Long Calls/Puts vs. Spreads (Long on the Wings)

Discussion in 'Options' started by jones247, Oct 16, 2008.

  1. Advice from many "gurus" such as Maverick and others (i.e. DMO, RiskDoctor & Atticus [I think]) recommend going long on the wings with spreads as among the best of option strategies. In many instances, it appears that an Iron Condor with an extra position on the wings were described. The problem is that whether or not you structure an IC with an extra long position on the wings or some other spread that enables you to go long on the wings, the slippage would kill this strategy.

    Why not simply go long on a call or put after the earnings report? The IV will get crushed after earnings, although the VIX is still extremely high. For example, Goog is now soaring after earnings. If I were to buy atm call with an expiration two month from now, wouldn't that be a better bet than the previous spread strategy with 6 entries/exits? That's A LOT of slippage to overcome. Or, I could have bought Goog today about 4 strikes otm before earnings, which would give better resuts as compared to a spread with extra long positions on the wings.

    Am I missing something here????? I think K.I.S.S. is best here...


  2. The more complicated it is, the more commissions. careful.
  3. My point exactly... why not simply go long with call or puts, depending on the outcome of the earnings report. Or as Nassim Taleb did, buy otm straddle options with several months til expiration and wait for the big move. Personally, I think heavily traded stocks, after dividends or earnings is the best play. Of coarse the earnings should be in alignment with the market (i.e. bad earnings in a down trend or good earnings in an uptrend).

    Any thoughts....


  4. Hi Walt,

    Keep in mind Nassim Taleb is a self-financing positions lover. So he never just buy out the money calls and puts. He shorts slightly in the money and at the money options to finance the previous ones.

    But Taleb is one of the oldest exotic option trader. His main strategy is to short at the money vanilla options (calls and puts) and to buy OTC out of the money "up and in" calls and "down and in" puts. Prices are cheaper and easier to be offset by vanilla thetas. The global position is delta hedged.
  5. I didn't know Taleb's main strategy was debit spreads, although the long wings were otc otm.

  6. dmo


    As a general rule, short the middle and long the wings is a nice position to be in. If you do it in such a ratio that you are vega neutral, you will find that as volatility rises you get longer and longer vegas and you make money. As volatility drops, you get shorter and shorter vegas and you also make money. Not bad!

    If the underlying stock or futures contract makes a big move up or down, you also get long gammas (which is what you want) and long vegas (usually what you want). You have a built-in "safety net" and if the market goes completely wild as it has recently, you rake it in. Those are the reasons why I (and presumably Charlie Cottle and Atticus) like being short the middle and long the wings.

    But is that a "good strategy?" As always, that depends on how much you pay for it! One of the reasons for the "smile" of volatility is precisely the desirability of owning those wings. That's why they tend to be more expensive (trade at a higher IV) than the ATMs.

    Are those wings overpriced, underpriced or fairly priced? Aye there's the rub. Your ability to evaluate whether options are overpriced or underpriced - both absolutely and relative to each other - is the essential skill that's going to determine your success. A pricing model serves as a useful point of reference, but after that you're on your own.

    That's why I'm so insistent about the importance of being familiar with an option contract's "personality" - including its skew - before committing any serious money to trading it.
  7. Thanks for the reply dmo; however, I don't understand how a butterfly or an iron condor can be profitable with a big move, unless you add additional positions on the wings. If you are indeed adding additional positions on the wings, then why not simply go naked long straddles without the spread?


  8. dmo


    Right, that's what I said - " If you do it in such a ratio that you are vega neutral" - which equals gamma neutral and theta neutral provided all your options have the same expiration date. That means being long more wings than you are short the middle.

    Naked long straddles are completely different in that they are pure long-premium plays. Every day that the underlying doesn't move you lose money - more today than yesterday, and more tomorrow than today.

    But if you start off short the middle and long the wings at a ratio that makes you gamma, vega and theta neutral, then if the underlying doesn't move, you get shorter and shorter premium (make more and more money) every day. If the futures DO move, you get long premium, which is usually just what you want. So this position has you short premium if the underlying doesn't move, and long premium if the underlying does move. It has you short premium if IV goes down, and long premium if IV goes up. These are exactly the characteristics you want in an option position. It is a very, very comfortable position to have. But comfort comes at a price. That's why those wings are expensive.
  9. Excellent point... but how would you overcome the slippage associated with so many positions for each trade???
  10. dmo


    Overcoming slippage is always a problem. But why would it be significantly worse than for other multi-legged spreads?
    #10     Oct 18, 2008