I mean, I’m pretty confident I’m right about “professional FX options traders never trade ITM options”. After ten years in the interbank market, I know what I’m doing around FX options. Nobody trades ITM options because:
1) Since 2003, when NAB Melbourne’s options desk was using ITM options to cover up the massive funding costs on their buried loss position, banks’ risk teams look for large volumes of ITM option trades as a giveaway sign of dodgy trading activity;
2) Since 2008, when funding markets really started to blow up, different banks have massively different funding costs, so it’s hard to agree on the discount rates for those premiums; the bigger the premium, the bigger the discrepancy, and ITM options have bigger premiums.
Are you sure you have three decades of FX options market experience? I think we’d have crossed paths before if you did.
Can you help me out here, getting back to our original question - what’s a “gut trade”? I know what I’ve learned it is, but I’d love to know what you understand it to be.
I would second Shiny Things on this. Over the last decade, compliance would not allow in the money option trades to be dealt save for exceptional reasons. Even rollover of contracts on a historical basis require approvals to be given before it is allowed. The main reason is to avoid tax fraud and hiding of losses. Even MAS has specific rules around these.
With the advent of Basel 3, Credit Value Adjustment (CVA) and Funding Value Adjustment (FVA) became serious considerations to the point that Desks may blow up if they do not adjust for these and not catering to the in the moneyness of option premiums is a sure way of losing money for most of these desks.
If VanillaBinary were a professional with 3 decades of experience, he would know standard market conventions (not knowing does suggest a lack of knowledge or he may have been taught by a fake who claims to be a professional) and the way options are dealt. eg, when the pros deal in options which involve several legs, they would not be spread on all legs... only a spread would be applied to one of the option leg while the other options would be choiced (ie the middle of the bid offer spread would be applied) I have also the same observation that few professionals (interbank traders, hedge fund and real money accounts) deal in in the money options.
A retail player would be spread on all legs and therefore subject to a higher "transaction cost" I would still stick to the view that retail players should not be dabbling with options unless he or she knows the intricacies of option pricing. Doing an occasional one if one has a very strong view may be a way to express that view but transacting it on a systematic basis and in the highlight example of selling naked options, especially without regards to levels, pricing or volume is a losing proposition over the long run. There is simply no edge.
A pit trader is merely a good trader who can read the emotions of the pit, trading the moment and maybe a good understanding of the marco variables that drive prices. At low levels, he just knows yours / mine. To know how to trade options, one would need to go beyond that and understand option pricing methodology. If one simply dismisses standard terminology, then one is likely to blow up his account or just mispriced his trades. There are more considerations other than yours / mine.
As for the self proclaimed 100% win rate using straddle options or so called guts trade, one may be winning in terms of direction. you buy a call and put at the same strike and when the market moves up or down, you may make. But when you consider the premiums paid, are you really making or losing? Add that to the fact that retail has no edge in option pricing, does one really have a 100% winning strategy? When vols are high, the premiums paid tend to be larger as well - so if Vanilla likes high vols and is doing straddles, his transaction cost tends to be very high. On the other hand, based on his trades so far, I can only see naked options being sold. In that, one would like high vols but it just takes one trade to wipe out all his premiums collected to date. The effectiveness of selling naked options have been well documented - so I would urge readers who are contemplating such strategies to research further and think twice.
