We recently had Adam Iqbal on our podcast show. We focused mainly on FX and options. We thought we'd share with you his 'Rules of Thumb For Trading Options'.
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1) "The best one, the one that I use every single day when I sit down the desk, really, what you need to do is just remember this one number, which is 4.2, it’s the most important number in options."
2) "So the formula for the breakeven price on a straddle is just 4.2 times the implied vol, times the square root of the number of calendar days to expiry. once you brought that number, you should make your decisions about options by just looking at a vol surface pretty quickly."
3)"So you buy an out-of-the money call and put. You have a V-shaped, symmetrical profile, pay-off profile. You make money in both directions, but you need spot to go, move more than what you paid for this thing. And that’s what you call breakevens, exactly that."
4)"it’s Thursday evening, it’s the first Fridays of the month, NFP is tomorrow, you look at vol markets and overnight Euro-Dollar volatility is trading at $10. So we just say 4.2 times 10 times the square root of one, which is one calendar date of expiry which is one, that’s 42."
5)"So 42 basis points is the breakeven price of that straddle. So now you can just think, Oh, well, if I think the data’s going to move Euro-Dollar spot by more than 42 basis points, I should look at buying this thing. In other words, I should look at selling this thing.”
6)"I just remember, well, square of one is one, so I know that one, then I just remember the 4.2 times a square of 30 is around 22. So I multiply one month vol. If one month vol was 10, that would be a 2.2% breakeven roughly..
7) ... And then the square root of 4.2 times a square of 365 is 80. So one year vol was 10%, then that’s an 8% break even. And I just remember those three points."
Our entire podcast transcript with Adam, discussing carry trades, options, volatility and FX is available here: bit.ly/3LMPHeH
And make sure to follow Adam Iqbal (@asiqbal) on Twitter! A good friend of ours and a master in trading options!
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