Options Mentoring

[Magdoran]

Hello Richkid,


Thank-you for the warm welcome, and please don’t be put off by Wayne and I rabbiting on about options – it’s just nice to have a shared passion as I’m sure you’ll understand. I suspect I may have had a hand in piquing his interest into delving into options when we were chatting a few years ago on another site (am I right here Wayne?). Hence the gratification seeing someone you’d chatted to about options in the past become a “monster” practitioner in their own right…

I do hope we’re not scaring people away, I’d be more than happy to go through the basics and up if there’s interest (and I’m sure Wayne and Margaret is the same, between the three of us, I’d suspect we’d cover a lot of ground). So, the door is always open, and I’m happy to shed light on derivatives and how they work on this thread as best I can. Anyway, Rich, you seem to have established quite a presence here on ASF yourself (I’ve read quite a few of your considered comments while browsing through the many threads on this site).

As for the Johnston book, I’ve never read it, so I can’t comment – I’ll pass that one back over to Wayne (seems I have yet another text to add to my to read list!).

McMillan’s “Options as a Strategic Investment” on the other hand is another matter. It is often described in professional circles as “the options bible”, with good reason. McMillan and Natenberg is a powerful combination if you want to get into advanced concepts.

McMillan is easy to read, and very thorough. I refer to it constantly, especially when I’m considering more exotic strategies. The text covers a range of market conditions, and carefully explains how to construct appropriate strategies for different market conditions, and goes into detail about the finer points of selecting the right options. But it’s an advanced text, and probably more suitable for intermediate options traders and up.

If you want a good ground floor to intermediate text, Guy Bower’s “Options: A complete guide for investors and traders” would be more suitable for beginners. The beauty here is that it will stand a new player in good stead for a long time, giving an excellent grounding for development. Also, it’s written by an Australian, with local conditions in mind as well as overseas markets which is a plus.

Interestingly Wayne and I have not read each other’s texts, but I had heard of Cottle before – he has a good reputation in options circles, so I suppose I’ll have to read up on him too!


Regards


Magdoran

 

[wayneL]

Re: Johnstons book

http://www.amazon.com/gp/product/04...102-1029944-0335331?s=books&v=glance&n=283155

It's mainly about futures options, and it's not a book for beginners as it assumes a knowlede of the basics.

It's not a book "about" options, it's about writing strategies, seasonals, non seasonals, statistics and a good dose of humour thrown in for amusement.

It is a good read IMO, but very different to Cottle, McMillan et al.

 

[swingstar]

Hi guys

Great thread...

I've been swing trading for a while using Dave Landry's techniques, but applying them to options instead of outright shares. I usually just buy calls/puts at the money or first in the money with 1-2 months left until expiry. So far have been doing pretty well (15-35% a month). I've also applied position sizing techniques from Tharp's books.

I still consider myself a major newb, so keep up the good discussion. I only knew what delta was before this thread!

 

[sails]

Hi Magdoran,

Thankyou for the detailed reply (Post #63) and my apologies for taking so long to reply. We've been busy with visitors over the last few days, so I've managed to keep up with the reading of new posts, but wanted to take a bit more time to post a reply.

Re the bull call spreads, I think Wayne hit the nail on the head where the delta of both options ends up being too close - on a close spread there may only be a net delta of about 0.1 or 0.2. If that's the case, then obviously the spread needs to be widened, but then that begins to increase directional risk making the OTM a better risk to reward. However, in a slow move, a spread would certainly outperform the long call/put. Always trade-off's in options!

One thing I'm puzzled is that you've found vertical credit spreads have worked better than vertical debit spreads. If they are positioned at the same strike and in the same month - aren't they completely interchangeable? I've compared these in Hoadley and they seem identical. I can understand that an OTM bull put would behave differently to an OTM bull call as they are positioned at different strikes. I haven't done live comparisions on these - so would be interested on what you have found.

