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Order Flow - Achieving the mindset

Nasir,

Thanks for the points above. I realise these events don't happen that often but I'm certain that if we took enough time studying the events that are causung these inefficiencies then it may be possible to make them a little more probable than hit or miss.

I also must give credit as these ideas were given to me by Unamed-playr.

At the moment I'm busy looking at how value areas tend to change amongst correlated pairs which can sometimes predict a move but more about that later.

James.
Hey guys,

Sitting on OANDA 5 min and IFR actually make you confused, I think at some point I have to learn how to divide good news (those who affect the market) and bad news (those who are priced in and don't affect).

Now what I was asking for is the question about option play/hunting.
What's with all of these different options?

I read a little bit about barrier options and it seems as if the price moves above the price of the option, it is a loss for the one who bought it.

Let's say there is a barrier option around EURUSD 1.35. If the price moves above it just by a couple of ticks, like 1.3505 then it won't be useful to the one who bought it right? But why does the market care about it? Why is it in the interest of the participants if the option matures or not?
It's not like you can use it to dump your inventory in it right? Because stop-hunting actually makes some sense, you dump the inventory in the buy/sell stops there but I really can't understand the meaning with penetrating into the zone of barrier options and/or vanillas or whatever option it is.

Now this question actually goes deeper but I really, really don't have any time due to extremely much to do in school, and in all honesty I am really thinking about quitting uni and getting a job instead, it's taking too much time just sitting with the stupid assignments while I could do other things that would benefit me much more!!

Take care
Hey Carnegie,

I'm currently looking for ways to distract myself from my Maths assignment, and well let's just say you've provided an means to an end.

Most of the options that are quoted on IFR are european style options. This means that they expire at a certain time period during the day given on the calendar. With a bit of digging around here, you can actually find the exact time of expiry of the options.

So imagine things with your order flow mindset.

Options will mean different things to different people. For hedge funds and the like, it will be a speculative vehicle; for corporations it will be used to offset foreign exchange risk. For the underwriters of the options, such as commercial banks, (who are higher up in the influence and information chain) if the option expires in the money, they will lose money, having to pay it to the options holders who will exercise the option to their benefit. If however the option expires worthless, the options underwriters will earn money in the form of commissions/options premiums etc.

Now when the position of the option barrier/strike price is divulged, think of who this would benefit the most. We know that the holders of the option will want to keep their option above/below the target price as necessary, while it will be advantageous to the options underwriters to drive price through and beyond it.

Think of the different implications this has, and the ways in which you can go about exploiting this, especially by aligning yourself with the more likely outcome.

Regards,
xXTrizzleXx
Quoting Carnegie
Hey guys,

Sitting on OANDA 5 min and IFR actually make you confused, I think at some point I have to learn how to divide good news (those who affect the market) and bad news (those who are priced in and don't affect).

Now what I was asking for is the question about option play/hunting.
What's with all of these different options?

I read a little bit about barrier options and it seems as if the price moves above the price of the option, it is a loss for the one who bought it.

Let's say there is a barrier option around EURUSD 1.35....
From what i think is that for an exmpl, u are trading near 1.3450 and have a barrier at 1.3500 so there could be sell orders around 1.3490 and than the people who put these orders also place Stops for these orders @ 1.3520.

So first u push through those Sell order's and break through the barrier than u can liquidate on there stops.
.
  • Post #365
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  • Edited at 5:59pm Feb 16, 2011 5:48pm | Edited at 5:59pm
Quoting xXTrizzleXx
Hey Carnegie,

I'm currently looking for ways to distract myself from my Maths assignment, and well let's just say you've provided an means to an end.

Most of the options that are quoted on IFR are european style options. This means that they expire at a certain time period during the day given on the calendar. With a bit of digging around here, you can actually find the exact time of expiry of the options.

So imagine things with your order flow mindset.

