augieboo's junk pile

[augieboo]

Max Pain & Delta Hedging, by Mishedlo

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From an SI post by Mishedlo
#reply-18223976
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To:Joseph Silent who wrote (59168)
From: mishedlo Tuesday, Nov 12, 2002 11:21 AM
View Replies (1) / Respond to of 76187

My final question is this: are their positions naked, fully covered, or partially covered?
If they have a LOT of control, then they need not fear having naked positions. They have the most to gain here, and less work to do.

If they have no control, they need to be covered. Here they have the least to gain, and most work to do.

If Mish is right about delta-hedging causing equity price to accelerate away from max-pain when it moves beyond a certain distance away from max-pain (i.e., the boys have lost control due to news etc) it seems reasonable to assume that they are a usually confident bunch of hoods who are initially naked.

This is a tough question but a hedge(by the option writers, the vast majority of the time) is not done with options but with common. That explains delta hedging. Stocks drop and there are tons of puts in the money thay have to short to prevent losing their ass on puts. Same thing in reverse last month with calls. Thus the eggagerated moves.

Now another problem comes in as in who did the option pits sell the options to. There is a big difference if average joe wrote a bunch of covered calls that the option pits own, or the option pits sold options to j6p. In the covered call case "da boys" want the stock as high as possible as they own the calls (assuming that all the calls were coverd calls that da boys own. Note that that is a horrid assumption but I show it for example purpose).

In general covered calls and naked calls are in the minority by far, but it is not always the case. Sometimes an institution or individual sell naked puts to acquire stock if it drops, banking on the collected premium to cover any loss.

From that point of view (the option writers may have written options on INTC as well as own options on the same strike of INTC).

In general one would have to believe that the vast majority of options are owned by j6P or a smaller hedge fund as opposed by "da big boys". On that belief, with the belief that "da big boy" seldom loses, and da big boy is going to succed at driving stocks to max pain (da big boys max pain, which can be different that what we guess at by lkooking at option chains). In general the more the options, the more this stuiff all balances out and the more likley pain is going to be hit.

Hope this is relatively clear.

M