If you accept delta as an approximation of probability, then the probable payout will be the $ difference between the stikes and a probability factor that will never go above 50%. long less short probability. Skew could be big factor on probable payout in deciding otm vs itm.
Well, I model it, although IV is an input that is hard to predict. So no, I don't accept delta as an approximation of probability. Not that it's all that far off, but I don't use it. How would your method ever predict a negative payout? $ difference is positive, delta difference is positive. My model shows that many (most) spreads have negative expectations. I must be misunderstanding your calc. I could sell DOTM and buy DITM, realizing a huge strike difference and nearly 100% delta difference. Explain more, please?
Is that a typo? The ask must have been $0.44 or $0.45, not $0.54. If I am mistaken there is no need to go off on a tangent. I don't see any profit in opening any sort of DITM spread. Perhaps you might get a few pennies once in a while, but most times they will end up negative.
Not a typo. Take the similar put spread available now: FXI @ $42.76 Jul15 $45.50 put B/A = $2.97/$3.10 Jul15 $46.00 put B/A = $3.35/$3.55 Best case: $0.25 (buy $3.35, sell $3.10) Worst case: $0.58 (buy $3.55, sell $2.97) I bet I could hit within a penny of the middle ($0.415). Not always, but if I can't, I don't take the trade. (Of course, I also evaluate expectation, and I only buy spreads that have significant positive expectation.) What you "see" doesn't matter. The spread referenced above should make $0.085 most of the time. That's not "a few pennies once in a while". You really need to consider the odds of success or failure and the implications thereof. For the spread I just referenced, my model says: Expire below $45.50 = 0.9115 Expire above $46.00 = 0.0565 Expire in between = 0.032 Expectation = (0.9115*8.50) - (0.032*16.50) - (0.0565*41.50) = $4.87 THAT'S what's important.
I thought your strategy involved both ITM options. With a a combination of ITM long call and OTM short call, you are only a few deltas away from a covered call. As such, a simple short naked put with your desired delta exposure may suffice.
Yes, my short leg is ITM as is (of course) the long leg. I was just trying to grok your estimation of payout. Can you explain in more detail? How would your calculation lead to a negative expectation in any scenario?
It's not negative. I explained the calc. long minus short prob. your long will always be bigger. If you don't accept delta as approxination of prob then i am out of my mathematical depth..
But my point is that some spreads MUST have negative expectancy. Your method doesn't allow that, as I understand it.