The Strategies window

A typical option chain contains an enormous amount of information.  It is not uncommon for a chain to have several hundred entries; taking into account multiple quotes for an option from several exchanges, the tally can exceed 1000 items. How can you extract useful possibilities from this quantity of data?

The Strategies window makes it easy. This window allows you to construct and score all the valid combinations that can be constructed according to any strategy you specify. Options Laboratory Strategist comes with several built-in strategies. You can use any of these, modify them, or add your own.

After downloading an option chain, verify the volatility slider setting in the environment panel (top part of the window). Options Laboratory estimates this value from the implied volatilities of all the nearby options that have traded. It's useful to review this setting by examining the chain's volatility scatter plot and adjusting the volatility slider as desired. 

Then click the strats speed button. Select a strategy by clicking from the list. Choose the strike limits (either 3 strikes above and below the current stock price, or all strikes, or limit the strategy to use only nearby options).

Now click the Generate strategy table button. The program proceeds as follows:

Hints

You can generate a strategy table by simply double-clicking the strategy name; then you don't have to move your mouse to the Generate strategy table button.

After generating the table, you can reduce the list by choosing the expiration month you want to see. This hides the entries for other months. 

By default, Options Laboratory sorts the generated combinations in decreasing order of probability of making a profit, so you see the best candidates at the top of the list. You can click any column heading to change the sort order.

To directly enter the transactions for any generated combination, just double-click that row of the strategy table. The program records the trades for you, and immediately displays a graph of the position. From here on, it works exactly as if you had entered that combination manually.

To change the selected combination, just double-click a different row in the strategy table. To pick a different strategy, select it as before and click Generate strategy table again.

It's that simple. Really!

What if the projections look just too darned good?

This does happen sometimes. It doesn't indicate a defect in the program. It reflects the detailed bid/ask quotes from the option chain you downloaded, and the modeling assumption that options ought to trade at their fair values even if they are not presently quoted as doing so.

If we didn't make that assumption, there would be no such thing as an underpriced or overpriced option. In other words, Options Laboratory assumes you can make trades at the best bid and ask in the chain, and predicts that those options will subsequently converge to their fair value. See the persistent option volatilities topic for more information.

The strategy generator normally ignores quotes where the option hasn't traded. Some of the options that have traded may be quoted at prices where they won't actually trade now. You enter the order, and the price suddenly moves away. It was too good to be true; the quote on that option hadn't been updated to reflect the most recent stock price movements.

On the other hand, don't discount extremely attractive combinations simply because they look too good. Really substantial price disparities can persist within an option chain for hours or even days. You have to look for them, and set high standards. Don't make marginal trades; if a trade isn't really attractive, with room for bad luck, let it pass. You can analyze the strategy closely with Options Laboratory to determine what price limits can be expected to yield satisfactory results. Price your the trade that way, and it may well get executed.