Index option trading with statistic

It was said that, for amateur players, option trading is the fairest game especially in the derivative products because the trader can choose the risk exposure by themselves and the prices are offered by a few market markers so it is comparatively fairer than warrant trading or CBBC.

There are many underlying assets for option trading in the U.S. market but in the local context, stock option and index option are the two mostly traded products. Despite the two have a common point that they are related to local stock market but indeed since their respective underlying assets are different so the trading skill sets and trading mindset differs from each other as well.

Personally I prefer index option trading because the analysis on it is a bit simpler than the counterpart as there are almost 70 stocks available for option trading but just two index option products, ie., the HSI and HSCEI only. To trade the index option, one just needs to have an view point on at what point the settlement point will be at the end of a particular month.

There are many strategies in option trading but they are just derived from the four basic orders, ie., long call, short call, long put and short put. A simplified job of an option trading player is that one must forecast the direction of the market, the volatility of the month and finally and most importantly is the settlement point at the end of the month. To me, simpler the better so I prefer just to play at the short side to receive premium and the relevant risk.


Being a short side player, what I need to do is just to place order with the strike higher/lower (for call/put) than the expected settlement point then I am safe. However it is easier said than done to decide that particular strike so I resort to statistic on estimating where the safe strike lies.

For any one who knows about statistics must have heard about the binomial distribution and the bell shape curve. All the outcomes of an event are bounded to be covered under the curve and the chance of the happening of a particular outcome is governed by its probability. A safe strike should be the one with low probability. Say by selecting a strike with 0.10 probability meaning the maximum chance I shall lose is 10% only. Of course lowest possible is best but a too OTM strike means very low premium will be rewarded so a trade off is to pick the not too OTM yet with a probability and the associated risk that one can afford.

One may wonder how to figure out the probability of a particular strike. Well, no valuable thing comes without paying effort in this world so one have to build a database to do this job. I have built my own database covering the last 18 years, ie., 216 months, for data-mining purpose. The possible ways of data-mining are only limited to one's imagination. I mainly use it to forecast the possible monthly volatility/closing point and to backtest the trading strategies though. I am going to explain a little bit how it works in my next post.