Pros and Cons for using options as a direct substitute for the underlying?

If you are expecting to trade them between now and Dec 2010, then yes, big time.

What I was describing was an 18 month long position in a LEAP, held to expiration. That makes it a simpler bet, and those factors had a role in setting the break even at the time of purchase. But the path to the expiration is unimportant as long as that break even is exceeded.

I don't view this as a trade, but as a hedged long position in the underlying.

 

That is the so called "sucker's approach"

 

You can "view" the trade anyway you like that does not change all the other risks associated with the LEAP and just going long a leap is far from the same as a position in the underlying.

 

I am not just going long on a LEAP, and doing nothing else. I am buying a LEAP and taking the money I would have used to buy the underlying out of play (into a risk free cash equivalent).

That is what I explained initially on this thread. I agree that to throw big parts of your investment capital into long option positions is not good trading or
investing.

Here is what I did recently:

Bought Dec 31 QQQQ 36 Call in June.
Paid $5.22 per contract. That was ATM.

That makes break even on Dec 31, 2010 at $41.22.

Took the other $3,078 I would have spent to buy the underlying and put it into an FDIC CD at 2.00%

For every $1 above $41.22 in QQQQ on Dec 31, 2010, I make $100.00.

If I am wrong, I am out $522, and still have the $3,078.00 plus interest.

What part of this is a sucker's play, exactly? Is it that I think QQQQ will be significantly above $41.22 in 18 months? Is it that I used a long LEAP position (plus cash equivalents) to play it?

To me this seems like a prudent and conservative play on a major index rising. Not much work involved.

Someone said you have to be right about price or IV to win on an options trade. Either I am right or not, and I make a modest bet on that line.

If you have a better idea on how to play the opinion (QQQQ gets much higher in 18 months), with insurance against Black Swans or other disasters,
I would like to hear it.

Thanks
Steve G

 

I am not judging your speculation on where the market goes, your guess is your business.

The price of the leap assumes you invest the cash you save over the underlying in the risk free investment, thats already in there.

There is no insurance on a black swan with that position, you lose your premium in that event. The cash you put elsewhere is priced into the option already its a moot point.

 

I am insuring a $3600 position in a stock. There are 2 ways I know of to do that:

1. One way to insure is to buy the stock plus a long put. If the stock tanks, I get to put it to someone at the strike price, and I am out only the premium of the put (assuming it was purchased ATM).

2. A synthetically equivalent way is to purchase a long call at the same strike, and sequester the cash. If the stock tanks, I am out only the premium of the call. This assumes I did not piddle away the cash on something else.


Thanks for the comments. I think this horse is dead now.

Steve G

 

As I said earlier you can justify your position anyway you like thats not the issue.

You incur other risks with the leap, vega and rho specifically. In addition the cost to carry the cash is priced into the leap. Locking up the money in a CD is not a hedge to a black swan and incurs rho risk.

 

Ok, maybe the horse is just sick

Xflat, I will stipulate that you know lots more about options than I do.

It would help me if you could respond:

1. If I intend to hold the LEAP to maturity, and not trade it, how does that expose me to vega and rho risk?

I thought I placed those bets when I bought the LEAP, i.e., they are what they are, and affect the break even, which I already know. I agree with you if I want to trade the LEAP before it expires, but I don't plan to.

2. If I have the cash money in a safe place, how is it not protected against an adverse move in the underlying?

There may be other black swans that, for example, destroy the entire US economy, and I will also stipulate I am not insuring against that. But barring a meteor strike on Wall Street, or Armageddon, why is not my FDIC CD a hedge?

Thanks in advance for your comments, and for taking the time to have this dialog.

 

I get the point you’re making that you don’t care about the risks in the position. Your point of view is that… this is your bet and you’re sticking to it.

The cash is protected, that’s a separate issue. I understand that part of your justification on this trade is helped by putting the cash away, that is of no real issue to the leap.

The same principle is in play with your exposure on the interest rate risk and the volatility risk. I understand that you have your reasons and you have justified that risk to the point you feel its moot because you have no intention right now of doing anything but riding that premium out; that’s fine but if you’re really looking at the risk over the life of the trade losing 100% of the capital in the trade is not something everyone likes to do and it should be noted that interest rates changes and volatility changes will have a big effect on the value of that LEAP.

Its not a question of who knows how much or more, its not a competition

 

I get what you are saying.

I was not inferring that there was a competition, there is none. I assume you and several others here know stuff I can learn.

Thanks again, for taking the time to respond.

Steve G