Advice on Long term Option positions

[Bombul]

Dear all,

Thank you for taking the time to read my thread. I am considered a new options trader since I merely started about half a year ago. I have some basic knowledge about options i.e. the greeks, volatility etc.

I am contemplating using options as a means to track the long term movement of a stock. Buying the underlying stock with covered writes is considered a conservative strategy; unfortunately, I don't quite have sufficient capital to buy a considerable amount of stocks and options at the same time.

I would like to seek some advice on using simple long options to leverage without buying the stock. For example, I have identified a trend for a stock lasting 3-6 months, or 6 months to a year.

Questions:

1. Am I able to buy the corresponding leaps option for 1 or 2 years and hold?
2. If so, how deep in the money should I be?
3. What kind of risk/reward ratio can I expect? (I have run some numbers and I do not seem able to generate favourable ratios using the analyser)
4. Are there any particular books out there that touches specifically on long term options strategy that you guys have read which are good, particularly pertaining to long options rather than covered writes?

I have never tried naked writes since I am aware how sudden movements can even bankrupt traders with stop losses.

Please advise, thank you! If there are already similiar threads/topics, I apologise, kindly direct me with the links.

 

[brad52]

I limit losses to 1 % of capital. I give a trade room and by this I mean 50% of amount at risk and Im out. No deviation. I want to make 100% on a trade or more and expect 60% losers.

You can hold LEAPS till expiration but I wouldn't. Helpful?

 

[wouter]

One idea is to buy the LEAPS and sell monthly premium against them kind of like a covered call. But before you do that you should get educated about that strategy.

 

[spindr0]

Quote from Bombul:

1. Am I able to buy the corresponding leaps option for 1 or 2 years and hold?

YES, if the underlying had LEAPS and if they exist for both years.


2. If so, how deep in the money should I be?

It depends. Deeper ITM has less time premium and a higher delta but costs more . Less ITM has more time premium and costs less. Which one does better depends on whether the underlying goes up or down and in what time frame.


3. What kind of risk/reward ratio can I expect? (I have run some numbers and I do not seem able to generate favourable ratios using the analyser)

Kinda hard to do this since the reward side is open ended (option goes up 2 pts, 5 pts, more?)


4. Are there any particular books out there that touches specifically on long term options strategy that you guys have read which are good, particularly pertaining to long options rather than covered writes?General texts usually cover most of the common strategies. McMillan's "Options As a Strategic Investment" will do the trick.

As someone else mentioned, consider looking into diagonal spreads (sell a 1-3 month hgiher strike call against your LEAP). It will defray the time decay.

What's best really depends on how good your are at identifying stocks that will move, in what time frame and your risk tolerance.

 

[Bombul]

Thanks for all the replies, much appreciated.

In general, I am able to trade on stock trends lasting on average 6 months. I do not go out to expiration ideally, so I will close out the trade once I detect a trend change within that window of 6 months. Therefore, I buy 1 year leaps.

I am jsut afraid that even with a time of 6 months prior to expiration, the vegas/thetas would have eaten away so much of the profits that it is just plain unfavourable.

I am aware of diagonal calendar spreads using leaps and front month options, but I hope someone can share with me specifics on this i.e. how far OTM for front month?

Thanks.

 

[spindr0]

Quote from Bombul:

I am aware of diagonal calendar spreads using leaps and front month options, but I hope someone can share with me specifics on this i.e. how far OTM for front month?

Find an option modeling program (your broker, option program, web site such as the CBOE which provides "The Toolbox".) Input various combinations and pick the one with the risk/reward that suits you.

 

[TheGoonior]

Quote from Bombul:



I am aware of diagonal calendar spreads using leaps and front month options, but I hope someone can share with me specifics on this i.e. how far OTM for front month?

It all depends on how risk tolerant you are and how big of a move you expect. It might make sense to find a strong level of resistance and set your OTM just beyond that. This way if you get a move, there's a good chance it'll take a breather near the resistance (eating away at the time decay of the OTM) or even pull back. If you think the move will continue higher, you can always buy back the OTM on the pullback.
I typically like to sell 2-3 months out, rather than the front month (so you'll sell 4-6 options in a year, rather than 12) for the following reasons:
1) Gamma on the front month is typically quite high, so you can run in to the OTM delta trying to catch your LEAP delta.
2) You reduce your commissions.
3) Selling 2-3 months out gives a bit more protection and while selling fronts OTMS every month wrings the most money out, I think the added protection and reduced gamma compensate.

 

[MTE]

Quote from Bombul:

...I am jsut afraid that even with a time of 6 months prior to expiration, the vegas/thetas would have eaten away so much of the profits that it is just plain unfavourable...

If you buy an ITM Leap, say delta 0.8 or more, and get the direction right then you don't have to worry about volatility and time decay as the underlying's move will be the major factor.

 

[drcha]

Quote from MTE:

If you buy an ITM Leap, say delta 0.8 or more, and get the direction right then you don't have to worry about volatility and time decay as the underlying's move will be the major factor.

Yes, this is the gist of it. Deep in the money, vega and theta are not such big concerns. It's all price movement. You'll end up paying something in the neighborhood of 1/3 of the underlying's price for these.