Options will mean different things to different people. For...
Hmm.. So either way the corporations aren't losing, because they aren't in the game for profit but for "hedging" reasons. The only one bearing a risk here is the bank.

It was clear to me from the beginning that SOMEONE want's to break the option by driving price thru it. But this was my thinking:

why be the underwriter if you still have to pay for breaking the option? That might sound a little wierd but here is my thinking:
Let's say a bank is the underwriter to a company of an option exercising at 1.3500.
If price stays below 1.35; the bank has to exchange $100 mil GBP for USD.
If price gets above 1.35; corporation loses and the bank earns the premium.
Now figure price is at 1.33. Isn't there a cost for the bank to drive price up 200 pips just to knock out the option? Yes I understand that $100 mil was a bad example and it should be a couple of yards atleast but that's not my point.

Take care

EDIT/
My order flow mindset is telling me that the BIAS on the particular currency and game theory has something to do with which hunting it is on each particular option..
Need to think about this one, maybe I should read up a bit on options.

EDIT 2/
I was thinking about something..

Quote
Now when the position of the option barrier/strike price is divulged, think of who this would benefit the most. We know that the holders of the option will want to keep their option above/below the target price as necessary, while it will be advantageous to the options underwriters to drive price through and beyond it.
To me the benefit is obvious.. ten times out of ten would the bank hunt for the option but that wouldn't be the case in real life. Also if we make the assumption that companies aren't in the game for FX profit then how come we can sometimes see a protection of the option? That means there are different participants in the options, sometimes maybe speculative; between two banks.. So the question should be, how do we know if it is between two banks (i.e. being a fight) or between a bank and a company (hunting the option)
Guys, vanilla options (either european or american style) are strictly pricing in the future expected VOLATILTY, not PRICE. Read that again. For a vanilla option it doesn't matter what price the underlier will have in the future, only how volatile it's going to be. If the underlier is more volatile than implied by the market, the option buyer will win. If it's less volatile, the buyer will lose. Future PRICE is not a factor in deciding who wins.

This is due to a peculiarity in the option market structure. In general there are much more option buyers (long volatility) than sellers (short volatility), thus the banks (which usually selling volatility) are having troubles matching the short sides of options - their short book is much bigger than the long book. To hedge themselves they do something called "delta hedging". This hedges the PRICE away, and only the VOLATILITY remains.

Note that you can't match puts and calls at the same strike as many would think. They are equivalent due to put-call parity, thus you can't offset one with the other.

Like I said, this is just for vanilla options, but it's important to understand this concept, that options are pricing in VOLATILITY.

For barriers it's more complicated.
My thinking is that the Bank who is the underwriter is not the only individual who will orchestrate the move which gravitates toward the barrier. As the bank has divulged the information, other players may use it to speculate as to the short-term movements of the currency, and may help catalyze the move to the stops, so that the Bank is not the sole mover in the exercise.

We must also think of the motives of other participants - say you were a large institutional player, and your current outlook for the currency pair is a downtrend, which should continue further according to your analysis of the fundamental climate.

Say that the options barrier to be taken out lies at a higher price than what is currently being offered now. The strategy used by these large institutional players, is to build up positions in intervals, slowly scaling into the trend, and thus it would also be favorable for them to enter new positions as the dust settles down from these option plays, and the currency continues to move back into the downtrend. Not to mention that the liquidity provided by the stops would make entering near the barrier quite profitable from a cost perspective, for the fact that the plentiful liquidity will allow the institutional player to obtain a great average fill, with little market impact.

However, as you noted there are costs involved, which is why you don't see options underwriters recklessly gunning for stops. It tends to be done when price happens to end up near the strike price close to the options expiry date. The move upwards also tends to be initiated at periods of low liquidity; so that it is cheaper to create jumps in price, as well as entice technical/momentum/informed traders to hop on board. The amount of money at stake is also something to take note of - look at how price gravitates towards a barrier when figures like 350Mio-500Mio are at stake.

