Welcome to the Maverick Vertical thread. I would like to begin discussion on a interesting strategy that I would like to put togethor on a very large scale. While I have done many of these over the years with small money, I would like to incoporate these into a massive vertical portfolio. For beginners, let me start off by telling you what these are. A vertical spread is basically a very simple spread where you are long one strike and short the next typically the same month. Example stock XYZ trading at $100. You could buy the dec 100 call and sell the dec 105. This would be a bull call spread. Or you could sell the dec 100 call and buy the dec 105 call, this would be a bear call spread. Obviously the first one is a debit spread and the latter is a credit spread. The same spreads apply with the puts. My interest is in composing a portfolio of all credit spreads both bear call spreads and bull put spreads. Lets say doing 100 of these with 50 of them being bull spreads and 50 being bear spreads. The goal here would be to obviously find strong stocks that are at key support levels for the bull put spreads and look for weak stocks near strong resistance levels for bear call spreads. Assuming you have any kind of minimal ability to selectively find 50 strong stocks and 50 weak stocks, there seems to be a lot of edge here. Let's assume for the moment you are absolutely horrible at picking strong and weak stocks. Let's say you picked the total 100 stocks completely at random. Now we have three market conditions that could happen here over this 6 week period. I would do these about 6 weeks out as that seems to be the optimal time to enter verticals. We could have either a big move to the upside, a big move to the downside or a choppy market that goes nowhere. Given a random portfolio of stocks, if we get a big move to the upside or the downside, one could reason that our portolio will be relatively flat by expiration, meaning we made maybe a little money or lost a little but probably nothing major. The reason for this would be that if the market made a big move to the upside, chances are most of are bull put spreads expired worthless. However we probably lost an equal amount on the bear call spreads as the market moved the stocks higher. Same scenario would be the case with a big move to the downside. However, in a choppy sideways market, we theoretically could capture all the premium. More likely we would capture some of it, maybe half. Now let's say we don't pick stocks at random, but rather we carefully selected very strong stocks at strong support levels and very weak stocks at strong resistance levels. This extra edge could make an enormous difference. Now we go back to the strong upward move in the market. Obviously we would probably do well on the bull spreads. But what if we can eke out 10 to 20 plays on the bear spread that actually hold their resistance levels and allow us to capture the premium from those plays. Same with the strong downside move. Then with a choppy sideways market, it is very realistic that we capture 75% to 80% of all the premium! It is reasonable to assume that in a very choppy sideways market that most support and resistance levels will hold until the market breaks either way. The key here is the fact that we have a strategy that we earn a lot of premium in choppy sideways markets and we capture some edge from stock selection. We also save a lot of money but not having to buy back the spreads that expire worthless. We save money on both the commision and the spread. Also by doing a large number of these we really can spread out the risk very evenly. Also for retail customers, this strategy is very margin friendly. Well let's begin a discussion on the benefits and drawback of this strategy. I pretty much know what they are but it should make for a very interesting thread.
would be the skew. since typical skew of equities is stepped up on the put side, you are buying low vol, selling high vol sorta like buying a $1 bet for 90 cents. Ditto on the put bear spread. Biggest issue is when the underlying vacciallates around the short strike. You are going to go crazy managing the gamma if you intend to do it delta flat. But if you want directional exposure , should;nt be too big a problem since you are resigned to 1 of 3 outcome and not adjusting deltas. Have done it a whle ago but on fences, in commodities. Nice skew!
Mav, Very viable strategy. I'll be following this thread with interest. To get the discussion moving, I was wondering whether you've settled on any criteria re (1) minimum reward:risk ratios for entering your credits; (2) stop-loss rules (i.e. you will buy back a spread once a technical S/R level has been breached, thereby negating the thesis for the trade, or the spread has widened to 2x the original credit); or (3) how the greeks play into your approach (i.e. you will only do these on stocks with some minimum relative IV percentile ranking). HD
Well, I would choose my picks more based on the underlying then on the option prices unless the prices were really bad or the skew is too flat. No stop loss rules, I would hold these until they either expire worthless or reach their max loss which would be 5 pts minus the credit. I figure most of these can be put on for 2 1/2 to 3 pts. I will ignore the greek as well. This is why I want to do a large number of these. I will not trade around them. Vol will not play any role since vega will be small to nil. I will make sure the skew is at least normal ie making sure I am not selling low vol and buying high vol. This strategy will really focus on stock selection. Of course you don't need to do 100 of these. But as many as possible.
First let me thank you for these PBS style of posts recently on the options thread, really jars the gray matter for me, anyway, and I think you were too silent for too long given your knowledge of the subject. As to your stock selection may I suggest a scan of stocks that that have been coiling at a stochastic(15,5) fast and slow above 90 for 3/4 days for your bear put spreads and a reading of below 10 for 3/4 days for your bull call spreads. "Round up the usual suspects" Louie
Mav, Why such a diversified number of verticals? Why 100 instead of say 20? PEACE and good-specul8tion...
No reason really, I just want to spread out enough spreads to keep the risk low. If you are particulary good at picking stocks at support and resistance levels then you certainly could do a lot fewer. Also, the more you do, the more premium you take in. I would rather do 100 spreads for a one lot then 10 spreads with 10 lots. Of course you need to be able to find that many.
How many contracts do you want to see trading in an option contract for it to be considered viable? And would any of you do this strategy before earnings or news? Putting on a bunch of vertical spreads on pumped up implied volatility?
I don't care. As long as I can get a 2 to 3 pt credit I don't care. No, I would not do it before earnings or news. Because then support and resistance levels don't mean squat.
Mav, Forgive my ignorance (you know I don't know much about option strategies yet), but what are we looking for here with the underlyings? Do we want strong trending stocks that are pulling back to s/r and hopefully going to resume their trends? Or Do we want markets that are relatively range bound and only looking to stay locked above/below critical s/r? PEACE and good-specul8tion... PS, me and your boy are in the room if you want to stopp by...