A long OTM call is definitely not the best way to play this, no matter what. You've gotten little in the way of delta, you're fighting a serious theta headwind, and you've done it at a pure debit. As a pure debit, you have additional, un-necessary vega risk. Would you buy a ton of 55 calls in the neart month? Those would expire worthless. Would you buy a ton of 55 calls in the next month? You'd get essentially no delta at all. Delta is king. In this scenario, it takes 2 ATM calls to get roughly the equivalent delta as a synthetic long. The synthetic long didn't cost you a cent (in cash).
Oh boy, I don't know where to start Perhaps we have different interpretations of: "the biggest % return" It appears that you consider deltas (the bigger the better) and static risk profile to be the only things that count. You may be missing the dynamic nature of options (prior to expiration) and also what I alluded to in my two earlier posts: leverage. Before you respond, I would ask you to consider what your interpretation of "the biggest % return" is... ...you may see a different perspective... If you still maintain your position, don't say I didn't give you 3 chances I'll gladly do a worked example. MoMoney.
I'm happy to consider that I missed something, but I don't really see it. Take the theoretical example, and let's apply it to a real stock. ENER is currently sitting at 47, and we can look at the various options greeks and prices to walk forward. Let's say you "know" it will hit 55 at exactly June expiration. I believe this is almost an exact parallel to the situation posed by the original poster. My play would be to buy a June 35 call, and sell a June 55 Put. The 55s have some time value, so I don't have immediate assignment risk. Also, as the price climbs towards 55, it will increase in time value, thus making it less likely to be assigned. That combo would give me a profit of 7.50 (calls) + 8.50 (puts) at June expiration (assuming I did not improve on current bid/ask). Each position I "bought" cost me a credit of 1.00. I will make ~$16 on a $8 stock move (a delta of 2.0). Again, this is all ignoring margin (which is why this whole argument is silly--you can't win)... You're buying OTM calls for a debit. Each one of my positions nets me 1.00. In other words, I can afford to do an infinite number of these. You can only afford to set these up until you run out of cash. Do you buy 55 calls? They're currently running .95. They will be worthless at June expiration, so you'll lose. Do you buy Sep 55 calls for 4.00? They will be worth roughly 3.00 at expiration, so you'll lose. Please show me the winning scenario for pure long OTM calls. How much cash will it cost for you to set them up? How much will you win for this $8 move per "unit"?
F_A , as Mo said , the original question was about " biggest % return" with upfront set up "what ifs" -> the price WILL hit 55. The poster didn't gave enough info , but if 52.5 call is available and its cost 5 c , this would be the BEST bet here. Have nothing to do with deltas and balanced/hedge position.
Well that is your intepretation. Mine is somewhat different: "is going to hit $55 over the next month." I interpreted that as the stock is going to hit $55 before the next expiration. I'm quoting that as $3.75 debit a combo. Not sure where the discrepancy is. That's a first So why are you ignoring margin? The OP explicitly said: "I'm looking for the biggest % return" What you've suggested is not tradeable or applicable as an answer to the OP. Well, you have to compare apples with apples and that means you need to take into consideration how much each position will tie up in the account for "return" purposes, whether as a debit or as margin. It's safe to say we are dealing with Reg-T here. An OTM call, in your example, the 50 strike (0.40 delta) would provide the best bang-for-the-buck due to the positive gearing from upslope gamma. When I say bang-for-the-buck this is what I intepret the OP's request for "looking for the biggest % return" to be. When you calcluate the return on margin for your combos vs. return on debit for the 50 calls. Let me know which one is best MoMoney.
LOL, thanks IV. I'm trying to be as patient and polite as possible here Agree, not quite enough info in original post...but we can infer. If 52.5 strike not available, ATM 50.
The best bet? Are you sure? Just to use your numbers, buying the 52.5C at ".05" and selling the 55C at ".01" would be a 20% better bet if the price will hit 55 at expiration. If it hits 55 tomorrow, then no doubt you're correct (vega + time value). If it hits 55 at expiration, then my +52.5C -55C would be superior. The simplistic responses offered here do nothing to answer the question, which was the point of my participating. Whether you have patience or not, it's simply wrong to say that "in all cases, an OTM call is the best play." Buying 52.5C is not "the biggest % return" in all conditions, which was my point. And in response to the puts increasing in time value being a "first". Today, DITM puts have 0% time value. If the price rises to the put strike tomorrow, they will have 100% time value. 100% > 0%, right?
This isn't a theoretical problem. Take a stock at 50 with liquid options: MRVL. You 'know' that on June 16th, 2006 (which is expiration friday), MRVL will close at exactly 55. You have $100,000 in your options account, and all margins are the exchange minimums. Assume all buy orders get filled at the offer, and all sell orders get filled at the bid. That's ok-The spreads aren't too bad on this one. Use your $100,000 to buy June 50 calls- You have $151,500 in a month. Buy June 52.50 calls- You have just $116,200 in a month. Buy June 55 calls- You have $0 in a month Buy June 47.50 calls- You have $159,500 in a month (best result so far) Sell naked 50 puts- Good going, you only have $121,100 in a month. Sell naked 50 puts, and buy an equal amount of 50 calls- The math is too tedious, but you have less than $135,000 in a month. Sell naked June 55 puts? Not so great. You have $136,500 in a month. Long 50 calls, short 55 calls (bull call spread)- Now you have $243,900 in a month. Quite a bit better. Long 47.50 calls, short 55 calls- You have $217,300 in a month. Second best so far. <b>Long 52.50 calls, short 55 calls- You have $277,700 in a month.</b> I think we have a winner! (But I haven't given it much thought.) Can anyone do better?
I think I can do at least one better without any margin impact: 55 call butterfly costs .55 (assuming no price improvement). If I followed your math right, your $100k would be $354,545 in a month. But there's at least another opportunity. MRVL has a beta of 3.74 and a 54% correlation to NDX. Better margins might be available through a Nasdaq-100 futures options. (I wouldn't be jumping on this one, but it helps to think out of the box a bit)