In my retirement account, I can't short a stock but I can buy put options. I have some strategies that average around 1% or more profit per trade. However when I look at the put options, the difference between the bid and ask is typically way over 1%, sometimes as high as 100%. I might be lucky and be able to buy on the bid and sell on the ask, but that's depending on luck. I believe that you should really count that bid/ask spread as an expense. Not counting that bid/ask spread as an expense would be like going to a used car dealer, buying a car for the retail price at $10,000 then hoping to sell it back to the dealer right away for a retail price of $11,000. That's not going to happen, you'll get the wholesale price of $8,000 if you sell it back to the dealer. When I buy or short an actual stock, the bid ask spread is much smaller, sometimes as little as 1¢, which in percentage terms might be as little as 0.1%, enough room for me to make a profit. Is there something different with the math for put options that I'm missing? It looks to me that I have to make at least an average of 5 to 10% a trade just to overcome the bid ask spread.
There is no "perfect" hedge. The point of hedging is to "protect the bulk" of the asset. Any hedge will work if called upon.... to a degree. Which will/would have worked best? Won't know until after the fact. You can't realistically hedge "spreads", you can't hedge "noise".... just cover the bulk of the risk... that's the best you're likely to do. "Hedging" is no assured pathway to success. If your hedge is successful, you protected capital. If not successful, the "hedge cost" hurt your returns. As in all "market things", there is no free lunch. If you want to make any REAL money... you likely have to take a large, unhedged position and be correct about it. All the rest... though you may feel like you're "trading" and accomplishing something.... is just "dancing around break-even".
Sam, I think there is just a better market for the stock - more buyers and sellers, driving the bid/ask close together. Not that big of a market for the options, thus a wider spread. Nothing funky with the math.
you are putting up little money to limit your loss if the stock soars upward. the above post about liquidity is also correct.
Yes, you're missing the main point of using options in the first place: leverage. In some cases, depending on time to expiration and IV, an option could return hundreds of percent profit on a 1% move in the underlying. The main disadvantage of options is time decay: with a stock that doesn't move, you lose nothing, but with its option you may lose up to 100% if you hold to expiration. Besides leverage, the main advantage of options is that you limit your risk to the option's cost, as opposed to risking up to the full cost of the stock, eliminating the need for stop loss orders, though you still have the choice to sell for a partial loss if the trade heads in the wrong direction.
Have you tried deep-in-the-money puts? The spread, as a percentage of the stock price, is usually much smaller.
The leverage for example, might make your put options move 10 to 1 compared to the stock price but that won't change the percentage difference between your bid and ask for the options. Am I thinking right with this example?: Say that I could buy one share of a large volume stock trading with a bid/ask of $9.99/10.00 for a purchase price of $10.01. I lose just 1¢ for the spread. I have a target of $10.30 and a stop of $9.71. For simplicity, let's say there's a 50/50 chance it can go either way. If it hits my target, I stand to gain 30¢ or about a 3% profit. If I lose, and it hits my stop, I stand to lose 30¢, for about a 3% loss. Now if I could buy an option that for simplicity sake, moves with 10 X leverage. The option bid ask would be $1/1.20. I would buy one option at $1.20. If the stock moved as before up by 3%, the option would move 10 X 3% = 30% to a bid/ask of $1.30/1.55. I could sell the option at $1.30 for a 10¢ profit. If the stock moves down 3%, the option bid/ask moves down 30% to $0.70/0.84. I would sell at $0.70 for a loss of 50¢. So the way I see it, I'm taking a chance of losing 50¢ in the hopes of just 50% of the time that I gain 10¢.
No, you can't expect to profit with puts as an alternative to shorting stock, based on your system profile. You're already nailed the main issues. If you still have any doubts - which you shouldn't - then trade a single contract on a few of your target shorts, and follow the results. Spreads, liquidity, and decay will be your killers. Best of luck.
If you're looking to hit your 1% target within a month, then options don't make sense. If you're doing a day trade, then a 1% move can make a near expiration option move by 100's or even 1000's percent. Someone who trades with 1% targets would tend to be a day trader or maybe a few days trader. If you can win a high percentage of trades in this time frame, then options could be very profitable in spite of time decay and B/A spreads. A day of exp. option could, for example, move from 1.00/contract to 10.00/contract on less than a 1% move in the underlying stock.