I apologize in advance cause this might be a long post and maybe a bit hard to follow... Basically it is a trade based on EEM (emerging markets ETF). The reason why I am posting it is because this is not a trade I would "normally put on"... EEM closed at 35.80$ friday. I figure the trend is still up and I am thingking about setting up a trade for december expiry. I figure my target is 40.00$ by then with a stop loss at 31.75$. I am looking at getting in at 35.72$ for 2800 units (or the equivalent in options). Basically thats a cost of 100 016$. Max loss: 11 116$. Expected gain: 11 984$. I have joined a probability table to the post. Basically it says there is 99% chances EEM will hit my limits before december expiry. Once you bring the chances of hitting either one, you get that you should hit the top one at 50.38% and the lower one at 49.62%. 61.91/(60.98+61.91)=50.38 60.98/(60.98+61.91)=49.62 So it is 50/50 really. If it hits the top one first, then thats nice but not so cool if its the low point cause then you sell kicks in. 0.5038*11984-0.4962*11116=+521.41$ Where it gets interesting IMO is if you choose to go with a synthetic long by selling the 36$ put and buying the 36$ call. I'd shoot for a net credit 0.15$ on 28 contracts. 2800*0.15=420$ I also would buy a protective put at 32$ for 1,10$. 2800*1.10= 3080$ So that gives a cost per unit of: 36-0.15+1.10=36.95$ Max loss: (36.95-32.00)*2800=13860$ Max gain: 8540$ It gives me a net debit of 2660$ so basically I could invest the 97 356$ for 5 months in a MM or something to add somewhat to the gain. Still it does not look like the number 2 option is better... Thats where you input comes in: The way I figure, with the first strategy if the ETF hits 31.75$ I'm screwed but not with the second one. The probability calculator also says there is 23,88% chances it will hit both strikes... So if it hits the lower one I still have a chance it will go to the higher one any way. 0.2388*0.4962+0.5038=62.23% That it would hit the highest one in any case... So: 0.6223*8540-0.3777*13860=+79.52$ (plus whatever I make on the MM for 5 months). I figure about 680$ total. The 680$ versus the 521$ would be the expected profit on this trade executed one hundred times... The fact that the E(x) is positive tells me these are acceptable bets... I think Feel free to shoot it down or give any input/advice...
you're bullish on EEM with a target of about 40 in a december timeframe. how about buying a 39/40/41 or 38/40/42 dec butterfly for an inexpensive, limited-risk, easy-to-manage trade with a very nice R:R?
There's no add'l gain from investing the bulk of the cash not used for the synthetic in a MM because that is the cost of carry which is imbedded in the option premiums. IOW, the net credit received for doing the -36p/+36c synthetic long (option premium plus MM interest collected for 4+ months) will be pretty darn close to the 28 cts of intrinsic (if assigned) that you're paying for doing the synthetic. That's why the synthetic presents no advantage over the long shares. Adding a long 32p to the synthetic 36 long gives you 3 legs when the synthetic to that is simply buying the 32c. All these gyrations in order to buy a call? Long share vs a long a call. It's an oft discussed comparison here. The screwing received from hitting $31.75 on long shares versus that received on a long 32c is different because they are different strategies with different risk profiles. Simple as that. I'm no fan of taking a trade because expected returns and probability of hitting a a stop loss 4 pts lower is slightly less than hitting a profit target 4 pts higher. Saying that "if it hits the lower one I still have a chance it will go to the higher one any way" is rationalizing with hope. And so is concluding that it's an acceptable bet because the expected profit is positive and therefore it's an acceptable bet. You're only doing this trade once b/t now and December (not 100 times). To me it's simply, I take this trade because I'm bullish. From that, what's the best way to have the potential to make a profit if correct in my timing and limit the loss if wrong? Is your synthetic the best way?
Thanks for the input. I guess I always look for the most twisted or complicated way for getting from A to B lol... Normally I would have done a short put spread with the 36/32 for a credit of 1.50$ but I was just trying to maximize the gain/loss ratio because I don't like to make so little vs what I could loose on what boils down to a rather long shot even considering a bullish outlook...
I believe spindr is 100% right... Neither strategy gives you free money over the other... What they do give you is different profit/loss profiles over the lifetime of the trade. One of these profiles may suit you more than the other. As a result, IMHO, you should stop looking at the probabilities and instead think how your trade performs under discrete scenarios. Then make a decision based on what you feel suits you better. Personally, because I am such a wuss, I'd just buy a call spread (don't like pinning strikes with flies, like willy suggests), but obv it would depend on the cost...
Another way to get a more favorable RR and have more of a gain in a trade like this is to buy an OTM call since you are bullish. And them sell a OTM put spread to finance the cost of that call. However, that is still 3 legs in the trade so watch the commissions but it is just a financing method that can be used if you want more upside.
FWIW, before it split 3:1, I used to gamma scalp EEM via long straddles and trading the stock intraday against it. I liked EEM because it and the China sector were volatile and there were often opening gaps as well as intraday continuations and reversals. Problems occurred with stretches of IV contraction and extended trends where stock acquired approached +/- 100 delta. I'm not recommending this. I'm just mentioning another approach. One of the difficukties with options is that they give you so many ways to approach a position and since everyone's risk/reward (objective/tolerance) is different, there's no best way to skin the cat. But that does lead clever people to consider "the most twisted or complicated way for getting from A to B" . Understanding synthetics won't make you money per se but at times, it will help you simplify your life.
That was not a bad idea. One of my main problems though is that I cannot get my head around "net buying" options. I know a credit or a debit spread have no inherent advantage, Its just a trading philosophy. Also I do like to know what I risk (obviously) but I do want to know whats my upside, I don't like "unlimited" strategies
Ya know, at some point you have to get past the negatives... I don't like paying time premium. I don't like being long options. I don't like being short options. Stock costs too much. Unlimited risk. No dividend. Limited profit. IV too high. IV too low... ad nauseum. At some point you have to man up and put the cash in front of the dealer To paraphrase/repeat what Martinghoul suggested, consider how various strategies perform under different scenarios and then make a decision based on what you feel suits you best. I'd add that you should also have an idea/plan of what you will do as price and IV change and time elapses. As you get ahead/behind, what are you going to do lock in profits, diminish add'l losses, etc. AKA, adjsutments. The beauty of the gamma scalping is that you tend pull out consistent small profits UNTIL you hit an extended IV skid, trade in a narrow box for a stretch (2X time decay) or get maxed out on the delta. What you won't get is a big profit from an extended move. To wit I repeat, it's all about risk vs reward. What suits you, small ball singles? Home runs and strike outs? Pick yer poison and start swallowing
I bet you don't like the RR. The Dec 38/40/42 long butterfly make more senses. It gives you at least 15:1 RR and profit zone: 38.1 - 41.9 that should meet your original plan. Check following chart, which shows the position with just one day left.