There are few absolutes when it comes to trading. Although spreads offer reduced risk and preserve buying power better than naked positions, they also reduce the probability of profit because the long option eats into the premium offered by the short option. I find that it usually only makes sense to do spreads in high IV environments.
buying stocks vs. options for short term trading
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There are few absolutes when it comes to trading. Although spreads offer reduced risk and preserve buying power better than naked positions, they also reduce the probability of profit because the long option eats into the premium offered by the short option. I find that it usually only makes sense to do spreads in high IV environments.
For me, the moderate reduction in profit potential with a vertical is worth it for the far more significant amount of risk reduction that a short put bears. Last year, many "safe" Dividend Aristocrats dropped 10-20% or more in short periods of time (CAH, TGT, GWW, KMB, HML, MDT et al). When you have a short put position and that happens, there's little you can do other than take the loss or roll down and/or out until you can't roll anymore w/o locking in a loss and then you're married to Buy & Hope. A spread gives you more ability to defend.
Kill the tail risk. I'll be the tortoise with verticals, diagonals and calenders. You can be the hare.
Kill the tail risk. I'll be the tortoise with verticals, diagonals and calenders. You can be the hare.
I read that book cover to cover already. McMillan does not recommend day trading options.
Kevin, if you box a profitable vertical and hold to expiry, does it gain value over that time frame? The original spread (assume both legs ITM) should be gaining value, but the second spread would by definition be OTM and losing value, right? Do they wash out? If so, does that make unwinding the next day as good as holding to expiry?
The book doesn't teach you to trade nor do I suspect many will. It teaches you the language of options and how they work. Other books will provide an even deeper understanding.
AFAIC, a lot of trading knowledge comes from actually trading and for many, there's a bit of market tuition cost to achieve that. No book or training course can hone your ability to react decisively in a fast market, especially one that is moving against you and you choose to defend.
I only trade options. I do not like the symmetric risk profile of equities nor the binary P/L.
With options you can make money when the stock goes up or sideways or even down slightly (as an example).
Or, if you vet stocks carefully, you can make returns of 200 - 1000% on long options - even more on lucky hits. 3-4 months out is best. I do it all the time, but it is offset by a high loss ratio. So total returns are FAR lower than 'gurus' tell you. Sure, sometimes you get a great setup and pick the right option for 10X returns, but most of those setups lose money.
Or, you buy ITM options on stocks that you think will rise soon. Then you can get 60-200% returns for a lot higher investment.
Or, you can buy OTM leaps (12 months or more out) on mega-cap steady risers after a pullback - I've done this often enough to know it works. Leaps lose premium very slowly, so if you're sure a low-vol stock will rise at least 2-3% in the next few weeks, you can often make about 50%. And if it stays where it is, you can close it for almost no loss in a month or so.
There is no point to selling covered calls. The R/R is EXACTLY the same as naked puts at same strike. A covered call is also a synthetic short put. You should do better on the naked puts because of 1) lower commissions 2) easier to close out a trade with only a single instrument 3) less slippage.
Only reason for covered calls is - Put spread is too wide at that strike, but normally that's a problem on the call side because on CC's you trade ITM, whereas the naked put is OTM.
The earlier reply wasn't clearly worded.
Short puts and covered calls are synthetically equivalent if they are of the same series. If XYZ is $48 and you wanted to sell the OTM $50 covered call, the synthetic would be the ITM short $50 put.
Conversely, if you wanted to sell the OTM $45 short put, the synthetic would be the ITM $45 covered call.
Correct. The synthetics are clear. In my view, the strategies often aren't similar. Most people selling naked puts are doing so OTM to "bottom feed" for stocks on the cheap, with the knowledge that the small profit they get when not assigned is at least money in their pocket. Most people selling covered calls are doing so OTM so as to "juice" their returns, with the knowledge they are limiting their upside on a big run. The two are not synthetic because the strikes are not equivalent.