Which strike for short term moves

Discussion in 'Options' started by switze22, Jan 29, 2008.

  1. I want to buy a company because I think their earnings are going to be announced positive on Thursday. So, I will buy tomorrow to hopefully because they will run up tomorrow ahead of their earnings.

    My question is:

    Should I buy an option for these companies that is in the money closest to the current price, or should I buy the closest out of the money option to the current price? And should it be Feb or March or...

    Which makes more money?
     
  2. The amount of the move determines which strike makes the most, percentagewise. On an equal dollar purchase, small moves favor ITM. Large moves favor OTM due to their leverage. And in both cases, the amount of the move must be enough to overcome IV contraction.
     
  3. If you have the direction but concerned about volatility, I would also consider the idea of buying an OTM butterfly. Place the short where you think the stock will go. OTM butterlies are real cheap.
    If you only know the direction, but not where the stock will land, I would place the short strike at 1 to 2 standard deviations from current price depending on how publish you are. Also check the history of the stock in relation to earnings.

    If your choice of short strike is perfect, you will have the problem of pin risk. But you can close the position before expiration day.

    Wish you well in your trade.
     
  4. Why dont you suggest a "risk free" trade for this kid as your name implies? Since the fly has risk associated with it.
     
  5. Just ask Bill Clinton :D
     
  6. Does this work well for short-dated options? In my experience, out of the money short-dated calls have a better risk/reward then out of the money butterflies, even if vol collapses. They also have the benefit of unlimited upside - and in situations where you are heavily bullish, upside is often much greater than what the option market is implying. OTM calls allow you to capture that, butterflies don't.

    Longer-dated butterflies can be good if you are a volatility bear, but then you have much greater risk of the underlying soaring past your upper wing.

    For a real-world example - at the recent panic lows in the S&P, I bought some March 1450 calls. I also bought 1300-1375-1450 butterflies. Despite the S&P going to 1375, the fly made no way near as much as the calls, relative to the premium paid.

    Now imagine doing that trade in the Feb or Jan 31 options. The call would just kill the butterfly in terms of risk/reward.
     
  7. I am not very bright, so that would be 1 or 2 stirkes in which direction?
     
  8. Such knowledge is not free, particularly for people like you. Plus the kid, unlike you, has a head and a correct attitude. He wants to understand and earn his money (not tend the hand). He will go far.
     
  9. You may not understand the fundamental reason of why one spreads. Also you may not understand butterflies and when to use them. OTM are specs and in case of earning vol is high on both sides up and low. SP is slow particularly on the upside. Plus calls vol is lower on the upper side than the lower side. OTM did what they should do for the SP.
     
  10. timbo

    timbo

    Try telling that to your significant other; perhaps the answer will be reciprocal.
     
    #10     Feb 2, 2008