When I did the Optionetics course, they taught that you should always go out a minimum of 90 days for debit spreads and less than 45 days for credit spreads - but I have since understood that both spreads benefit from the same greeks if at the same strikes and expiry month, so they should technically perform the same. Obviously there is a cost of brokerage to close them which is not the same - the bull call expires worthless if it's wrong and the bull put expires worthless if it's profitable.

Would like to look into the diagonals a bit more - just wondering if you have a recent example you might be willing to share? Doesn't need to be a real trade - just to give a better idea. Woud be interested to see how far OTM you would go with your long and also how far out in time.

Will read through the other posts (you guys have been busy typing!) in more detail again sometime and will add any other comments or queries another day!

Thanks again for sharing,

Margaret.

 

[RichKid]

Hi Magdoran,
Thanks for all the help, picking up bits and pieces here and there, most likely will revisit this thread once I get into options seriously, may take years to feel comfortable! Currently just buying straight calls and puts. Thanks for the tips on the books, I do like Guy Bower's book, I'm so glad he published it instead of spruiking it as a weekend workshop.

Wayne,
Looks like Johnston is a bit too much for me, might give it a miss for the moment- thanks for the feedback.

Swingster,
Sounds like you're doing quite well, hope to hear of your adventures on ASF, feel free to start a 'follow my trade' thread if you like on options. We have a thread on real time examples of trades some members make in the Trading Tactics forum. Must be quite a bit of activity at this time of year with prices going all over the place.

 

[swingstar]

Thanks RichKid. I'll think about doing that soon.

Re: activity, I've only been holding some AMC puts for the last couple of weeks. I reached my target for May so decided to stay out of the market whilst it's so volatile and unpredictable.

 

[wayneL]

When I did the Optionetics course, they taught that you should always go out a minimum of 90 days for debit spreads

I don't get that one Margaret! Presuming the debit spread is ATM (i.e. the bought option is ITM and the written option is OTM), that amount of time, and particularly when IV, is high is going to flatten delta right out.

I mean thats fine if that is what the trader wants... as in a vega play with a directional bias, or specific time horizon. But thats not necessarily what a trader might want. I have no hesitation in entering atm verticals 30-60 days from expiry, if I'm after some delta and positive theta (presuming things go to plan).

Remembering, when playing an atm vertical, we by definition have an expectation of not much higher that the higher strike. Therefore one can get delta a lot cheaper (in other words less number of spreads and therefore less contest risk) with nearer dated options.

Lets never forget contest risk. With a straight $27.50 call we can get 1000 deltas with the equivalent cost of 6 of the above spreads. It is a big consideration not taken into account often.... particularly if we plan entering and exiting before expiry

For instance lets say we have XYZ @ $30 IV @35%. We want a $5 ATM spread, ie long $27.50 call and short the $32.50 call. Lets say we want 1000 deltas.

We can get 1000 deltas with 20 spreads with a 45 day till expiry series, plus some decent positive theta.

If we take a series with 135 day till expiry, we will have to buy 34 spreads to get our 1000 delta, with all the increased contest risk and negligable theta... YUCK!

The longer spread will have more vega, and that is a consideration that should be taken into account, but for the shorter term swing trades we seem to be mostly concerned with, I'll have the nearer dated spread thanks

Not forgetting, if the time horizon is 4 months, then fine, take the longer ones.

I just hate it when these jerks say you should "always" do this or that. As you said Margaret, there are always trade-offs with options. We should be encouraged to trade-off the greek we don't want for the one we do want.

Cheers

 

[sails]

Warning - options jargon to follow - so if you're not into options suggest you pass .
However, those that have an interest in options, I really encourage you to persist with these types of posts as difficult as they may seem and try to learn the jargon. In the last 3 years of learning options it has been discussions like these that helped me more than seminars, etc in becoming fluent in the options "language" and understanding of the greeks. Like any other career, we have to learn the necessary jargon if we are going to improve our chances of doing well at it. While it doesn't guarantee trading success with options, it does help to eliminate unnecessary mistakes due to lack of knowledge

I don't get that one Margaret! Presuming the debit spread is ATM (i.e. the bought option is ITM and the written option is OTM), that amount of time, and particularly when IV, is high is going to flatten delta right out.

