Some Basic Options questions...

Discussion in 'Options' started by user83248324, Feb 20, 2009.

  1. Hi guys, just have some basic options questions I was hoping you could help out on..

    1. Should I never worry about how many options I am buying/selling, and whether that will effect me down the road as I try to sell and buy them back because market markers have to provide a liquid market? For example, I am worried about buying some vertical spreads as it seems like in even some pretty heavy volume stocks and ETFs, if I wanted to take on a $3,000(this is hypothetical as I am still in paper money) vertical spread. I could end up owning more volume then there is trading in the day. And sometimes own maybe a 8th of open interest, is this a problem?

    2. As a follow up to the above question, does it make sense with spread positions to widen out your strikes. For instance, on the SKF I could buy a Mar 150/155 put spread that is trading at $2.00(4/10 ratio) or I could buy a Mar 150/160 put spread that is trading at $4.00(4/10 ratio again). With the latter spread I have a better break even price (150/160 is $156.00 and 150/155 is 153.00) pay half as much in commissions both ways, and hopefully could sell the spread a little quicker since I would have less options to move. Is there a downside that I am not seeing to this?

    3. If you can tell by an option’s pricing that the market is already expecting a price decline, would you be better of shorting a stock then buying the options if you believe the stock will decline since a lot of the downside is already priced into the options(same theory applies to the upside as well)?

    4. And just to check that I am on the right path, when you believe that a stock has upside potential but has a super high IV due to a recent decline, it would make more sense to buy the stock alone or the vertical call spreads right due to the vol. skew the calls will suffer from?

    5. And also this is just somewhat of a philosophical question that probably has no right answer for all investors but I would be interested to see what you guys have to say. Do you believe that it would be better to master one stock/index/ or etf and trade all kinds of options strategies within that stock that you know so well, or would it be better to master a specific options strategy and try and trade that across all stocks and markets, or would you just say that it is better to have a combination of the two?

    Thanks for all the answers you guys have been providing on this board as I have been reading just about every thread and is has certainly helped along with everything else I am doing.
  2. Mark
  3. WAY..WAY..TOO Complicated!

    A tip on doing a option spread would be wait for the last week before expiration, do a Credit spread that is at least 2 strikes OTM (to be safe).

    Example of a good stock to do this with would be GOOGLE.(10 point between strikes) Idealy I would suggust not to do spreads unless you have at least $15K + in your account to be able to make it profitable
    I used to do a credit spread every month during the last week of trading. Once expired I would just sit by and DO NOTHING until the last week came around again.

    Try this on your "Paper Trading".
    I would really suggust that if you are still "researching and testing"...keep it simple, or you will loose your shirt when you try real $$$. Complexity will kill your account quickly
  4. As far as the stock buying vs option buying question, I am not quite sure why this was such a terrible question to ask. It seems from the little experience that I have that there should be times when you should use options and time when you should simply use the underlying. I understand the advantage that simply buying plain old options can give, they can give you more leverage with smaller amounts of capital and can allow IV to work in your favor if a drop occurs in price(on the call or put side) and that does not happen with stocks. But along with these positives they suffer from time decay and can suffer from large price drops if the IV drops. Now if you were bullish on a stock that just suffered a large decline, we will say you could either buy the underlying or buy a call. If the stock suffered a large drop the call would be difficult to make money off of as the IV would be so high that as soon as a recovery began to occur the options value would drop due to the vol. skew and you would also suffer from time decay. This would led me to believe that either buying the underlying or buying some sort of spread would be better. Now maybe there is something I am totally off base with here and do not get, but this seems fairly simple.

    Now as far as buying the spreads I am not sure if I used the wrong term, but I thought that buying a put spread does not involve selling anything naked nor does it involve receiving a credit as the two repliers said. It is simply a bet that if I hold till expiration and the stock drops below whatever the lower strike is I will receive a full profit of the distance between the strikes.

    So with the options I gave in my original post:

    Buy SKF 150/155 MAR put spread:
    Cost was $2.00, chance of success was 40%, you would pay twice as much in commissions, you would own more options possibly making them more difficult to sell. Break even price is 153.00
    Buy SKF 150/160 MAR put spread:
    Cost was $4.00, chance of success was 40%, you would pay half in commissions, you would own less options possibly making them easier to sell. Break even price is 156.00.

    Now, I normally do not concern myself with commissions, and I simply concern myself with the trade. But with the above example it appeared that these trades were basically identical risk wise, except you had a better break even price, less options to buy and sell, and less payment in commissions with the wider strike trade. Now if I could essentially set up the same trades but receive better commissions and better break even prices why would I not want to at least possibly look at this? It's not as if I am looking at a completely different trade just for the sake of commissions. I am simply looking at what I believe would be an identical trade, risk wise, just with more things(break even price, commissions, number of options held) working in my favor.

