20 Things to Do Before You Ask for a Price (Part 4)

Welcome back to the last installment of “20 Things to Do Before You Ask for a Price”. This 4-part series has been geared towards illustrating how the equity derivative salestrader can be a meaningful part of getting two institutional counterparties to “yes” with respect to the transfer of option risk. The salestrader, sitting between the trader and the client, can quarterback the process by appreciating the context of the trade and contributing insights on the risk profile of it. Context is about the client, the underlying stock, the trade motivation and the risk environment. The risk profile is about the many nuances of different option trades and what they imply for how the sell-side trader will think about pricing and providing capital. In today’s highly electronified markets, prices are streamed continuously by tireless bots with neither faces nor names. But risk transfer still occurs the old-fashioned way as well – and these voice trades require superb communication, led by the salestrader. If you are executing upon “20 Things”, you are adding alpha to this process. Below are Things 16-20. I hope this 4-part series has been interesting and you’ve enjoyed the perspective. 16. What is the bid /offer is in vol terms? For example, if an option has 30 cents of vega and the bid / offer is 50 cents, the vol bid/offer is 1.6 vols. Bid / offers on long dated options often seem wide in terms of prices, but are not really in terms of implied volatility. This can be useful in defending your trader’s price. 17. Look at the combo. Check the implied vol on the put vs. the implied vol on the call of corresponding strike. Are they reasonably the same? If not, there could be a borrow issue or a dividend issue. When put vol is much higher than call vol, a borrow issue is often present. In instances where market is forecasting an increase in dividends, it is also the case that the put vol will be higher than the call vol. 18. Understand div risk. On long dated options, dividend risk is a big issue – especially for high delta options where the stock hedge is large. Example: buying the Jan’25 35 puts in VZ carries a great deal of dividend risk – if we buy the puts and buy stock we are effectively buying the dividend stream which, if cut, is painful. Use the Bloomberg function DVD and BDVD. 19. Know put/call parity. C = S + P = PV (K) – PV (Divs) and be prepared to use it to explain pricing to accounts especially on deep in the money or out of the money options. 20. Lastly, have an opinion on every single price you get. You should have a feeling of what you think the price should be before you get a price. Understand that traders are responsible for prices, but that your informed input is very important.

Om Podcasten

The Alpha Exchange is a podcast series launched by Dean Curnutt to explore topics in financial markets, risk management and capital allocation in the alternatives industry. Our in depth discussions with highly established industry professionals seek to uncover the nuanced and complex interactions between economic, monetary, financial, regulatory and geopolitical sources of risk. We aim to learn from the perspective our guests can bring with respect to the history of financial and business cycles, promoting a better understanding among listeners as to how prior periods provide important context to present day dynamics. The “price of risk” is an important topic. Here we engage experts in their assessment of risk premium levels in the context of uncertainty. Is the level of compensation attractive? Because Central Banks have played so important a role in markets post crisis, our discussions sometimes aim to better understand the evolution of monetary policy and the degree to which the real and financial economy will be impacted. An especially important area of focus is on derivative products and how they interact with risk taking and carry dynamics. Our conversations seek to enlighten listeners, for example, as to the factors that promoted the February melt-down of the VIX complex. We do NOT ask our guests for their political opinions. We seek a better understanding of the market impact of regulatory change, election outcomes and events of geopolitical consequence. Our discussions cover markets from a macro perspective with an assessment of risk and opportunity across asset classes. Within equity markets, we may explore the relative attractiveness of sectors but will NOT discuss single stocks.