implied distributions, making risk capital allocation challenging.
Risk arbitrage resembles an out-of-the-money put option due to occasional substantial losses.
question_answer ANECDOTE
Cash Takeover Volatility Mishap
A salesperson pitched low-volatility options to a hedge fund, emphasizing the discrepancy between implied and realized volatility.
The hedge fund bought the options, only to discover the underlying asset was subject to a cash takeover, making the volatility irrelevant.
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Welcome to Part 3 of “20 Things to do Before You Ask for a Price”. To review, “20 Things” is a to-do list I developed more than 2 decades ago while running a derivative sales team. The desk committed a substantial amount of capital in pursuit of business, which made it easy to win trades but also easy to lose money in the process of winning those trades. 20 Things was about playing defense and offense simultaneously by requiring the salesperson to be an active part of the price discovery process. While the trader would ultimately make the price and bear the risk, the salesperson, through 20 Things, could be a valuable part of the process. The result: better risk taking and a more sustainable business. Here are things 11-15. I hope you enjoy and find this useful. I wish you an excellent Thanksgiving holiday.
11. Corporate action? Is this stock a deal name or subject to some other corporate action? Use the CACS function on Bloomberg to look for corporate actions. Deal names can have very unique implied distributions and are difficult to provide risk capital into in option trades.
12. Evaluate the vol. What is the implied volatility of the name? How does it compare to realized volatility? How does the name spread versus index or sub-index volatility? Run the GV function.
13. What does strike skew look like? The skew may be indicative of the amount of gap risk potential in the name. Run Bloomberg command OVDV SKEW and look at the spread in risk reversals on the OMON screen.
14. What is the shape of the term structure? This can give a sense as to how much the market is willing to pay for an event (ie, earnings or an FDA announcement). Run Bloomberg command OVDV TRMS.
15. What is the vol risk in the trade? Is this a long-dated option on a high-priced stock? If so, you should know what the vega of the option is. Example: 10k F Jan’25 11 strike calls have far less vega than 10k MSFT Jan’27 430 call. These very different options call for different kinds of dialogue with the trader and client. Use the Bloomberg OV function.
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