    Now, as far as my first question asking about whether I should worry about how many options I buy/sell and what effect this will have when I buy or sell back....I was just simply asking what would happen if I buy a far out of the money vertical spread, were this isn't a lot of volume traded or a lot of open interest, but I for some reason believed the stock was going to rise hard. I could end up buying spreads that are less than ten cents. For instance, if I thought the DOW ETF (DIA) was just due for a nice size rally up to around 83, this is not an outrageous number as we have seen the Dow trade in this range and do so very quickly. If I bought the 83/84 MAR call spread in the DIA, it would come to .08 cents. So if I wanted to risk an ok sized amount of $3,000 on this, I would have to buy 400 contracts. Now that is just a tad under what its volume has been today in both strikes. So if decided to buy in and then get out of this trade, would I have to worry about lowering my ask, because I would have such a relatively large supply for what the demand is, or would the market maker be forced to take care of this and cover my options at whatever the market ask is? Now if there isn’t a downside risk to my above question about spreading out your strikes but keeping the risk the same, I obviously would not do a 1 dollar spread in this trade, but am just using it here as a way to get my example across. Also note that I am by no means planning to take this trade in real money or paper money or anything,, I am just curious to learn how it would or wouldn’t work out.

    And options4me, as far as waiting till the last week for selling credit spreads, it seems a little risky to me as the gamma risk you suffer from seems to be to large for the time decay you get. If I was looking at credit spreads I would usually try to avoid the last week especially in this crazy market. But then again what do I know.
  5. This is a good tip for how to go broke quickly.

    I strongly advise doing everything just the opposite.

    Open your spreads earlier and close them when two weeks remain.

    There is absolutely nothing safe about 'two strikes OTM.' NOTHING


  6. Mark
  7. This may be tangential to the actual question, but can you actually trade SKF combos at the price the OP's paper trading system gave? The bid-ask spreads seem to be at least $1, possibly leading $4 or more slippage on a two-legged combo round trip.
  8. Hi Mark, thanks for the reply and the kind words. At times it is a little difficult to tell how well I am progressing with all of this as I am only 19 and kind of isolated in my learning; its not like I can discuss and question the ins and outs of iron condors or unbalanced butterflies with many of college buddies for help. So I am just kind of taking in as much information in as I can, but cannot really gage how well I am progressing at times, so it was nice to get a little recognition that I am on the right track.

    But anyways, in my first post I was trying to make things less confusing but I actually just made them more confusing. I was just trying to show an example of two vertical put spreads where you buy and sell the same amount of puts. I simply put the 4/10 ratio thing in there because I was trying to show that both vertical spreads were equal in pricing since one cost $2.00 when the strikes were $5.00 apart and one cost $4.00 when the spreads were $10.00 apart(so both spreads cost 40% or was at 4/10 of the max profit), again sorry for this as I realize now it just made things much more confusing.

    So, just to go over it one more time. I was looking at:

    Buy SKF 150/155 MAR put spread(buy and sell same number of puts, nothing naked):
    Cost was $2.00 with max profit of $3.00, chance of success was 40%, you would pay twice as much in commissions, you would own more options possibly making them more difficult to sell. Break even price is 153.00.
    Buy SKF 150/160 MAR put spread(buy and sell same number of puts, nothing naked):
    Cost was $4.00 with max profit of $6.00, chance of success was 40%, you would pay half in commissions, you would own less options possibly making them easier to sell. Break even price is 156.00.

    Now both of these prices are being quoted at the mid-price, but even if I have slippage wouldn’t it amount to an equal percentage amount on both trades, still leaving the advantages with the wider strike spread?

    And as to your response about my DIA example where you would buy a 400 lot vertical spread, do you have any idea if say five trading days into the trade I realize, that the market isn’t going to rebound as quickly as I thought and I want to get out of the trade. The DIA has stayed flat at around 73-74, IV has dropped about five percent, and time decay has dropped the price to say, .04 cents. So, if I wanted to get out of my large position but my options were still far ATM, would this be to difficult to do as their would not be enough demand or would the market markers have to take them?

    So as you can probably tell from my questions I am beginning to get what I feel is a solid base of knowledge of the market and options themselves, but where I am still confused is on the real world pricing of options and on the market maker side of the market and how it all comes together and whether supply and demand is as large of force as it is in other markets. This is obviously the fault with paper trading as it is difficult to understand real pricing if you are not able to get real pricing and this is of course why I will eventually need to move on. The only problem is at this point I still do not feel that I am quite ready, but I would still like to began to learn how to understand pricing. I am not sure if there is a forum post out their, or book or podcast or something, that really covers how pricing works in both the options and stock markets as a whole; But I still at this point have no idea at what prices I should be able to get filled at, how much risk there is of a sold option in a spread of getting exercised, if you go short is their anyway you can understand how likely a buy in is, or how much slippage will their be when buying a stock or options(i,e, if a stock is trading with a five cent spread but is very liquid, does it work like some options where you can get a mid price fill or not)?

    Hopefully someone can shed some light on these questions and thanks again for all your help.
  9. Mark