Managing Trades
Once the trade is on, the greeks come in handy for trade management. The
most important rule of trading is Know Thy Risk . Knowing your risk means
knowing the influences that expose your position to profit or peril in both
absolute and incremental terms. At-expiration diagrams reveal, in no
uncertain terms, what the bottom-line risk points are when the option
expires. These tools are especially helpful with simple short-option
strategies and some long-option strategies. Then traders need the greeks.
After all, that’s what greeks are: measurements of option risk. The greeks
give insight into a trade’s exposure to the other pricing factors. Traders must
know the greeks of every trade they make. And they must always know the
net-portfolio greeks at all times. These pricing factors ultimately determine
the success or failure of each trade, each portfolio, and eventually each
trader.
Furthermore, always—and I do mean always—traders must know their up
and down risk, that is, the directional risk of the market moving up or down
certain benchmark intervals. By definition, moves of three standard
deviations or more are very infrequent. But they happen. In this business
anything can happen. Take the “flash crash of 2010 in which the Dow Jones
Industrial Average plunged more than 1,000 points in “a flash.” In my
trading career, I’ve seen some surprises. Traders have to plan for the worst.
It’s not too hard to tell your significant other, “Sorry I’m late, but I hit
unexpected traffic. I just couldn’t plan for it.” But to say, “Sorry, I lost our
life savings, and the kids’ college fund, and our house because the market
made an unexpected move. I couldn’t plan for it,” won’t go over so well.
The fact is, you can plan for it. And as an option trader, you have to. The
bottom line is, expect the unexpected because the unexpected will
sometimes happen. Traders must use the greeks and up and down risk,
instead of relying on other common indicators, such as the HAPI.