The Sky is Falling Tomorrow (Option Strategy)

Hello-

I'd like to get some thoughts from people out there (options gurus are especially encouraged) about a trading system I have been thinking about.

I am particularly interested in recommendations from forex options traders.


ASSUMPTION: Once in a while something incredibly unexpected happens. These events might be classified according to severity - we have minor events (one or two a year), intermediate events (one or two a decade) and exceptional events (one or two a lifetime). The frequency does not really matter, the fact is that we believe these things happen, and they cause a 'shock' to the financial markets.

TRADING SYSTEM: We want to cash in on these events, but (obviously) we don't know when the events will occur. So we buy options regularly in the hope that the sky will fall tomorrow. We want to buy cheap options.

So....

We buy out of the money puts on the GBPJPY every week, with an expiration a week away.


Right now I have a quote for a Dec 18, 2007 put on the GBPJPY at 227.00 for
1 lot at $535.33

The spot is trading at
229.24/17

I propose that one of the best ways to implement this system would be to buy these puts for the rest of my life, hoping for something crazy to happen in the next week.

I may switch up to a different pair if the interest rates on the Yen and the Pound get closer in the future, but the basic idea stays the same.


Does anyone have a better idea for trading this "system?" I am particularly interested in hearing from the options people......

Thanks,

Bagger


$535.33

I should've added this:

The implicit assumption is that we would expect that the profits from these dramatic events would more than wipe out the monotonous losses that pile up every week with the (worthless) expired options.

$535.33 x 52 weeks = $27837.16

what would it take to cover that?, ALOT i would assume

There is a strategy that right now i'm still testing with stocks but as of the newly introduced fx options i will be testing it with fx as well. If you expect a fairly volatile move within a specific time frame you can by an at the money put and an at the money call. If a fairly significant move occurs in either direction the one option will be worth more than the other is down. For example in stocks you can use this with earnings if you have a fairly volatile stock that is typically volatile on earings reports. As I said I havent tested it in fx options as yet, I was think something like using this strategy prior to a big report ie. NFP. But i would practice it for sure before putting money behind it. It's been suggested in another thread that you could employ this strategy on the GBP/USD and it's natural volatility will produce a profit. Again I haven't tested this.

Hi Bagger,

I would suggest that you do an indepth study on Dr. Nassim Taleb. He's even mentioned here at FF. He made milliions with a strategy similar to yours. He received his Phd in Financial Mathematics and has over 30 years of trading, including the pit. He's written books on his trading philosophy as well.

Walt

Bagger,

BTW... who did you get the quote from for the gbpjpy with 12/18/07 expiration date? That's seems to be an extremely expensive premium...

Walt

Yes, well, one of the reasons why the GBPJPY is my pair of choice is that when the poop hits the fan, the GBPJPY loves to move. Even more than the GBPUSD.....

PFG Best..... is there someone else that might offer more competitive premiums???

Yes, I am familiar with Taleb - very interested in replicating his results, just not quite sure how to go about it......

Currently, I'm testing a similar strategy. However, I straddle at-the-money. With my straddle, if gbpjpy moves more than 430 pips in one direction by the 21st, then I will make a profit. Of course I'd have to factor in the time decay (theta) associated with the options I bought. However, since one option will always be in-the-money, I hope it won't be much of a problem. The other problem is the spread, but that part of the game. It's common for the gbpjpy to move 300+ pips in a given day. Therefore, a break-out in any direction over the course of a few days can be very profitable. Of course, you cannot exercise the option until the expiration date; however, one can liquidate a given position at anytime.

The real quandry for me is to decide which arena to trade the currency options. For example, there's futures options, as well as currency options through ISE and PHLX, or spot options & vanilla forex options through Saxobank. Decisions...decisions...decisions...

Walt