46 lines
3.8 KiB
Plaintext
46 lines
3.8 KiB
Plaintext
273Chapter seventeen: A summary a nd concluding comments
|
||
irony, behavioral markets, the stock markets, are used as the basis for derivatives, or
|
||
options whose price is determined largely by the operation of algorithms called “models.”
|
||
The original model that created the modern world of options trading was the Black–
|
||
Scholes options analysis model, which assumed the “fair value” of an option could be
|
||
determined by entering five parameters into the formula: the strike price of the option,
|
||
the price of the stock, the “risk-free” interest rate, the time to expiration, and the volatility
|
||
of the stock.
|
||
The eventual universal acceptance of this model resulted in the derivatives industry we
|
||
have today. To list all the forms of derivatives available for trading today would be to expand
|
||
this book by many pages, and it is not the purpose of this book anyway. The purpose of this
|
||
paragraph is to sternly warn general investors who are thinking of “beating the derivatives
|
||
markets” to undergo rigorous training first. The alternative could be extremely expensive.
|
||
At first, the traders who saw the importance of this model and used it to price options
|
||
virtually skinned older options traders and the public, who traded pretty much by the seat
|
||
of the pants or the strength of their convictions, meaning human emotion. But professional
|
||
losers learn fast and now all competent options traders use some sort of model or anti-model,
|
||
or anti-antimodel to trade. True to form, options sellers, who are largely professionals, take
|
||
most of the public’s (the buyers) money. This is the way of the world.
|
||
Options pricing models and their importance
|
||
After the introduction of the Black–Scholes model, numerous other models followed, among
|
||
them the Cox–Ross–Rubinstein, the Black Futures, and others. For the general investor, the
|
||
message is this: he must be acquainted with these models and what their functions are if
|
||
he intends to use options. Recall, the model computes the “fair value” of the option. One
|
||
way professionals make money off amateurs is by selling overpriced options and buying
|
||
underpriced options to create a relatively lower risk spread (for themselves). Not knowing
|
||
what these values are for the private investor is like not knowing where the present price is
|
||
for a stock; it is a piece of ignorance for which the professional will charge him a premium
|
||
to be educated about. Unfortunately, many private options traders never get educated, in
|
||
spite of paying tuition over and over again. But ignorance is not bliss—it is expensive.
|
||
Technology and knowledge works its way from innovators and creative geniuses
|
||
through the ranks of professionals and sooner or later is disseminated to the general public.
|
||
By that time, the innovators have developed new technology. Nonetheless, even assuming
|
||
that professionals have superior tools and technology, the general investor must thoroughly
|
||
educate himself before using options. As it is not the province of this book to dissect options
|
||
trading, though the reader may find references in Appendix B, Resources.
|
||
Here it would not be untoward to mention one of the better books on options as a
|
||
starting point for the moderately advanced and motivated trader. Lawrence McMillan’s
|
||
Options as a Strategic Investment is necessary reading. In addition, the newcomer may contact
|
||
the Chicago Board Options Exchange (the CBOE) at http:/ /www.cboe.com , which has
|
||
tutorial software.
|
||
Futures on indexes
|
||
Futures, like options, offer the speculator intense leverage—the ability to control a
|
||
comparatively large position with much less capital than the purchase of the underlying
|
||
commodity or index. Futures salesmen are fond of pointing out the fact that, if you are
|
||
margined at 5% or 10% of the contract value, a similar move in the price of the index will |