Balancing DITM with Expiration

T

TradeCat

Question is an age old one. If you are trading short term, either intra day or no more than an overnight hold, it's best to pick DITM to mimic the underlying price penny for penny (1 gamma).

Assuming very limited capital for a small retail trader which would you pick:

1) Current/following week expiration, DITM (0.90+ gamma), low theta (0.07), high volatility (20%+)

2) 1 month out expiration, DITM (0.68+ gamma), low theta (0.05), low volatility (10%)

3) 2 months out expiration, ITM (0.50+ gamma), low theta (0.03), very low volatility (<10%)

Perfect world, you would pick a very DITM (1 gamma), 2 months out, but those options are very expensive and I want you to assume a small capital, hence a choice to balance odds for a very short term play.
 
As you said, this is an age old dilemma. Any one of the above can be appropriate, but it just depends on the stock.

The Greeks quantify very well, but in 2016, we need a new Greek. The 24 hour media/cnbc/Cramerdribble/NajarianDrabble/Media-Memes Greek. Call it Mu... M for media.

It sounds like you and I trade similarly. I can't put a finger on it, all of the above are smart.... but there's just a certain feel. An intuition as to which one is right at the time. And I can only explain that for me as Mu. (μ)

So to answer your question, they're all good, but pick the best for that day incorporating the Mu factor.
 
Expiration day options are great. Very liquid, high volatility, but if you're wrong on the direction, and have to hold your position until close, what you make in profits, is eaten away by the significant time decay. And 1 Gamma DITM aren't always liquid.
 
The other question is, if you're buying on a Monday, what is the difference in the ITM same week expiration VS. following week's expiration?
 
TradeCat said:
And 1 Gamma DITM aren't always liquid.
More...

That is the key as to why it's not a good idea. To trade DITM intraday or overnight is inviting too much slippage. That's the reality of the marketplace. You're better off trading the UL smaller size.

Theoretically, you should trade the nearest expiry with the most liquidity. Many equities and ETF options have decent weekly liquidity. But I'd imagine that some, as in the case of CL, have better monthly liquidity and virtually no weekly market.

But even the most liquid options generally don't have a decent ITM market. And the best way to close ITM is with the UL, rather than RT. Usually, you'd be at such a disadvantage trading ITM that trading the UL is a no brainer.

Of course, if you are so undercapitalized that you can't trade the UL, then options may be your only choice. I still wouldn't go with ITM, though.

BTW, you mean delta, not gamma.
 
TradeCat said:
Question is an age old one. If you are trading short term, either intra day or no more than an overnight hold, it's best to pick DITM to mimic the underlying price penny for penny (1 gamma).

Assuming very limited capital for a small retail trader which would you pick:

1) Current/following week expiration, DITM (0.90+ gamma), low theta (0.07), high volatility (20%+)

2) 1 month out expiration, DITM (0.68+ gamma), low theta (0.05), low volatility (10%)

3) 2 months out expiration, ITM (0.50+ gamma), low theta (0.03), very low volatility (<10%)

Perfect world, you would pick a very DITM (1 gamma), 2 months out, but those options are very expensive and I want you to assume a small capital, hence a choice to balance odds for a very short term play.
More...

Back test, and which ever scenario shows the smallest potential loss is your answer, IMHO.
 
I think you have gamma and delta mixed up. DITM is delta 1 not gamma... gamma diminishes further OTM/ITM. Gamma is highest ATM.

Anyway, why would you want to trade DITM delta 1 instead of underlying? The stock is way more liquid and has a better b/a-spread.

Is it because of financing/leverage? Mine is similar in margin requirements, whether I trade the stock or equivalent ITM option.
 
Yes sorry about the delta/gamma mix up. Friday's got me all screwed up.

DITM 1 delta - there's been a lot written about using these as an alternative to stock ownership. Theta is negligible for a day or two and you get more in terms of leverage/gain percentage. But they aren't that hot. Most traders like their ATM 0.50 delta options. You go a couple of strikes in and it's like a ghost town. Really disappointed that more traders don't see the advantage of high delta.
 
That's because they are mostly used for Vega/Gamma trading... and therefore traded ATM and OTM...

The high delta doesn't mean anything to professionals because they'd rather trade the more liquid underlying... which makes sense, since options are priced on the underlying and not the other way around...
 
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