It is not something that happens all the time, nor can we guess exactly who is battling - for as you stated previously, we are working with probabilities. Based upon that scenario a positive expectancy system can be built, and that is all you need to make bank.

Hope this helps,
xXTrizzleXx
Quoting Adal
Guys, vanilla options (either european or american style) are strictly pricing in the future expected VOLATILTY, not PRICE. Read that again. For a vanilla option it doesn't matter what price the underlier will have in the future, only how volatile it's going to be. If the underlier is more volatile than implied by the market, the option buyer will win. If it's less volatile, the buyer will lose. Future PRICE is not a factor in deciding who wins.

This is due to a peculiarity in the option market structure. In general there are much more option buyers...
This new information leads me to believe there are some gaps in my knowledge.

Are you willing to divulge further details on the workings of options? If not then I completely understand - no hard feelings.

Regards,
xXTrizzleXx
Quoting xXTrizzleXx
This new information leads me to believe there are some gaps in my knowledge.

Are you willing to divulge further details on the workings of options? If not then I completely understand - no hard feelings.

Regards,
xXTrizzleXx
What I said are option basics. No secret there As always, the secret is in being one step ahead of the market.

I'm not a great teacher, so I searched for some explanations of what I said. Here is what I found. You can probably find better ones in beginner level option trading books.

http://www.eurekahedge.com/news/16_j...ty_Trading.asp

In contrast to the relative volatility spread strategy, in gamma trading strategy, one is predominantly betting that the implicit volatility of an option does not agree with the expected volatility as seen from an absolute point of view. In other words – one bets on the absolute change of volatility. If one uses the long gamma trading strategy, the aim is a particularly large profit if unexpected external shocks occur, eg political elections, terrorist attacks and environmental catastrophes. With the short gamma trading strategy, on the other hand, one is betting on quieter waves, or better still, no waves at all. In the case of the both volatility strategies, market direction only plays a subordinate role, or in some cases, no role.

Wikipedia is also useful, as always:http://en.wikipedia.org/wiki/Volatility_arbitrage

To an option trader engaging in volatility arbitrage, an option contract is a way to speculate in the volatility of the underlying rather than a directional bet on the underlier's price. If a trader buys options as part of a delta-neutral portfolio, he is said to be long volatility. If he sells options, he is said to be short volatility. So long as the trading is done delta-neutral, buying an option is a bet that the underlier's future realized volatility will be high, while selling an option is a bet that future realized volatility will be low. Because of put call parity, it doesn't matter if the options traded are calls or puts. This is true because put-call parity posits a risk neutral equivalence relationship between a call, a put and some amount of the underlier. Therefore, being long a delta neutral call results in the same returns as being long a delta neutral put.

There was a paper which explained really nice why options are pricing mostly volatility (because of the highly asymmetric market I talked about in the previous post), but I can't find it know.
Quoting GEfx
Hi Carnegie,
I think it is best that I pass on posting anything, and instead I will check in from time-to-time to see what is developing here. I have been reading some of the material that Gaston and DS have posted. I would recommend a read through the Technical Analysis Falicy thread for fti's material on market structure, too, if anyone has the time (fti ran a tier one currency operations in Sinapore but is not around much now due to health reasons). Good luck everyone and good trading (been good today so far!).
good advice

Not to take away from what's being discussed here, but a search on his thread for his posts using order flow, market structure, hitting, ducks will pull up some good reads... .

Here's a quote from him about order flow, and his mindset from a Tier 1.

http://www.forexfactory.com/showpost...3&postcount=67
It's not only how currencies interact between each other to spot some kind of inefficient pattern.
Noticing what's happening in the futures and options market is very important.
In which of them can be made money with little effort and on which is the focus.
The money shifting can be very divergent among them to a certain point and you have to understand why is that and then how to exploit it.
Quoting Adal
What I said are option basics. No secret there As always, the secret is in being one step ahead of the market.