I agree Wayne - just checked their manual to make sure I had it right - and there it is in print! The rationale given at the seminars was that with a debit spread you are buying premium so you must have more time and, of course, the opposite for credit spreads. Anyway, I believe it is more to do with the positioning of the spread rather than just a blanket rule for all debit or credit spreads, eg. with an OTM bull call spread (or it's ITM bull put counterpart) it may be better to buy more time due to negative theta whereas an ITM bull call (OTM bull put counterpart) starts off as theta positive so technically better with less time.

I haven't traded OTM bull call spreads further out, but have read of others that have with quite good results. I really don't like the trade off of such a small delta position!

Remembering, when playing an atm vertical, we by definition have an expectation of not much higher that the higher strike. Therefore one can get delta a lot cheaper (in other words less number of spreads and therefore less contest risk) with nearer dated options.

Spreads in near dated options do work well on a slow move, but since I actively hunt out potentially explosive moves, they seriously cap profits when right. If I don't get the move I want, can always spread the long off into a calendar or a vertical - lots of options (pun intended ).

However, I usually start with a smaller number of long calls or puts to get the deltas I want (in preference to placing a larger number of spreads with the associated contest risk) and then adjust if/as necessary. However, no matter what strategy is being used, it's always important to know which greeks are at risk and how we plan to manage that risk.

 

[Magdoran]

Hello swingstar,

Sounds like you’re heading in the right direction. Also, while I don’t want to make broad statements about the current market here, I think your approach of staying out of the market when you perceive that there is considerable risk, and are unsure what the market conditions are is very sensible, especially when using unhedged leveraged instruments.

Well done on the AMC trade, and sounds like the way I trade sometimes, exiting at a price and time target (at least a partial exit to lock in profit). This is an effective method of swing trading, and if used correctly keeps profitable trades from becoming losers.

Also, getting your positions size right, ala Van Tharp is critical in my opinion to managing risk, so well done there too.

As for the discussions on this thread, as you can see, there are so many approaches to choose from, which is why it takes a long time to become really proficient in options trading in a broad sense, but don’t make the mistake of believing you have to know all the nuances. You don’t. Sometimes it makes sense to stick with a strategy you know, and become proficient using it. Then you can slowly add to you repertoire at your own pace.

I think there are many roads to success here, the important thing is to simultaneously be effective in the field while growing in your knowledge. Some options players focus solely on the non directional strategies like condors, butterflies, strangles and straddles. Others are primarily directional, using straight calls/puts, bear calls/bull puts, bear puts and bull calls, ratio back spreads, diagonals, etc. Some are “Greek players” focusing on volatility, gamma etc.

The trick I think is to find out what works for you, and you will know this intuitively. But the key is to fit the strategy to the conditions, or fit the conditions to your favourite strategy (seek markets that conform with your preferred strategy).

Interestingly Wayne and I are similar in that we like trading our favourite markets, and fit our approach to the market, while others scan for a market condition and have a favourite strategy. Both approaches can work, it’s up to the individual.

Glad you are getting something out of the discussion, and please feel free to ask both the silly and the hard questions!


Regards


Magdoran

 

[Magdoran]

Hello Margaret,


Hope you had fun with the visitors (although it can be nice to get back to normal too, can’t it?). No problem with replying, we all have higher priorities in our lives, don’t we?

Ok, here’s some points to consider about Credit vs Debit spreads:

Debit Vs Credit Spreads – Bull Calls Vs Bull puts, and Bear Puts Vs Bear Calls:
The key difference is the effect of time. Time is detrimental to debit spreads, while it is helpful for credit spreads. If the underlying goes sideways, the credit spread if positioned and entered correctly has a better chance of either becoming profitable, or at least breaking even than a debit spread.

Of course, if the underlying moves in your favour, you may look to wind out the position at a certain target, in which case both strategies do well. Beware though that a real risk to both positions is slippage based on the width of the bid/ask spread. If the move is very favourable however, the credit spread expires worthless though reducing 2 legs of brokerage, where the debit spread requires some transaction to close it.

