Timer calls are an exotic option that enable investors to specify the level of volatility used to price an asset. They are designed to provide additional flexibility, helping to ensure buyers don’t overpay for an option. This guide will help you understand the basics of trading timer calls with everyday examples. We will discuss how they work, compare them to other exotic options, list the pros and cons, plus provide tips for developing an effective trading strategy.
Below we list the top-rated brokers that offer retail options trading in 2023.
What Are Timer Calls?
Simply explained, timer calls afford traders the ability to specify the type of volatility used to price a product. Volatility represents the degree of price changes in a security, commodity, or index over a period.
Instead of a broker-dealer using implied volatility to value an option, the volatility in timer call options is fixed. Investors set an estimated maturity level constructed on projected volatility. If the volatility estimation over a period is correct, the option would mature. If the volatility is lower, the option will expire later than the estimated maturity period.
Importantly, timer calls are designed to give investors more time flexibility while eliminating unnecessary overpayments for options. Whether you want to trade in the US, UK, Russia, South Africa, Japan or India, this product is an interesting concept.
Trading timer calls is a relatively new investment product. Their origination can be dated back to the 1990s with Bick and Neuberger discussing the pricing and hedging of products.
The official launch of the concept to retail traders was seen in 2007, hosted by Société Générale Corporate and Investment Banking (SG CIB). Having analyzed stocks within the Euro Stoxx 50 index since 2000, SG CIB calculated that 80% of three-month calls that had matured were overpriced. ‘High implied volatility means call options are often overpriced. In the timer calls option, the investor only pays the real cost of the call and doesn’t suffer from high implied volatility’, quotes Stephane Mattatia, part of the hedge fund team at SG CIB in Paris.
Traditionally, financial products and strategies have ﬁxed maturities. But investing in timer call options often brings a flexible maturity and is driven by the realized volatility. According to SG CIB, ‘a timer call option is empirically cheaper than a traditional European call option with the same expected investment horizon, when the realized volatility is less than the implied volatility’.
Today, although still fairly limited in availability, the investment product has grown in popularity and interest.
The timer call option has an infinite maturity so it can expire on any given date. This date will be the first time that a pre-defined variance budget is fully consumed by the realized variance of the asset price or at the pre-set expiration date. Which one happens, in reality, is contingent on which criteria are met first.
Below we outline some of the key characteristics of timer call options:
- Systematic market timing is utilized. If volatility increases, the timer call option will terminate. If the volatility decreases, the timer call will take more time to reach maturity.
- Timer calls may be offered by financial institutions to overcome the challenge of setting prices for calls and puts with implied volatility. As an asset may be difficult to value, the pricing is effectively handed over to traders. This is particularly true in markets where a volatility dataset is limited or non-existent.
With this product, the buyer can specify an investment time and likely volatility. Once established, a variance budget is calculated and this forms the foundation of the option’s price. This is calculated using the formula:
- Target volatility² x target maturity
Let’s say an investor purchases a timer call. A three-month timeframe is set with expected volatility of 30. The variance budget in this instance would be 0.0225 (0.3*0.3*(91.25/365). Essentially, once the realized volatility squared, times by the number of expired days divided by 365 is more than the variance budget, the option would terminate.
Say the investor correctly calculates and the realized volatility is 30, the option will mature in three months. If the realized volatility is less than anticipated the option will expire at a later date. If the realized volatility is higher, let’s say 40, the option will expire quicker.
The first trade via SG CIB was made in April 2007. The hedge fund client moved their existing HSBC vanilla call with a June expiry date, to a timer call. At the time of trading, the implied volatility on the vanilla call was holding marginally above 15%. The investor fixed a target volatility level of 12%, a little higher than the prevailing realized volatility level of 10%.
There are many strategies that you could implement when trading timer calls. These can be selected based on your risk appetite, available tools or desired timeframe. With that said, all options strategies are essentially based on two fundamental contract types; calls and puts.
A covered call is popular with retail investors. It comprises selling a call option against the same asset you hold a long position on. The approach aims to increase the level of profit that you can make from the long position alone, by receiving the premium from selling an options contract. The level of flexibility and ability to set an option’s price using this type of contract means you won’t be paying above the odds to open and close a position.