I'm not a great teacher, so I searched for some explanations of what I said. Here is what I found. You can probably find better ones in beginner level option trading books.

http://www.eurekahedge.com/news/16_j...ty_Trading.asp

[i]In contrast to the relative...
Thanks for the info Adal,

I just had a bit of confusion taking it in, as the said-same Wikipedia places an importance on the underlying price of the option; ie. the spot-rate.

http://en.wikipedia.org/wiki/Option_style

In finance, the style or family of an option is a general term denoting the class into which the option falls, usually defined by the dates on which the option may be exercised. The vast majority of options are either European of American (style) options. These options - as well as others where the payoff is calculated similarly - are referred to as "vanilla options." Options where the payoff is calculated differently are categorized as 'exotic options'. Exotic options can pose challenging problems in valuation and hedging.

The key difference between American and European options relates to when the options can be exercised:

A European option may be exercised only at the expiry date of the option, i.e. at a single pre-defined point in time.

An American option on the other hand may be exercised at any time before the expiry date.

For both, the pay-off - when it occurs - is via:

Max [(S-K), 0], for a call option
Max [(K-S), 0], for a put option;

(Where K is the Strike Price and S is the spot price of the underlying asset)

Options contracts traded on the futures exchanges are mainly American-style, whereas those traded over-the-counter are mainly European. (ie. Forex)

Perhaps the discrepancy can be explained by how we interpret options to be used? Perhaps you are looking at options from a volatility arbitraging perspective, whereas my view is towards that of a more speculative role?

Regards,
xXTrizzleXx
Quoting xXTrizzleXx
Perhaps the discrepancy can be explained by how we interpret options to be used? Perhaps you are looking at options from a volatility arbitraging perspective, whereas my view is towards that of a more speculative role?
Of course you can use options for directional speculation. But most of the options sellers are forced to delta hedge the options using the underlier, thus they engage in volatility arbitrage even if they would prefer not to.

Anyway, this is a little bit off-topic on this order-flow thread. I just wanted to highlight that when you sell or buy an option, you don't necessarily need to defend the price, you might need to defend/attack the volatility instead. Think about this when you see three days in a row where EUR/USD stays put or increases slowly, or when you see a sudden spike. I'm not implying that somebody manipulates the market, only that some options players will make/lose a lot of money on the calm days or on the spike days.
Yesterday I read there were a larger option at 0.9850 at USDCAD and if you look at the chart, there has been some attempt to fight for it.

Now it finally gave away, but in my mind, that has to be some kind of inefficiency. Because if you say that banks hunt the option to save their own ass, then price has moved down irregardless of value. If it moves down irregardless of value then the price is inefficient.
Therefore the price isn't efficient and now that the option hunt is over, my order flow mindset tells me that this would entice traders to enter LONG.

I have a long entry at 0.9850 price currently 15 pips away. So let's see how that one works out, in my mind.. that is one kind of inefficiency as price dropped really fast on friday just to try to break it but was moved away. So hypothetically, price should move back up to ~0.9950.
Probably wrong but just testing and learning.

Take care, and btw all comments are welcome.

PS. Another question and maybe the most important one for me.
I don't understand why you are talking about stops when we are talking about options? Do you mean that there are stops just above/below the options? And why would that be? That would only be the case if someone was trying to defend their of option right.. in that case there would be stops above/below.. and that actually makes stop hunting ideas easier to understand; IF IT IS SO?
Quoting Carnegie
Yesterday I read there were a larger option at 0.9850 at USDCAD and if you look at the chart, there has been some attempt to fight for it.

Now it finally gave away, but in my mind, that has to be some kind of inefficiency. Because if you say that banks hunt the option to save their own ass, then price has moved down irregardless of value. If it moves down irregardless of value then the price is inefficient.
Therefore the price isn't efficient and now that the option hunt is over, my order flow mindset tells me that this would entice traders to...

