Long Call Verticals on LEAPS, legging out

lionline · Nov 9, 2011

Quote from spindr0:

Your account value will always show the the net effect of paper gains and paper losses.

One of the many problems with your premise is that whatever the further OTM short leg decays, the long leg will decay more. That means a net loss of account value. Only a cooperative underlying will offset that. Get that? NET LOSS.

If at the present time, calls are considered expensive at $1, doing spreads at a lower net cost and waiting waiting six months for those $1 long leg to be worth 20 cents will lose account value. If you're that bullish on the underlying, just buy whatever strike is currently at 20 cents. Period.

I appreciate all the effort that you put into your posts but your strategy as described just isn't going to work.
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+1

also - i suggest looking into the reverse.

if you are bullish, run your simulation on writing OTM puts, and buying further OTM puts.

that has a much greater stability.

ForexForex · Nov 9, 2011

Another potential problem could be the unlikely event that the short calls spike in value higher than the long calls for a brief time. Hard to believe but something to be aware of.

http://www.elitetrader.com/vb/showthread.php?s=&threadid=225150

spindr0 · Nov 9, 2011

Quote from cqm:

Hey so I have run some paper trades (let some weeklies depreciate) using the methodology

and basically the risk profile max loss changes from 100% to max 200% loss after realizing the gain on the decayed short leg. This is tolerable if your position size is only 3% of your entire portfolio - as it is in these paper trades.

Now I did this simulation with weeklies, but with LEAPS you will still have 6 months and 2 earnings seasons to retain your bullish outlook. as well as buy inexpensive puts for the next reason:

Initially lets say the long leg costs $1.00 /contract , your account is $20,000 so you literally could only afford 200 of those contracts.

Assume stock price remains stagnant.

After the short leg has depreciated you now have an additional few thousand dollars in paper profit (your account net worth won't show this because the long leg also has a few thousand dollar loss). The long leg is also now worth only $20 , so now you can actually afford buying dozens more of the long contract, that you initially couldn't afford.

Your average price on the long contract will be only a third of your original entry. So lets say you entered at $1.00 , then bought multiples more at $20, your average price will be $35/contract.

In a normal situation where price remains stagnant, you need a much further bullish move in the underlying just so your calls become profitable at all.

So in several scenarios this gives you more bang than just buying outright calls, because now you averaged down the entry price of your long calls greatly, without greatly multiplying your risk.

Now you own 5 times as many long contracts and still have 6 months for something bullish. one put can offset losses, a bullish move will GREATLY offset the put.
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Here's anther way to look at all of this.

I buy a long call. You buy the same long call but you also sell the next OTM strike against it (a vertical spread). The difference b/t our P&L will be the short call's performance.

We all know that a naked call is profitable below the total of the strike plus pemium received. Above that, it loses, possibly severely. The further the UL goes up, the more it loses. Fortunately, you have a long call so for the most part, your profit is b/t the strikes. Above the short strike, they offset. I don't have that problem. As long the UL rises, I do well. The UL's downside is a different story but not relevant here.

Now you can conjure up some upside scenarios where the spread outperforms (certain price/time/IV levels) but they're going to be few and far between. To the upside, the bang for the buck is with long, unencumbered calls, not spreads.

OK, that horse is dead!

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Long Call Verticals on LEAPS, legging out

lionline

ForexForex

spindr0