best options technique for the retail trader

Discussion in 'Options' started by eagerbeaver, Jun 19, 2005.

  1. yeah that's what I meant sorry buying ITM is generally advised because it acts exactly as the stock. Since I don't want the same dollar exposure- point for point, I don't want to buy ITM options. ATM options have the most time value and usually have a delta of 0.5 or more, I am looking for deltas around 0.3-0.4. Obviously I would rather see the options go ITM and stay there but that is not necessary for the trade to be profitable.
     
    #11     Jun 29, 2005
  2. I do not think calendar spreads are the best because they rely on too many factors for a profit to occur. If you are doing ATM calendars then you need the stock to stay sideways until expiration. OTM spreads require you to basically pick a direction so it become just like any other directional play. Also Calendars require an IV skew to open up the position with an advantage and you want to avoid an IV crush on both sides or an IV expansion on both sides far from expiration. SO IV becomes an important factor on top of direction and time to expiration. Lots of factors to consider.

    I like calendars for certain situations but it is quite diffucult to trade them 100% in a portfolio. Too many factors have to be correct for you to reach a profit but at least the risk is limited. I also do not see this strategy giving you any advantage over the house compared to other strategies.

    In my opinion, simply credit or debit spreads such as bull call, bear call, bull put, bear put give you the flexibility to trade any direction or no direction at all while negating the effects of IV changes and time decay, to an extent. Spreads are the best example of the usefulness and risk management capabilities of options in many ways.

    Just an opinion but these kind of spreads show the true benefits of trading options.

    Phil

     
    #12     Jun 29, 2005
  3. probably the easiest way to trade is to buy atm call or put verticals at least 6 months out....

    premium is built in for time and the volatility is almost nill...

    the farther out verticals are cheaper than those with less time remaining...

    the only caveat is that you have to have a long time frame...

    as a pro you can short premium and volatility but as a customer you have be long or net flat units...

    kinda sucks but that is the way it is...:)
     
    #13     Jun 29, 2005
  4. I place vertical put credit spreads, same month $5 strikes apart. There can be a good % made from the credit compared to the margin required for the trade. i.e $1.50 cr, $3.50 margin required. However, I am NOT bearish on these stocks. I am neutral or bullish. Selling puts = if the stock drops, I lose. I do give myself some room for the stock to flucuate by selling OTM.

    Correct me if I'm wrong, but to place a bearish put credit spread, wouldn't you have to buy a put with a higher strike than the put you sell, for a credit? Even with a leap calendar spread, I don't see how you can buy a put at a higher strike for less than the put you sell.
     
    #14     Jul 1, 2005
  5. OptionCoach -- You're sure right about calender spreads being all about i.v., but this is so quantifiable, don't you think? The odds of volatility crush are greatly reduced if your back i.v. is, say, in the lower half of 100 day s.v. while your front month i.v. is in the upper reaches of that range. Pretty black-and-white next to the challenge of picking a stock direction? Also, with, say, a six-month long option, you have so many opportunities for rolling..

    I am confused by one point, however. You said verticals aren't impacted by i.v. From my (albeit limited) experience, volatility is definitely an issue here. Can you explain further?
     
    #15     Jul 2, 2005
  6. My favorite "technique" is the good ole vertical credit spread. If you're selective about the trades you take with regards to the ratio of credit taken in to max risk, you can put yourself in a fairly comfortable position to fairly well on a month-to-month basis; if you're willing to adjust the position abit and make it into more of a directional play by writing the ATM or just ITM strike, you can do pretty well if you're comfortable taking an opinion on the direction of the stock.

    While you'll find pretty favorable risk:reward profiles on OTM spreads, you can find them a lot more consistently - and a better profile - with the ATM/ITM spread if you're comfortable with the directional component.

    Just my opinion.
     
    #16     Jul 3, 2005
  7. Some general thoughts:

    1. calendars still require a directional pick. Sideways is a direction afterall. If you place an ATM calendar spread and the stock moves higher or lower by expiration, then the spread has a loss. Although you can roll to the next month, you are then making a prediction that the stock will move back to your strike in a sense. So calendars do not eliminate the need to understand and establish some sort of directional bias and is subject to same difficulties. However, the advantage of the calendar comes in taking advantage of the skew and this is where IV plays a pivotal role. Although IV is quantifiable, you still cannot predict it with any certainty. The skew allows us to take a directional position (higher, lower, sideways) using the skew to decrease our cost of debit.

    Moreover, the time factor gives us more opportunities to make adjustments by rolling month to month or rolling on the long month after the short expires. Given all these factors calendars can be rewarding but certainly not easy and not for the beginner. Although they are a good strategy I feel they are better suited for specific situations as opposed to a single strategy to trade solely in the market. I use them when I see a nice skew and I have a directional bias (up, down, sideways).

    So there are cons and pros to calendars but I view them more as a situational strategy where terms dictate their use rather then a strategy you can use for any stocks or directional analysis.

    2. Verticals negate the effect of IV to an extent. You are both long and short an option so if IV increases, your long and short strikes will increase in value as well, albeit not equally. If IV collapses, your long and short strikes will both decrease in value, albeit not equally. The vegas of each strike are not far apart and the fact that you are both long and short helps offset the effects of IV. It is not a perfect offset since one strike is always further OTM than the other but it negates it to a large extent.


    One way to visualize this is with an option calculator. Derive the price of each leg of an ATM bull call spread using the same IV to get the net cost of the spread. Then decrease or increase IV by 5 points and recalculate the total value of the spread. Huge swings in IV will show a change but most normal changes will be offset to an extent.

    Phil

     
    #17     Jul 3, 2005


  8. How do you estimate what is a "pretty favorable risk:reward profile"? I can see that a OTM spread has little cost and could possibly widen to the max of the distance between strikes, but you have to incorporate the probability of this happening as well. Otherwise, why not buy just the cheapest spread available?

    Isn't this the basic flaw of all riks/reward reasoning with options?: the price ot the option is based on a statistical model using the volatily of the underlying. Estimating the chances of any outcome is in essence re-determining the value of the option. But that is exactly how the price was determined in the first place.
    So, your only edge would be if you knew in advance that the chances of some outcome differ from those used in the model, but how would you know that?

    So is the only gain in directional trading after all?

    Ursa..
     
    #18     Jul 4, 2005
  9. bvam1

    bvam1

    My favorite is bear call/bull put calendar spread. Don't know if it's an official name, but it's a combination of those spreads.

    Like the game of chess, the goal is to position your pieces to attack your opponent. Likewise, the goal of this spread is not to make money the first month (although you could), but to accumulate nearly free positions to prepare for a directional trade the following month.
     
    #19     Aug 3, 2005