The strategy is ideal for timer call options traders who are bullish on the underlying asset, believing that the price will increase in value over the long term but face little movement in the immediate term.
A married put involves the simultaneous purchase of an asset and put options of an equivalent volume. Also referred to as a ‘protective put’, the strategy can be used to protect traders from downside risk when holding an underlying asset.
Let’s say you invest $100 into asset A and simultaneously purchase one timer call put option in the same asset. Essentially you are covered against the event that a negative change occurs, and at the same time benefit from positive price opportunities.
A long straddle options strategy can be used when trading timer call contracts. It involves purchasing a call and put option on the same underlying asset with an identical strike price and maturity date. This is ideal for trading timer calls when you are unsure of the price direction. The maximum loss you will experience is the cost of opening the positions.
Trading timer calls successfully often relies on sourcing and examining reliable volatility information and historical data.
The Cboe Volatility Index (VIX) has been a useful tool to understand volatility in the markets since its introduction in 1993. It measures expectations of the 30-day S&P 500 in the prices of options. It is an implied volatility index and removes additional factors such as dividends and sets interest rates to zero so traders can view a true picture of patterns. Characteristically, VIX is negatively correlated with the S&P 500 meaning traders will typically hedge against market downturns.
See our guide to VIX trading here.
Pros Of Trading Timer Calls
- Increased Profit Potential – Effective trading strategies guarantee a profit margin when the realized volatility is higher than the implied
- Cheaper – The difference between the implied volatility used by financial markets to set an option’s price and the realized volatility of a security over time rarely converges. The implied volatility is almost always higher, therefore investors will often pay more for a traditional contract
- Reduced Risk – Investors can use trading timer calls to hedge risks against sudden market drops (with uncertainty in timings). Although uncommonly offered, it could be good to implement on indices such as the London Stock Exchange (LSE), New York Stock Exchange (NYSE), NASDAQ, Dow Jones, or DAX
Cons Of Trading Timer Calls
- Limited Liquidity – As an exotic, timer calls options are traded over-the-counter (OTC). This means it may be difficult to find a brokerage that supports this trading product
- Not Suitable For Beginners – Unlimited gambling on the volatility of an underlying security is not straightforward. It is a challenging product and can require hours of analysis, particularly on assets with no real volatility pattern. For example, studying the crypto market can be complex. The instability of digital currencies such as Bitcoin (BTC) and Ripple (XRP) can make it difficult to determine any sort of relationship
How To Get Started
First, you will need to find a broker that offers this style of investment product. Your brokerage must have the technology to support timer calls, including the flexibility to select an asset price based on volatility. The best brokers in 2023 will have access to educational resources, mobile apps, competitive pricing, plus responsive customer support. The top-ranked options platforms will use real-time ETL pricing (extract, transform and load) meaning you can view live rates.
When opening a position, relevant commissions and charges will be displayed. Here you will be able to set an estimated maturity level constructed on your projected volatility. Keep an eye on your trade in the real-time terminal/dashboard. Alternatively, algorithm-based programs such as Python can be used to create and customize positions.
Contact your broker’s customer support team for any issues including timer calls not showing on your account, why they keep dropping or ending, understanding keyword calls plus how to change scripting language settings.
You may want to view daily volatility history, pricing patterns and stay abreast of economic news. There are also books, web pages, live Zoom webinar sessions, plus social trading forums. Alternatively, YouTube has a wealth of accessible video content, with educational resources from Jeff Moore, for example.
Time Calls Vs Other Options
Trading timer calls is different from traditional options. Exotic options differ in terms of expiration dates, strike prices and payment structures. They tend to offer more flexibility and customization, meaning you can align your risk tolerance and desired profit levels.
A traditional options contract gives traders the choice to buy or sell an underlying asset at an established price before or on the expiration date. The investor has the right to buy the underlying security with a call option, while puts provide the ability to sell the underlying security.
Below we list other common exotic options you may come across in your trading journey:
A lookback option allows a trader to reflect on the price history of an underlying asset when deciding when to exercise the option. They are also sometimes referred to as hindsight options. Investors essentially have the option to review the prices of the asset during the established timeframe. After reviewing pricing, the investor can agree on the price that they want to continue to exercise the option.
