regards to everyone at et. i joined this forum only last year and it has proven to be a great decision. i have been able to learn a lot about options from the most expert members in here, but i also prematurely thought i already knew enough to trade long positions in options with great profitability. i never bothered to ask some very concrete questions about the systems i’m trying to trade to the experts in these fora and i sure have paid for the mistakes i have made. i have been trying to trade a strategy that looks like this, but with long calls and puts positions instead of long and short positions on shares. the following are some screengrabs with the results of trading one of my systems with positions of 100 nflx shares from 01-I-2018 to date: initially i just had no idea which strike prices to choose and then for a long time i thought that i could maximize my returns if i concentrated on the options contracts which offered the highest proportion of deltas to monetary cost for the premium paid. i ran the calculations for the options chains of several different symbols and arrived at the conclusion that otm contracts with around 5 or -5 deltas were the best to buy as they had the best proportions of deltas to cost compared to all other contracts. i have now learned that there is no way to trade long cheap options profitably. if one buys, let’s say, a short term 10 delta call contract one needs the underlying instrument to move several percentage points in one’s favor in a short time just to break even, and then keep moving several percentage points higher if one is to make any kind of relevant profit. if the price of the underlying is never bought significantly higher then the entire chain segment of p.o.s. out of the money calls will end up expiring worthless. in the case of puts it is the same story in the opposite direction, and all this ends up making a huge difference when it comes to the profitability of any system. in the case of my strategies, the percent of profitable trades will drop from more than 30% to far less than 10%; the profit of every winning trade will be reduced significantly; and all losing trades will end up destroying 100% of the premium paid. this will result in devastating losses when trading any kind of strategies with otm options contracts. even when the monetary cost of the premium paid is very low, the risk of the strategy is actually much higher as practically 100% of all positions will end up worthless. paraphrasing what mr. Robert Morse once wrote in a post in this forum, there are options which are similar to replacements for shares but out of the money options are lottery tickets at best, and i add that there exist no systems to make money buying lottery tickets. cheap options contracts are nothing but trash, they are really cheap compared to the cost of holding positions on the underlying instruments and that is for multiple good reasons. anyone who buys cheap options contracts has every single factor going against them every time, either a uselessly short period to expiration, or a ridiculous distance for the underlying to move in one’s favor for the contracts to become in the money, or both. i have learned my lessons and won’t ever be buying cheap options contracts again, i have figured that what i needed were options contracts that functioned like replacements for shares and now that those are the only contracts i’m trading there has been a significant improvement in my results. i decided to post this summary of my experience so far so that others won’t make the same mistakes i have made. if anyone is trying to trade strategies with long positions on options contracts, make sure to stay well away from all the "cheap" crap.
To attempt to summarize: 'Using far-OTM options as a substitute for the underlying with swing trading the way "I" trade is a mistake!' This seems to support the notion of using far-dated deeper ITM options as surrogates for the underlying! A word of caution: statements such as "won’t ever be buying cheap options contracts again" may loose conviction when you discover how they may aid in your trading! (I once stated I would never trade Butterflies, and now, that is my primary trade!) I appreciate the post, as it helps to illuminate the journey of option trading!
Delta is a good proxy for probability, so a 5 delta means there is only a ~5% probability the underlying will touch the strike. IMHO, you should not make blanket statement like that. There are lots of folks who specialize in trading black swan events and make a good living doing it. You just have to look for those. Usual screeners won't do.
You sir are one step ahead of me. I am learning to trade butterflies after 6 years of single legs. Harder than I ever imagined but slowly getting there. I now see lots of reasons why you pros are trading it. Regards,
For me, there is a process, that is "slowly" being tweaked. I am looking for consistent "base-hits", so when a great pitcher is on the mound, I don't go to bat! I think each individual will have unique process to suit his/her comfort zone. -- I also think this is getting more and more difficult as "edges" are being sanded down, so may not be worthwhile for a retail trader at some point! --IMHO
IMO, that is not a scalable process. IMO, you need to pick a stock or index for a reason. Have a expectation based on some process that a stock will trade or not trade in a direction or range during a period of time, and then and only then, use an option strategy that fits your expectations. Or, have a process to expect that options are priced wrong. Otherwise, the stock pick, the strikes you choose, the time to expiration are all random like throwing a dart.
Putting on randomly doesn't work for me. I backtested (mechanically) butterflies on actual 6 month historical option data on equities I normally traded and didn't find any profitable combinations, 121,132, 231, different body/wing... Maybe I have not looked hard enough but a butterfly in itself is not an edge.
I kind of came to the same conclusion after many months of painful backtesting. What bugs me is if my opinion is correct, I am better off going single leg? The only thing I can think of for butterfly is I want to trade single greek. With some combination, I can almost trade single greek.
Yes! Agree. -- the trade must support what the market give you and "roll" with the changes. -- These are NOT "cannon-launch" trades, but are managed! -- by "not a scalable process" are you referring to position sizes or "consistent amount of money at risk?" -- or something else.