The strategies are quite different in that a credit spread is benefiting from the time decay if the underlying doesn’t move much. The debit spread will make a loss in many conditions where the credit spread will make a profit, or at least break even. Even in loss situations, the debit spread will tend to fare worse, since you should really be managing these positions, and winding them out before expiry if they are going wrong.

Be careful of comparing exact or even equivalent strikes when you are dealing with a put spread and a call spread too, one being a debit spread and one being a credit spread. Don’t just look at the risk and reward chart at expiry; this only gives you half the picture. Have a look say 8, 10, or 15 days out from expiry and see the difference on your chart (I don’t know if Hoadley’s can do this?). Their natures are quite different, and the skews are often different - the POD/risk chart actually diverges as you approach expiry.

The point is that you may need to manage the credit position before expiry, and wind it out. If you try to do this with the debit spread, the theta decay is likely to be unfavourable. This is where the difference is most notable. Of course there are other variables involved such as IV and how the underlying is moving. You really want to enter the bull put/bear calls when you think the underlying is likely to move to a favourable forecast price within the projected time frame.

There are some important points to note here about entering a credit position:

• You are looking for a trending underlying to trade.
• Look for favourable IV skews
• Should have at least a 1:1 ratio of risk to reward or better.
• They work better in high IV conditions.
• Time value premium is greatest ATM, so this is the area you want to sell in.
• Aim for around 30 days to expiry
• They are best entered on a counter trend against the main trend for the period selected (and it is at these times that the risk/reward ratios can move heavily in your favour – like 2:1, or even 4:1 in your favour – but this requires a bit of luck on the day, and a knowledge of how to finesse a good entry).

If the underlying for example moves slightly in your forecast direction, but not as far as projected, think about the effect on the two spreads. The debit spread is losing value since the theta decay is detrimental to the more near the money bought position (as opposed to the credit positions sold strike), and the OTM sold position while compensating doesn’t lose as much value (as opposed to the credit spreads bought strike losing value more slowly). A lot depends on a range of factors – where in the money you entered, how far the skew was in your favour, where the underlying moves, what IV does…

Think about this though. If the underlying goes nowhere, what is IV likely to do? Hmmm, go up or down? If the move is sideways, and there isn’t any news or events coming up (like reporting time), the IV is likely to fall, or at least not rise, isn’t it? Which spread do you think will benefit from falling IV? Consider that the objective of the credit spread is to sell to get a credit, and the aim is to keep as much of this credit as possible.

Traps for credit spreads:
Beware though, there is a catch! That is the prospect of being exercised, so be careful about selling too far in the money with too short a time and not enough time value premium sold. This is especially true for call spreads where you can end up owing the dividend, so be careful. If there is a prospect of early exercise, it is worth considering winding out the position pre-emptively to avoid this kind of risk.

Morphing:
Another concept is how to morph these positions. If the underlying in your view has clearly reversed and is going against your forecast direction, and in your considered opinion is likely to reach a target in the opposite direction, you may consider just buying back the sold option, and reversing your net direction. Sure, you buy back the sold strike at a loss, and it is risky changing direction, but if you think the probability is sufficient, reversing can sometimes be a profitable choice. But please exercise caution here, this is an advanced trading approach for experienced traders.


As for the Optionetics approach, I suspect that they have tailored the bull call spreads to the US market, and favour the OTM approach over the ATM/ITM versions. The main aim is to have small debit amounts, and get a risk/reward graph with more maximum profit potential to maximum loss (they describe this sometimes as “bet a Volkswagen against a Ferrari” – no offence to VW drivers!). The aim is to select the best bull call spread which has the most chance of success combined with a favourable risk/reward graph and a low debit entry. They also try to avoid theta decay in debit positions, presumably to reduce this risk for part time traders…

How’s that Margaret? Sorry, but the diagonals are even more involved, so I’ll have to find time to post that one up later (pressing things to deal with this week)…

Regards


Magdoran

 

[Magdoran]

Hello Richkid,

Great! Hope the reading goes well. Take your time though, this stuff takes a while to get used to, and to actually trade for real is a new dimension in itself.

