I think I've got a decent long strategy that does pretty well at finding bottoms on large equities. (I know! I know!) Holding period is 1-10 days. Let's assume that I really do have a good system: what options strategy would I use to enhance my risk and/or return profile? I don't mind doing my homework but I don't want to read 500 pages of an intense option book when I really just want to probably examine one or two strategies. Straddles, strangles, spreads, butterfly this - can someone give me the buzzwords to start researching?
If you're looking for bottoms, you're greatest risk is a sharp drop after you buy. Simply buying a small amount of puts (probably OTM, front month) will at least partially protect you in case of such a drop. If it does occur the front month OTM puts will shoot up in value, much faster than your long underlying will drop in value (99% of the time). It all depends on how your strategy works/what it trades. If you tend to find bottoms that slowly materialize into a slow moving rally, you may look into covered calls to make the most out of your position. If you're looking for a quick turn around, you might even consider using options flat-out (calls?) to build your position rather than buying underlying.
Okay, the covered call idea is intriguing. I think I can see how to make it work for me. But let me pose a hypothetical scenario. Let's say I buy XYZ at 34.30 and then sell a call at 35 for 1.55 that expires one month out. Now if the underlying falls to say 31 or 32 two weeks from now, what happens if I want to get out of both the stock and the covered call, i.e. what happens to the value of the call?
Options will not help you in this scenario. You are better off trading the underlying. With long calls, you will find that the decay and spreads will kill your gain in the timeframe you are dealing with. Short puts, forget it. Covered calls will cap your gains and create a number of complications when you want to exit, since you are holding for only a few days. Trust me here. I trade pullbacks, and have tried every options route to boost results. But not at all worth the effort.
It's generally thought that simple directional strategies are best played using the underlying. In my experience that is accurate, but I still like to use credit spreads for a directional trade that might last anywhere from a day to three weeks or so. The options books will call these vertical spreads. Let's say you think XYZ, which has declined to 50, is ready to bounce. You would sell a put, perhaps the 50, and buy aput with a lower strike price, say the 40 or 45. Since the lower strike will be cheaper, you recieve a credit, and that credit is the max profit you cna make. The max loss is the difference in strikes minus the credit. Now the beauty is that the short put has more delta than the long one, so if the stock does move in your favor, ie up, the put you are short will lose value more quickly than the one you are long. You can buy it back for a profit and hang on to the long put, or just close them both out. It's often tempting to hang on to them until expiration in hopes of expiring them both for the max profit ( and no commish) but that can also turn into a painful expiration week if it reverses on you. You can do the same thing with calls, only you would pay a debit. You buy the lower priced call and sell the higher. The profit curve is exactly the same at expiration.
Long stock, short straddle. Best Strategy for the scenario you described with the most positive edge.