There are two types of lookback options; those with a floating strike and those with a fixed strike. Similar to the timer call option, the hindsight option does not tend to trade on major exchanges. Instead, it trades in the over-the-counter (OTC) market.
Let’s take a look at this in practice…
Say shares in a global company trade at $20 at the start of an options contract. There is no change in the price at the end of the two-month contract. At one point during the lifespan of the option, the highest price reaches $50, and the lowest is $10.
- Fixed Strike Lookback – The fixed strike implies the strike price is stable. The options contract is not exercised at the price of maturity. The payout settlement is the maximum difference between the optimal underlying asset price and the strike price. In this example, the strike is $20. The best price during the lifespan is $50. At strike, the stock is worth $20. The profit for the investor is $50 – $20 = $30
- Floating Strike Lookback – The floating strike takes the optimal value of the underlying asset’s price during the lifespan of the option. The settlement is the difference between the market asset’s price at maturity and the floating strike. In our example, the lowest price during the lifespan of the underlying asset is $10. At maturity, the value is $20 which is the strike price. The investor’s profit will be $20 – $10 = $10
A basket option collates a group of underlying assets with one or more securities, currencies or commodities. Similar to timer calls, basket options reduce trading fees as only one transaction is required vs multiple individual trades. Another similarity is the use of risk management. Investors can essentially hedge risk on multiple assets at the same time.
A shout options contract is another exotic option. The product involves an investor locking in a gain at a chosen time, with the contract remaining open. The so-called ‘shout’ secures a minimum profit, even if the underlying asset value drops after the call. For instance, if an asset has a strike price of $40 and it trades at $45 before expiration, the trader may ‘shout’ and gain the $5 profit. The contract remains open and additional profits can be made if the price continues to increase.
The more volatile the underlying asset the more probability that the option will be “shouted”, increasing the likelihood of a payout. They are, therefore, more expensive than traditional options. The more ‘shout’ opportunities, the more related costs.
Barrier options are similar to traditional vanilla calls and puts. Investors agree on the terms of the contract, including the strike price, the barrier price, and the expiration date. Trades, however, are only activated or voided when the price of the underlying asset hits a predetermined level, known as the barrier price. As with timer call options, barrier options offer less liquidity than traditional options contracts.
Barrier options can be broken down into several categories:
- Up And Out – The spot price starts below the barrier level and rises for the option to be knocked out
- Down And Out – The spot price starts above the barrier level and declines for the option to be knocked out
- Up And In – The spot price starts below the barrier level and has to increase for the options contract to be activated
- Down And In – The asset’s spot price starts above the barrier level and has to decline for the options contract to be activated
Let’s say an investor purchases an option with a $50 strike price and a barrier of $55. Today, the underlying asset trades at $45. The option contract will not activate until the underlying asset’s price climbs above the $55 barrier. If the option doesn’t touch the $55 mark, the option will not be triggered and the investor will lose their stake.
Final Word On Trading Timer Calls
Although trading timer calls sounds complex, the benefits are appealing. Avoiding the sometimes costly implied volatility pricing set by broker-dealers means the likelihood of a greater profit margin is possible if the price moves in the right direction. But as always, trading options is not for the faint-hearted. A lot of market research and prior knowledge will be required to execute this type of option with success.
What Are Trading Timer Calls?
Trading timer calls are an exotic type of options contract, permitting investors to specify the level of volatility used to price an instrument. Instead of a broker using implied volatility to price an option, the volatility is fixed.
When Do Timer Calls Expire?
Timer calls have an infinite maturity so they can expire on any given date. This date will be dependent on the first time that a pre-defined variance budget is fully consumed either by the realized variance of the asset price or at the expiration date, whichever comes earlier.
How Can I Start Trading Timer Calls?
You will need to find an options broker with the technology that supports timer calls. It is also worth researching the previous volatility and price patterns of your asset. This will help determine future movements and support setting your target volatility.
Is Trading Timer Calls Suitable For Beginners?
Trading options with timer calls is a challenging concept, often requiring many hours of market analysis. Beginners may prefer a more systematic and repetitive strategy to start with. See our guide to trading options for more information.
Is Trading Timer Calls Good Or Bad?
Whether you trade timer calls successfully will come down to your investment style, risk appetite, timeframe and more. For newbies, a demo account could be a good place to test out trading timer calls and respective strategies.