You are right in your comment that it takes years to really develop using these instruments – I’m learning every day!

Regards


Magdoran

 

[sails]

Hi Magdoran,

Thanks for the reply, however, I'm not sure that we are talking apples for apples here with the debit / credit spread issue though - so have put some thoughts below:

...The key difference is the effect of time. Time is detrimental to debit spreads, while it is helpful for credit spreads. If the underlying goes sideways, the credit spread if positioned and entered correctly has a better chance of either becoming profitable, or at least breaking even than a debit spread. ...

If they are at the same strikes and expiry month, they form a "box" spread. I first learned about them as well as other synthetic equivalents from Cottle's CWS and also Natenberg and McMillan explain boxes in their books. As an example, I just had a quick look at NAB currently trading at approx $35 and the June $35.00 / $34.50 box is priced as below:

Strike Option Bid /Ask Mid Price
$35.00 Call .63/.67 .65
$34.50 Call .94/1.00 .97
= Total debit (risk) of 32c for a bull call with a max profit of 18c.

$35.00 Put .51/.55 .53
$34.50 Put .33/.37 .35
= Total credit (max profit) of 18c for a bull put with an 32c risk.

I'll keep an eye on the progress of this box spread - as it is most unlikely that the box will ever be worth more than 50c meaning that when just trading one side of the box as a debit or credit spread, they technically should behave in the same way and time and IV fluctuations should affect both in the same way. In fact, if it did move away from the 50c mark, I would first be looking for the reason why (eg divdends, etc) otherwise it would present an arbitrage opportunity = free money - and we know the MM's don't do that!

Of course dividends, capital returns and the like do change the pricing of the box and some new option traders mistakenly believe that there is an arbitrage opportunity not realising the risks they are taking on with such a position.

... If the move is very favourable however, the credit spread expires worthless though reducing 2 legs of brokerage, where the debit spread requires some transaction to close it. ...

Totally agree that this is so - but also the debit spread doesn't need closing out when it's wrong which reduces brokerage. However, if one has a large win rate with these, then it would be best to trade the bull puts to save on fees.

...Traps for credit spreads:
Beware though, there is a catch! That is the prospect of being exercised, so be careful about selling too far in the money with too short a time and not enough time value premium sold. This is especially true for call spreads where you can end up owing the dividend, so be careful. If there is a prospect of early exercise, it is worth considering winding out the position pre-emptively to avoid this kind of risk. ...

Agree - sold puts assignment don't have the risk of owing the dividend as sold calls do and is one of the reasons that dividends skew the box giving the illusion of a risk free trade.

As for the Optionetics approach, I suspect that they have tailored the bull call spreads to the US market, and favour the OTM approach over the ATM/ITM versions. The main aim is to have small debit amounts, and get a risk/reward graph with more maximum profit potential to maximum loss (they describe this sometimes as “bet a Volkswagen against a Ferrari” – no offence to VW drivers!). The aim is to select the best bull call spread which has the most chance of success combined with a favourable risk/reward graph and a low debit entry. They also try to avoid theta decay in debit positions, presumably to reduce this risk for part time traders…

Actually the example in my Optionetics manual is an ITM/OTM bull call spread, but agree that in the seminars they would teach selecting the best risk to reward as you have outlined above, however, their bull put example is an ATM/OTM spread. I discussed this in a post to Wayne today where I believe that it actually depends more on where the spreads are positioned to determine their sensitivity to theta - not because they are a debit or credit spreads. No question that an OTM/ATM bull put will behave differently to an ATM/OTM bull call (where the bull put sold strike is ATM and the bull call sold strike is OTM),

No rush on the diagonal question - when you have time is fine!

Cheers,
Margaret.

 

[wayneL]

- just checked their manual to make sure I had it right - and there it is in print!