Carnegie, this exactly what I've been trying to talk about with respect to options. I'm just a n00b here, but basically what you just typed is exactly what I've been trying out.
Guys, I may be completely wrong here; but if you compare the chart for USD/JPY right now, the downtrend may be an underlying USD weakness. In that case, the downtrend may not be an inefficiency. Just me $0.02.

Thanks.
Quoting Carnegie
Yesterday I read there were a larger option at 0.9850 at USDCAD and if you look at the chart, there has been some attempt to fight for it.

Now it finally gave away, but in my mind, that has to be some kind of inefficiency. Because if you say that banks hunt the option to save their own ass, then price has moved down irregardless of value. If it moves down irregardless of value then the price is inefficient.
Therefore the price isn't efficient and now that the option hunt is over, my order flow mindset tells me that this would entice traders...
Why buy at 0.9850, when you can wait for the level to be broken and buy at 0.9840 / 0.9830?

What makes you think there are aggressive buyers to take the price up 100 pips? Sure price may have made a false breakout to 0.9820 and bounced, but does that necessarily mean the the fundamental value is at 0.9950?

Also take note there is probably another option barrier at 0.9800. The people hunting probably do not want price to spike 100 pips.

How do you know that the inefficiency you are describing has not already taken place and any market moves have already happened?

Why hasn't the price moved up yet? What is the market waiting for? Where are the order flow generators to move price up? What is taking them so long?

The longer you hold such trades into the few hours to few days, you become susceptible to the order flow from market sentiment. If the sentiment stays bearish or accelerates to the downside, then your trade is smoked.
Private message me for a link to my order flow website.
Quoting Carnegie
PS. Another question and maybe the most important one for me.
I don't understand why you are talking about stops when we are talking about options? Do you mean that there are stops just above/below the options? And why would that be? That would only be the case if someone was trying to defend their of option right.. in that case there would be stops above/below.. and that actually makes stop hunting ideas easier to understand; IF IT IS SO?
If you "know" that there is a large option on the E/$ at 1.3650, and that it expires tomorrow, you might put your stops a safe distance above 1.3650 because you "know" that the large bank that wrote the option will defend that price level, which might make your stop safer, at least in your mind it is safer. If someone very large is willing to defend your stop, who are you to argue? However, once the option expires, the assumption will be that there are lots of stops above 1.3650, so the market might sweep them as an easy liquidity play.
Quoting grkfx
Why buy at 0.9850, when you can wait for the level to be broken and buy at 0.9840 / 0.9830?

What makes you think there are aggressive buyers to take the price up 100 pips? Sure price may have made a false breakout to 0.9820 and bounced, but does that necessarily mean the the fundamental value is at 0.9950?

Also take note there is probably another option barrier at 0.9800. The people hunting probably do not want price to spike 100 pips.

How do you know that the inefficiency you are describing has not already taken place and any market moves...
Are you suggesting that using option barrier information isn't a legitmate way to trade, or that we need to rethink the way in which we use that information in our trading?
Quoting grkfx
Why buy at 0.9850, when you can wait for the level to be broken and buy at 0.9840 / 0.9830?

What makes you think there are aggressive buyers to take the price up 100 pips? Sure price may have made a false breakout to 0.9820 and bounced, but does that necessarily mean the the fundamental value is at 0.9950?

Also take note there is probably another option barrier at 0.9800. The people hunting probably do not want price to spike 100 pips.

How do you know that the inefficiency you are describing has not already taken place and any market moves...
That's the shit I am thinking about.. how low can this hoe go?
No but seriously, I always think about stop hunting occuring at round number but sometimes it goes as low as 60 when the barrier was at round number 00.. that's 40 pips. How far down/up can the price move?
This might have to do with the price cascading, although I have read allot the alst hour from darkstar that is giving me some more ideas...

You're 100% correct on the trade, where are the order flow generators and what is taking the time? Obviously it was a bad trade, just don't know how I should change my thinking.. in my mind that really was an inefficiency

tyler: it obvioulsy is the WAY..
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