Posted on 11th August 2010 by Van in Trading Techniques
Options Arbitrage is a complex strategy that involves the simultaneous purchasing or selling of an option and hedging the risk through an underlying financial instrument. Traders who adopt the strategy focus on capitalising on mis pricings in the market due to volatility, volume or economic changes. In its simplest form, Options Arbitrage is determined by effectively valuing the underlying, which in the majority of cases is an equity position. There are a number of key strategies in options arbitrage that traders focus on. In most cases due to the size of the arbitrage, only market makers, or professional traders have the resources to execute the strategies.
Conversion Strategy
The conversion strategy is the first options volatility model which capitalises on expensive premium pricing. A conversion strategy is constructed by shorting a call position and going long a put position whilst holding a long stock position. As discussed early these strategies are usually executed quickly when the mispricing between the underlying, and options appears. An example of when the arbitrage becomes evident is highlighted below.
Eg. Trader is holding Stock A at $20.00
Call Options for a $20.00 strike are trading at $1.20. The Put Options for a strike of $20.00 are trading at $1.05. Effectively there is an arbitrage opportunity – not taking into account commissions or trading fees. The trader has the opportunity to sell a call option and receive $1.20, whilst protecting their position at the same strike level by buying a put option for 15c cheaper at $1.05. The arbitrage is 15c on the trade.
Many traders have also adopted this strategy in protecting their overall portfolio. By selling a call position, the cost of purchasing a put can be covered. This is dependant on the options strikes chosen.
Reversal Strategy
The reversal strategy is the opposite of a conversion, in that the trader hopes to capitalise on lower option premium valuations. A reversal is constructed by being long a call position, short a put position and shorting an equity position. An example of a reversal strategy is highlighted below.
Eg. Trader is short a stock at $20.00
Call options with a $20.00 strike are at $1.20, Put Options for a $20.00 strike are trading at $1.30.The trader will capitalise on an inflation in the put options by buying a call and selling a put option with a 10c profit. As the position is perfectly hedged, the trader has arbitraged the market.
Options Arbitrage like any other form of arbitrage is only for experienced traders and in most cases can only be capitalised on if the trader has a substantial bank balance. Market Makers and Prop Traders usually have the technology and systems to capitalise on arbitrage opportunities in the market.
Posted on 15th June 2010 by Van in Technical Analysis
Candlestick Charting is an attractive technical analysis solution for many traders and investors. The concept of candlesticks and using this technique for charting grew out Japan where rick traders used the patterns for the identification of daily price movements. Candlesticks are broken up into two distinct patterns which highlight either a bearish or bullish trading range.
(images supplied by wikipedia)
If the market opened lower and closed higher the candle will be a white formation where as if the market opened higher and closed lower, the candlestick will be bearish and black in its formation. At a glance a trader can then determine a trend based on these preliminary technicals.
Candlestick charting is sometimes referred to as a complex form of technical analysis due to the number of patterns and formations that are available to the trader. Unlike other forms of charting, Candlesticks also require multiple bar confirmation for certain patterns. One defined pattern needs confirmation as to its meaning if it does not fit the strict strong buy or strong sell signals. Some of the main candlestick charting patterns are highlighted below. (images courtesy: Wikipedia)
No.1 & 2: Basic Bullish or Bearish Candlestick basic formation highlighting a low or high lose and a strong finish to the close
No.3 & 4: Bullish and Bearish Upside Strength: Significant trading range, with strength towards the close. Unlike the basic pattern, the trading range is significantly higher than the opening and closing price ranges.
No.5 & 6: Hammer and Inverted Hammer: Both Patterns are strong in their nature and highlight consistent up and downtrends depending on their formation.
No. 7 & 8: The spinning top pattern is indecisive and neutral in its nature. Usually this candlestick will form leading up to earnings or a significant news situation etc.
No. 9 & 10: The basic doji pattern is also indecisive in nature with the long legged doji highlighting the possibility of a reversal in pricing.
No. 11 & 12: The dragon fly and gravestone doji patterns form interesting reversal patterns and can be effectively used in conjunction with other candlestick formations.
No. 13 & 14: The Marubozu pattern is one of the more famous candlesticks as it highlights significant strength or weakness in the trend. Many traders utilise the maribozu pattern as a solid bullish or bearish indicator.
Posted on 13th June 2010 by Van in Trading Techniques
Scalping is a technique of trading whereby the trader endeavours to find a pricing discrepancy between the buyers and sellers. In its purest form the technique is predominantly adopted to the Forex Market and other OTC or market made markets. Scalping is a high frequency / volume style of trading which predominantly adopted by professional traders or market makers.
A popular form of scalping for retail style traders is scalping for price gains. This technique involves the trading for short price movements. (ie short term momentum). Alot of the time traders who adopt such an approach will place large volume of trades over a short period. An example of a scalper is highlighted below:
Example
- Trader Places a Buy order for Currency A at $1.22055
- Spread for the Currency is (Bid = $1.22055, Ask = $1.22059)
- Currency price falls and the Trader gets filled at $1.22055
- Spread for the Currency is now (Bid = $1.22050, Ask = $1.22055)
- Trader places a Sell order for Currency A at $1.22060
- Currency A rises and the Trader gets filled at $1.22060
In this example the trader has taken a small profit on a large volume traded. Scalping is inherently risky if adequate money management settings are not implemented. Professional traders in many cases utilise an effective 1:1 or 1:2 risk management strategy which focuses on setting take profits and stop losses that are of equal distance from the price or vary slightly.
Posted on 22nd January 2010 by Van in Economics
It is interesting because Economics plays a key role in the Forex market. Today I wanted to touch on the fact that Gross Domestic Product is sometimes overlooked because of long term nature of the economic indicator. Unlike Interest Rates and Employment Figures, GDP focuses on the the overall state of affairs within an economy. Interest Rates affect the overall Gross Domestic Product by governing saving and lending levels and employment figures influence the social welfare and productivity levels within an economy.
Posted on 12th January 2010 by Van in Technical Analysis
The V Shape Recovery is sometimes a term referred to the recovery of a market based on changes in economic data. Many economists use the term to describe the sudden change in GDP, Employment figures etc.
Forex movements can be affected by sudden drops or rises in economic figures. When one currency experiences a sudden price fluctuation or extreme price movement, sometimes the price gap can be filled by sudden buying or selling pressure. This phenominon is called the “V Shape Recovery”.