Hi Margaret,

I happen to be the proud owner (NOT) of "The Options Course" by Georgie Peorgie Fontanills. ( The chief clown at Optionetics for those who wonder who he is ) I just looked up the section on Verticals and this prompted an extended rant that my wife was forced to endure. She pretended to know what I was on about and agreed wholeheartedly... bless her.

Anyway, I think the whole chapter is a load of cobblers.

I'll pick one example to completley destroy the credibility of this cowboy.
Stock trading @ $44
Long 1 45 put @ $3
Short 1 50 put @ $7.50

This produces a rather pretty looking payoff diagram with $50 risk and $450 reward. Hey not bad 9:1 risk reward and we take in $450 credit... wonderful.

Two problems with this. 1/ We are theta negative unless the stock goes above ~$45.30 and our probability of profit theoretically is < %50. We NEED to be right with direction, and we need to be VERY RIGHT to get maximum profit from this spread

2/ the sold put is WTFITM (Way The F%$# In The Money). If the cost of carry for the stock holders exceeds the extrinsic value for the puts, they're going to start exercising early i.e there is a strong possibility of being assigned stock early. This is not catastrophic in and of itself, however our $450 credit has turned into a $4,650 debit PER SPREAD! Is the cash in the account?

What we will have ended up with is a synthetic long $45 call at $4650 each. Doh!

If one particularly wanted this payoff diagram it would have been far smarter to use calls instead of puts... no risk of early assignment.... or.... looking logically here, we're looking at quite an explosive move at $44 to $50+. Why not consider the $45 call? IE what we would have ended up with synthetically anyway, and for a small fraction of what the synthetic version wo0uld have cost us.

I can't believe Georgie doesn't know all this stuff. If he doesn't, then WTF? But it looks to me more like intentional subterfuge... intellectual immorality. It seems he is presenting these spreads in the most favourable light possible without introducing the attentant risks and disadvantages.

Poor Show!

 

[sails]

Wayne, it wasn't until I learned about synthetics, boxes, etc that I realised that there was never any need to do an ITM bull put spread and struggle with wide bid/ask spreads). Much easier to the OTM bull call counterpart (same strikes) then, if the sold call doesn't have enough value to sell, as you say, just buy the call - fees are less, slippage is better, etc.

Undertanding synthetic equivalents has made option jigsaw puzzle pieces fit better into place.

 

[wayneL]

Wayne, it wasn't until I learned about synthetics, boxes, etc that I realised that there was never any need to do an ITM bull put spread and struggle with wide bid/ask spreads). Much easier to the OTM bull call counterpart (same strikes) then, if the sold call doesn't have enough value to sell, as you say, just buy the call - fees are less, slippage is better, etc.

Undertanding synthetic equivalents has made option jigsaw puzzle pieces fit better into place.

Yes that was the lightbulb for me too, Margaret.

... and folks, guess where Cottles book starts:

C O N T E N T S
C H A P T E R 1
Picking Up Where The Rest Leave Off - Synthetics 1


Cheers

 

[professor_frink]

just starting cottle now- I'll come back in about 6 months when I've read, reread and understand it

 

[Magdoran]

Sorry Margaret,


This is a fiddly subject, isn’t it? Perhaps I may not have explained myself very clearly, so I’ll try to clear a few things up here. The exercise I set out to discuss was that in my experience bull puts tended to be profitable more often than bull calls in practice, and I was trying to reason why this was. I did suggest that they were more likely to succeed IF they were entered correctly in the right conditions.

I accept that some bull calls may outperform some bull puts both in theory and practice, just like any two strategies – sometimes the risk to reward is favourable, and sometimes it isn’t. The objective was to determine the strategy we feel is most appropriate to meet our risk to reward requirements.

The particular results you came up with from the spreads you chose is in part because you chose strikes that are not equivalent, or for that matter realistic if one was to enter either strategy. Firstly, the bull call spread does not have good risk to reward parameters, nor does the bull put spread, which also does not follow the parameters I set out in the previous post.

