i have a better idea - you don't want to buy options - ever - so- why not buy the stock and sell the 80 calls against it...
One thing you should be careful of is entering the spread at a good price. IBM spread markets should be fairly tight, probably .20, even if the market in the individual options are 20 or 30 cents wide. If you don't, a couple point move in the underlying will turn into a small profit at best(smaller than it should be). Look at what the delta of the spread is too. A 70/80 call spread will have a higher delta than the 70/75. These deltas change as volatility changes. With IBM at 68 and 2.5 weeks to expiration, the OTM options are going to rapidly decay. The 75 and 80's have false deltas which, unless the stock move up rapidly, means the option values would not rise as fast as theoretically implied. This is the effect you are looking for. Vega on verticals is sometimes hard to take into account on front months options. Declining Vega values as expiration approaches combined with strikes close together can cause the spread to look cheap or expensive on a theoretical basis. This can be a little deceiving when a twenty cent wide market also has an IV spread similar. For front month liquid options, it is better to price verticals in relation to the box. A long 70/75 call spread is the same thing as a short 70/75 put spread.
Just to clarify, this is the situation: I want to position myself long but at the same time protect from a fall in IV as the position would be taken at a time when the IV is high compared to historical volatility. What would be the best option strategy for such a trade ? (selling a put excluded, as it is too dangerous)
Try putting on a condor or a fly around the zone you expect the stock to go up to. Depending on the skew and the IV levels you leg the spread at, it could be vega neutral than straight purchase of call. You can't also disount the possibility of IV going higher as long as HV goes up too.
Excellent idea. If the options are liquid, you could leg at decent prices. When IV shoots up, MMs are sometimes able to enter into flys at no cost. It is also a trick to see where options are under or overvalued with just looking at the screen.
__________________________________________ ________________________________________________ Are you referering to the cost of the butterfly? I did not follow what you meant by the value of the vertical spread determined by the cost of the box either. I followed the msft trade you mentioned in another thread. It seemed like it would never get to max profit, I didnt check it on expiration day though. If you were looking for a 1 to 5 day swing move, would a vertical spread be better. With the msft trade the bull put would have been the best choice to take advantage of a quick move. That surprised my I would think a debit spread would be best for a short time frame. My question should be, what option value characteristics/spread would take best advantage of a quick move and protect you against decreasing volatility.
Yes. The markets line up so that buying on the bid and selling on the offer would allow you to purchase a fly for a net credit or zero. Doing so is obviuosly free money. Theoretically, you should never be able to do so. However, due to the spread in the bid and ask and market volatility, it happens. Using this, when the market is less volatile, is more of an art form but still pratical. For instance, in IBM, a 75/8085 call fly should be worth more than the 80/85/90. Or, you could compare it to the 70/75/80 put spread, because, buying one and selling the other would be a lock. Options are all relationships. It is a July spread so it hasn't expired. Volatility never really came in. Another reason it has just turned profitable is that it was entered into at bad prices, hence, my recent emphasis on entering into spreads at good prices. If I remember right, the price on the 50/55 vertical would have been 2.65 with the stock at 52. With expiration in two weeks, it will rapidly appreciate in value if the stock approaches 55. If you are bullish, the most long deltas in a position will yield the most profit. You give something up by entering into vertical. It would have been a better demontration if I used June options instead of the next month out as front month options often give off the false deltas. If you have a large dynamic position, the best way to get long is simply to buy stock and sell calls. Why? Stock is hard deltas while options aren't. As mentioned earlier, options can give you false deltas. So, why not just trade stock all the time? In a large position you would have a hedge somewhere to protect yourself if it turns down. Without that, you expose yourself to a larger loss. Why not just sell a put? The otm calls would most likely be more liquid than the itm puts. Plus, as the stock rises, there will be call sellers coming in. You would close your position based on the natural order flow. So, for a 1 day swing you would want as many deltas as possible. For a five day swing, you have more "options." One factor would be a weekend is included. This is true whether it was entered into on a Thursday or a Monday. By Thursday afternoon, people are thinking about their exposure for the weekend. By Friday afternoon, Monday is factored into the market. On a basically four day weekend like we have now, MMs were probably looking at Monday. On a five day outlook, theta and vega become more of a factor in a positions risk profile. This is not to say vega can't implode or explode in one day. It is more things can change in the time frame.
True, but if he is bullish (for example), it shouldn't matter if he has a small debit. If he can middle the bid/ask, even a little, say it costs him .50, he has a $5 upside. So he is risking his fifty cents to possibly make ten times that. The problem then becomes the commisions as I mentioned earlier. But if he can do the trade for say $5 per contract, that is $20 in, and more than likely $5 out. If it is more than that to close, who cares? That means he has maxed out, and made $450 less the commisions which would be at most $40. Now that admittedly is a huge percentage, which is why I said that butterflys are not really practical. But if he can do them for $1 or $2 a contract, it starts to make more sense. These rates are available I believe....echo trade comes to mind. I am sure there are others. Do the math at a dollar or two instead of 5, and the return is so much greater.
I totally agree. The zero debit spread is an extreme case. A .50 debit with a possibility of earning 4.50 is a hell of a risk reward ratio. If you could trade stock or options around it, ooohhhhhh, as close to free money as you could get! A lot of things are possible in today's era of $1 commissions. Just a few years ago, you would pay 40 bucks to trade one contract. You would significantly reduce your likelyhood to enter a profitable trade. It is even possible to run a dynamic position.