Secondly, in the example the two strategies use the same strike price levels for two totally different applications. For a start, 34.50 is 50 cents OTM for a put, while it is 50 cents ITM for a call. These are not equivalent strikes. Does that make sense? What is happening here is that we are comparing an ITM debit spread with an ATM credit spread. This is why we have ended up with some odd figures, wouldn’t you agree, and why this starts to become confusing?

In effect, I was not intending to look at spreads with arbitrarily fixed strike prices, but at the overall viability of different strategies to a situation in the real market. I could also find examples where we pick two strike prices that have a radically different result to the one published, reversing the effect, but this isn’t really relevant to the points I was trying to make.

Try this approach on for size: Try selling the NAB June $36 put, and buying the June $35 put for the bull put spread. (Have a look at the diagram attached – this is the yellow lines on the chart).

Compare this with buying the $35 June call, and selling the $36 June call for the bear call spread. These have a very similar risk to reward chart (see the black lines on the attached chart). This is roughly the equivalent of the bull put spread in strikes.

The net situation is similar. Granted the charts are not significantly different. What is different is the way these play out in the market. In higher IV situation if you can sell the put in this case with a good skew, the time element is advantageous; this can be a great play to make.

Certainly if you can get a good IV skew on a bull call this is a plus too. The advantages I spelt out before though in the long run I think make the bull put a preferable play, but this is just my opinion. Sometimes another strategy looks better, and sometimes it doesn’t. But if you’re going to use bull calls, my suggestion is to also consider bull puts as an alternative (or the bearish equivalent), and be aware of the advantages and disadvantages of each.

Also, the volatility effects at these levels are quite different since one is ITM and the other is OTM relative to each spread. Also, the acceptable risk reward chart for each strategy will be based in part on price and time objective and volatility outlook.

The big plus in my view is that the sold high IV tends to reduce the possibility of the skew moving against you, where this is sometimes a problem with bull calls. A point to note here is that some people only look at the expiry graph, but don’t consider IV effects days out from the expiry which is where the action usually happens. Bu this assumes you consider this when you enter.


Hope this makes sense Margaret.


Regards,


Magdoran

 

[Magdoran]

Hello Margaret,


Respectfully, I just cannot agree with your conclusion in Post #94. Again, are you sure you are choosing equivalent strikes, not exact strikes, (since exact strikes for a put and a call are radically different). If you are talking about the configuration I posted above, then the outlay is about the same, and the risk to reward parameters at expiry is similar.

I do agree with the idea that sometimes it's worth just going for an OTM single option series, this makes a lot of sense from a risk to reward perspective. Sometimes you can combine a bull put with an OTM call which is a bit like a synthetic, but with limited risk…

But I don’t agree at all with the idea that an ITM bull put spread is necessarily going to have wide spreads, and this is certainly not true for many traders I’ve worked with during the bull market. In fact in my experience the reverse is true.

The bull calls yielded less on average, and lost more, were harder to get a good skew in, and on the way out the skew often moved adversely – not as much of a problem for bull puts… but maybe this is a freaky skew that you have the opposite experience to mine, but maybe it is based on our T/A styles and time frames.

If you have a preference for bull calls, and it works for you, great! Please, stay with what works for you. But for me, I have the opposite experience.

Anyway, I think we’re going to have to agree to disagree on this one (which is common for traders – I like chocolate and someone else loves sticky date pudding). As Wayne says “horses for courses”.


Regards


Magdoran

 

[wayneL]

What about assignment risk Mag?

 

[Magdoran]

Hi Wayne,


I did list upfront being exercised as one of the disadvantages to be aware of for credit positions - so any decision should consider all these factors to determine which way to go, shouldn't it? It’s based on your forecast view of the underlying, isn’t it?

Anyway, you can get exercised with a bull call (less likely, and easier to deal with, but a nuisance just the same).

If the risk of being exercised is too high, how hard is it to wind out the position? If you entered as suggested with sufficient time value premium, this should reduce the risk. This kind of a position is a trade off, and should be used in the right conditions just like any other strategy.

Mag